Tracking After-Tax IRA Basis with Form 8606

Whenever you make a nondeductible contribution to a traditional IRA, you must file Form 8606 with your tax return to establish your cost basis in that account. Without this form, the IRS treats withdrawals as fully taxable, leading to double taxation: once on the contribution (when you made it with after-tax dollars) and again when you withdraw (as ordinary income).

Why Form 8606 Matters

A nondeductible IRA contribution is made with after-tax dollars—money on which you have already paid income tax. When you file Form 8606, you are telling the IRS: “This amount is my basis (cost paid) and should not be taxed again when I withdraw it.”

Without filing, the IRS has no record that you paid tax on this money. When you withdraw anything from the IRA later, the entire withdrawal is treated as taxable income. This creates double taxation: you pay tax on the contribution in year 1, then pay tax again on the withdrawal in year 5 (or whenever you take it).

Form 8606 is not optional if you have a nondeductible contribution. Filing it protects your basis and ensures only the earnings—not your original after-tax money—are taxed on withdrawal.

When You Must File Form 8606

File Form 8606 whenever you:

• Make a nondeductible contribution to a traditional IRA.
• Convert (convert a traditional IRA balance to a Roth IRA).
• Receive a distribution from any traditional, SEP, or SIMPLE IRA during the year.
• Recharacterize a contribution (roll back a Roth contribution to a traditional IRA, or vice versa).

The form accumulates over your lifetime. If you file it in year 1 and again in year 5, the IRS combines the information to calculate your total basis.

The Pro-Rata Rule and Multiple IRAs

Here is where Form 8606 becomes critical: the pro-rata rule. If you have both pretax money (from traditional IRAs or deductible contributions) and after-tax money (from nondeductible contributions) across all your IRA accounts, any withdrawal is treated as coming proportionally from both.

Example: You have:

• Traditional IRA (pretax rollover): $100,000
• Nondeductible IRA (after-tax): $10,000
• Total across all IRAs: $110,000

Your basis (after-tax portion) is $10,000 / $110,000 = 9.09%. If you withdraw $20,000, only $1,818 (9.09% of $20,000) is treated as a tax-free return of basis. The remaining $18,182 is taxable ordinary income.

This rule applies even if you withdraw from only one IRA. The pro-rata percentage is calculated across all your IRAs, regardless of which one you actually take money from. Form 8606 ensures the IRS and you agree on what portion is basis.

Reconciling Backdoor Roth Conversions

A backdoor Roth conversion uses Form 8606 to track basis:

1. Contribute $7,000 nondeductible to a traditional IRA (file Form 8606).
2. Immediately convert the $7,000 to a Roth IRA.
3. File Form 8606 again to report the conversion.

If the contribution earns $100 before you convert, the conversion is partially taxable: $100 of earnings triggers tax, but the $7,000 basis passes to the Roth tax-free. Form 8606 allocates which dollars are basis and which are earnings.

If you have other pretax IRA balances, the pro-rata rule complicates this: a portion of the conversion is forced to be pretax, increasing your tax bill. That is why backdoor conversions are only clean if you have no other IRAs.

Calculating Basis Step-by-Step

Form 8606 walks you through:

1. Line 1–2: Nondeductible contributions made this year.
2. Line 3: Total basis from prior years (carried forward from last year’s Form 8606).
3. Line 4: Combined basis through this year.
4. Line 5–7: IRA distributions received this year.
5. Line 8: Your basis fraction (basis / total IRA balance).
6. Line 9: Tax-free portion of distributions (line 8 × line 7).
7. Line 10: Taxable portion of distributions (line 7 − line 9).

The form is straightforward if you follow the lines; the IRS provides a worksheet in Publication 590-A.

Conversions and the Pro-Rata Rule

When you convert a traditional IRA to a Roth, Form 8606 tracks:

• How much of the conversion is basis (tax-free).
• How much is earnings (taxable).

If you have a $50,000 pretax IRA and convert it, even though you are moving pretax dollars, the pro-rata rule does not apply to conversions the same way. Conversions are treated as proportionally coming from basis and earnings, but you report the taxable portion on your tax return that year. After the conversion, your IRA basis declines (because you moved basis out).

Roth conversions do not themselves require Form 8606, but if you have nondeductible IRA contributions, Form 8606 must account for them to calculate the conversion’s tax impact.

What Happens If You Forget to File

If you made nondeductible contributions but failed to file Form 8606, you have options:

• File amended returns: File Form 1040-X for the years you did not report; attach Form 8606 for each amended year.
• IRS relief: The IRS can grant relief if you failed to file but did not claim the deduction. Consult a tax professional.
• Going forward: File Form 8606 for the current year and all future years to establish basis from that point.

Not filing does not erase your basis, but it makes proving basis to the IRS harder if audited. Filing protects you.

Reporting Distributions Correctly

When you take a distribution from an IRA, you receive a Form 1099-R from the custodian. The form reports the gross distribution. You use Form 8606 to calculate what portion is a tax-free return of basis. Then on your Form 1040, you report only the taxable portion as income.

If you fail to file Form 8606 and the IRS sees the 1099-R, it may treat the entire distribution as taxable, creating a tax bill for amounts that were basis.

Inherited IRA Basis

If you inherit an IRA with a basis component, the beneficiary files Form 8606 to track basis going forward. The basis does not disappear; it transfers to the beneficiary. This is critical if you inherit a nondeductible IRA from a spouse or family member.

See also