Non deductible IRA contributions

[DWard23]

I have 2 Traditional IRAs.  I have taken distributions from the 1st in tax year 2020, but not the 2nd.  In the 2nd IRA I have made a total of $12,000 of non-deductible contributions over the years and tracked them on the 8606.  In using Turbotax it asked if I made or tracked any non-deductible contributions.  I answered yes and put in the $12,000.  The program then subtracted the $12,000 from IRA #1 even though the non-deductibles applied to IRA #2.  Should I just not enter the $12,000 this year or does the IRS treat all IRAs as one and wants me to "use up" my tax free distribution as soon as possible.  Thank you.

[AnnetteB6]

The situation you described does not sound exactly correct for Traditional IRA distributions with non-deductible contributions.  

You should enter the non-deductible contributions that you have made to the Traditional IRA #2 even though your distribution was from Traditional IRA #1.  However, you should go back through your entries very carefully to be sure that you have not indicated anywhere that the distribution was from a Roth IRA instead.  

When you take a distribution from a Traditional IRA (even if there are multiple accounts), all non-deductible contributions are taken into account so that a portion of each distribution is attributed to non-deductible and deductible contributions.  When you have both types of contributions in a Traditional IRA, there would never be a distribution that is 100% taxable or 100% not taxable.  This means that the entire non-deductible contribution would not simply be subtracted from your distribution.

The situation is a bit different when taking a distribution from a Roth IRA when taking an early distribution.  The contributions made to the account (the basis) are considered to be taken out first.  So, in that case, if the distribution was less than the total basis in the account, then none of the distribution would be taxable.  

[Hal_Al]

Q. Should I just not enter the $12,000 this year?

A. No.  You must enter that.

Q. Does the IRS treat all IRAs as one?

A. Yes.  All traditional IRAs. including any rollover IRAs.  But not Roth IRAs.

Q,  Do I have  to "use up" my tax free distribution as soon as possible?

A. No. But you must prorate the after tax (non deductible)  portion of the withdrawal. 

It's best explained by example. Let's say you have a $6,000 balance in all your existing traditional IRAs on 12-31-20 and earlier in 2020 you withdrew $4000. The $10,000 (6000 + 4000), that was in your IRAs, consisted of $3,000 in non-deductible (after tax) contributions, $2000 in deductible contributions and $5,000 in earnings (interest, dividends & capital gains). Your basis, in all your IRAs, is $3,000. Only 30% of the $4000 withdrawal ($1200) is tax free. TurboTax will divide that $3,000 basis by the $10,000 balance (the $4000 you withdrew plus the $6000 year end balance) to arrive at the 30% tax free ratio.  $2,800 of the withdrawal was taxable. Your revised basis, after that withdrawal, is $1800 (3000-1200).

[DWard23]

Thank you Annette for your quick response.  None of these have ever been Roth IRAs.  You said, "the entire non-deductible contribution would not simply be subtracted from your distribution."  Does that mean Turbotax will keep track from year to year how much of my non-deductible contribution is left?  Also, on the next Turbotax question it asked to list the total value of all IRAs as of 31 Dec 2020.  When I entered that amount, almost the entire savings was wiped out.  Is there a max income where I no longer get the advantage of making a non-deductible contribution? Thank you

[DWard23]

Thank you for your direct answers.  I understood your example but to put it in real terms, I took a $48000 distribution from IRA #1 and zero from IRA #2.  I entered my $12,000 basis and saw my tax due drop.  On the next screen I entered, as requested, the total value of my IRAs as of 31 Dec 2020.  That amount is $1,159,370.  The tax savings for this year almost completely disappeared.  Considering all these numbers,  did the program just prorate the percentage of non-deductible contributions used and keep track of them for all years to come?  Thank you.

[dmertz]

Your basis in nondeductible contributions applies to your traditional IRAs in aggregate, not to any particular one of your traditional IRA accounts.  The tax code requires that all of the traditional IRAs that you own be treated together as if they were one large single IRA, so the TurboTax's calculations on Form 8606 combining your two IRA accounts is correct.