Form 8606

Form 8606 is the guardian against a tax mistake that costs money twice. It exists because the IRS applies a brutal rule: if you own any traditional or SEP or SIMPLE IRA with a mix of deductible and nondeductible contributions, every withdrawal is taxed pro rata—proportionally. You can’t cherry-pick the nondeductible part. The form calculates your basis and prevents you from reporting it as income again.

The pro-rata trap: why aggregation kills planning

Suppose you have two IRAs. One has $100,000 in deductible contributions (pre-tax money invested). The other has $50,000 in nondeductible contributions (after-tax basis). You want to withdraw the $50,000 and roll it into a Roth—a “backdoor Roth” conversion—thinking only the $50,000 is taxable. Wrong.

The pro-rata rule says: aggregate all traditional, SEP, and SIMPLE IRAs (not Roth). Your total balance is $150,000; your basis is $50,000. Your basis percentage is 33.3%. So when you withdraw or convert the $50,000, only 33.3% ($16,667) is basis; 66.7% ($33,333) is deductible-contributed (pre-tax) money and fully taxable. You owe income tax on $33,333 of the withdrawal you thought was tax-free.

This is the reason backdoor Roth conversions fail for many high-income earners: they forget to account for an old 401k they rolled into an IRA years ago. Form 8606 forces you to remember.

Part I: This year’s nondeductible contributions

When you can’t deduct a traditional IRA contribution (usually because you or a spouse have access to an employer plan and earn too much), you file Form 8606 that year to create a record. Box 1 of Part I is the amount you contributed directly (not a rollover) in the current tax year that you chose not to deduct.

This is voluntary. You can make a $7,000 contribution, deduct $4,000, and report $3,000 as nondeductible. The deductible part flows through to reduce your adjusted gross income; the nondeductible part creates basis that you report on Form 8606.

Part II: Accumulating basis across years

This is where the form gets serious. Part II takes all your prior-year nondeductible contributions and sums them—creating your cumulative nondeductible basis. The IRS and custodians have no obligation to track this for you. If you made nondeductible contributions in 2015, 2018, and 2024, you must remember and report them all on the 2024 return.

Many people lose track. They make a nondeductible contribution once, file 8606 to document it, then years later make a withdrawal and forget to claim the basis. The IRS then treats the entire withdrawal as income, and you end up paying tax on money you’ve already been taxed on. Form 8606 filed in every year with nondeductible activity prevents this disaster.

Part III: The pro-rata calculation on withdrawal

When you take a distribution from any traditional IRA, Part III forces you to calculate: “What percentage of my total IRA balance is basis?”

Example: Over 10 years, you’ve made $70,000 in nondeductible contributions (now in three separate IRA accounts worth $85,000 total). Deductible contributions and investment gains total $280,000. Your total IRA value is $365,000. Your basis percentage is $70,000 / $365,000 = 19.2%.

You now withdraw $40,000. Of that, 19.2% is tax-free basis: $40,000 × 0.192 = $7,680 is returned tax-free. The remaining $32,320 is taxable income. The form calculates this; you report the $32,320 on your return.

Part IV: Roth conversions and the pro-rata rule

This is where the rule really bites. If you convert an IRA to a Roth, the entire converted amount is taxable income in the year of conversion—except for the portion that is basis.

Backdoor Roth strategy: earn income you can’t directly contribute to a Roth because you’re over the limit. So you make a nondeductible traditional IRA contribution, immediately convert it to Roth, and pay tax only on any pre-tax money mixed in.

But the pro-rata rule doesn’t care about timing. If you have $100,000 in an old rollover IRA with deductible contributions and you make a $7,000 nondeductible contribution and convert it the next day, the IRS treats the conversion as pro-rata: only 6.5% of the $7,000 converted is basis; 93.5% is deductible-contributed and fully taxable. The strategy fails.

Part IV of 8606 calculates conversion taxability using the same pro-rata logic. The box for “total basis at end of year” tells you what portion of next year’s conversions will also be pro-rata.

Roth conversions and “first-time homebuyer” relief (SECURE Act 2.0)

Starting in 2024, you can roll back up to $35,000 (lifetime) from a Roth to a traditional IRA if you’re a first-time homebuyer and the Roth was opened within the last three years. Form 8606 Part IV has a box for this. If you satisfy the rules, the rollback is not subject to pro-rata calculation—it’s as if the conversion never happened for tax purposes. But you must file Form 8606 to claim the relief.

Common filing mistakes and penalties

Failing to file 8606 when you have nondeductible contributions: You report a $40,000 IRA withdrawal on your return without filing 8606. The IRS doesn’t know you have $15,000 in basis. They treat the entire $40,000 as income. You’ve under-reported income. When they discover the error (often through a custodian’s reported FMV on Form 5498), they assess a 6% penalty on the underreported amount each year, plus interest.

Using stale basis numbers: You file 8606 in 2015 and report $20,000 cumulative basis. In 2024, you file again and forget that you made a $5,000 nondeductible contribution in 2022 and 2023—you don’t update your basis total. You underreport; the IRS catches it and assesses penalties.

Mixing SEP and SIMPLE IRAs in the pro-rata calculation: SEP-IRA contributions (by an employer on your behalf) are deductible contributions, not basis. But they’re still subject to pro-rata if you have a traditional IRA with nondeductible money. The form requires you to include the value of all traditional, SEP, and SIMPLE IRAs on line 7 of Part III.

What happens if you don’t file it

If you withdraw from an IRA and you have nondeductible basis but don’t file 8606, the IRS will treat the entire withdrawal as income. You may discover this years later when you get a notice. You can file an amended return and claim the basis retroactively, but you’ll owe interest from the original due date. Filing 8606 creates a contemporaneous record that’s far harder for the IRS to challenge.

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