How Do I Reclassify a Deductible IRA Contribution to Non Deductible?

[JonBoy69]

Last year My wife deposited the maximum amount into her IRA. She also has a 401K. I made a little too much last year for her to qualify for the IRA deduction (over $120, 000.00 income). I work on commission. My taxes aren't due until Oct 15. When she made those deposits she classified them as deductible. Also, she withdrew $1000.00 last year early on in the year. Can she use that $1000.00 against her non-deductable deposits? She is over 60

When last years deposits become non deductible as a result of the higher income, how does she reclassify them? Because when she pulls money out she will get a 1099 and we dont want that to be taxable. Also, we would like to move the non-deductible portion over to my personal IRA for 2021 (I dont have a 401K). Is there a form that needs to filed now? I hope there isn't a penalty

[Critter-3]

In the IRA entry section you should be told that the contribution is non-deductible so you can choose to leave the contribution in the IRA and consider it a nondeductible contribution. Doing this will populate a form 8606 which you need to save a copy of it with your IRA information for use in the future when you start taking distributions.

[JonBoy69]

But wouldn't I need to file that form with my 2020 taxes, or does it get filed when I make a withdrawal?

I did withdraw a small portion of the non deductible contribution in 2020, how is that reconciled?

Could I just reclassify the 2020 non-deductible contribution as a 2021 deductible contribution?

So confused

[macuser_22]

Your question is not clear.    Are you not filling a joint return?    What do you mean your taxes are  not due until Oct 15?       How did she say it was deductible if she has not filed yet.

[JonBoy69]

Sorry, Yes we file joint. I have an extension to Oct 15/

I work on commission so its looking like I will be close to or over the $125,000 income limit to take the IRA deduction. Its my wife IRA but she also has a 401K at work so the income cap on the IRA is $125,000.00

This year I may be more under the $125,000 limit. So it may be better to just move the non deductible money in 2020 to a 2021 contribution. Not sure how to do this. She could just withdraw it and immediately deposit it back for this year. Also, how does she reconcile it on the form with IRS.

Also, she withdrew $1100.00 last year. Can she avoid paying taxes on the $1100.00 since she has money that should be reclassified as non deductible?

[macuser_22]

Then after you enter all your income enter her IRA contribution last.  TurboTax will tell you if the deduction is not allowed and it would be non-deductible.

Being non-deducible gives her  "basis" on the IRA so it will  not be taxed when finally withdrawn but that is on a pro-rated basis with the total IRA value.

She has the option to have the contribution returned as " A return of contribution" before the extended due date with any earnings that attributed to the contribution that the IRS custodial should    compute.  Only the earnings would be taxable.

[JonBoy69]

"She has the option to have the contribution returned as " A return of contribution" before the extended due date with any earnings that attributed to the contribution that the IRS custodial should    compute.  Only the earnings would be taxable" 

Its in her IRA at Bank of America. So if she does this, she would just initiate a transfer to her checking account and then she is free to redeposit it back into the same IRA as a 2021 contribution I assume. If the does this does she still have to declare it on the 2020 return as a non-deductible contribution? If BOA can return it as a return of contribution wouldn't they need to reissue the 2020 1099? 

[macuser_22]

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@JonBoy69 wrote:

"She has the option to have the contribution returned as " A return of contribution" before the extended due date with any earnings that attributed to the contribution that the IRS custodial should    compute.  Only the earnings would be taxable" 

Its in her IRA at Bank of America. So if she does this, she would just initiate a transfer to her checking account and then she is free to redeposit it back into the same IRA as a 2021 contribution I assume. If the does this does she still have to declare it on the 2020 return as a non-deductible contribution? If BOA can return it as a return of contribution wouldn't they need to reissue the 2020 1099? 

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There is not 1099-R for a contribution.  1099-R's are only for distributions.

If she gets a "return of contribution in 2021 for the 2020 contribution  then it will be issued on a 2021 1099-R that you will receive in 2022 with a code P in box 7.  That will need to be reported on an amended 2020 tax return since the earnings reported in box 2a are taxable in 2020.  (It"s a PITA but that is how the tax law works.)

[JonBoy69]

So to avoid the amended return, isn't it easier to just fie form 8606 with the 2020 return and list the funds as non deductible. Then make the withdrawal in 2021 and re-deposit in the IRA for 2021 as deductible? Seems like less paperwork and avoids the amended return. 

[macuser_22]

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@JonBoy69 wrote:

So to avoid the amended return, isn't it easier to just fie form 8606 with the 2020 return and list the funds as non deductible. Then make the withdrawal in 2021 and re-deposit in the IRA for 2021 as deductible? Seems like less paperwork and avoids the amended return. 

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It does not quite work that way if this is an existing Traditional that has other funds.   If you make is non-deductible the n the IRA will have a basis.  If she withdraws it then it will be party or mostly taxable and also have an additional early distribution 10% penalty if she is under age 59 1/2.

You can NEVER withdraw ONLY the nondeductible part - it must be prorated over the entire value of ALL Traditional IRA accounts which include SEP and SIMPLE IRA's. (For tax purposes you only have ONE Traditional IRA which can be split between as many different accounts as you want, but for tax purposes they are all added together).

For example using rough figures: if you had $60K of nondeductible contributions in an IRA with a total value of $600K (10:1 ratio), then when you take a $60K distribution from any IRA account $6,000 would be nontaxable and $54,000 would be taxable (same 10:1 ratio) , with the remaining $54K of basis staying in the IRA for future distributions. As long as there is any money in the IRA, there will be some basis.

TurboTax will ask for your non-deductible "basis" and then the *Total Value* of *all* Traditional IRA, SEP and SIMPLE accounts as of Dec 31, of the tax year. That is so the prorating of the basis can be properly proportioned between the current years distribution and the remaining IRA value. That is done on the 8606 form.

[JonBoy69]

Oh I understand. Thats terrible lol. Well thankfully its only about $5000.00 that is non deductible. What if she takes withdrawals in the same tax year as she made the non-deductible contribution? would that still have to calculated on a "basis" level?

One other question, is the balance in her 401K also calculated in the "basis" for future withdrawals from the IRA?

Last questions I promise 🙂

[macuser_22 · Accepted solution]

As I said above, she had until the extended due date to take a "return of contribution" distribution that is not taxable except for any earnings.

A 401(k) has nothing to do with her IRA.

[JonBoy69]

Regarding the return of contribution: Would she need to contact the bank to do that or just do the withdrawal herself like a normal withdrawal?

Would she still file form 8606 for 2020 indicating the non deductible contribution?

Why does she need to amend the 2020 return? If its non deductible nothing is changing. Wouldn't she just report the Return on her 2021 return next year?

There is no earnings in the IRA as its in a money market type account. Less than one dollar per year in earnings

[Critter-3 · Accepted solution]

An excess contribution MUST  be withdrawn as an excess contribution ... do NOT make an ordinary withdrawal.  Talk to the IRA custodian to get the correct paperwork filled in. 

[JonBoy69]

Got it. Would the 8606 need to be filed with the 2020 return or next year with the 2021? I assume the 8606 would need to report the excess in one of the years.