After-tax IRA Example
Rev. 08/05/04, E-mail Alert 2004-16

In our example an IRA owner has traditional IRAs located at three different institutions:

The IRS Form 8606 requires tracking of Basis by the IRA owner based on the total of all IRAs.*

IRS Form 8606 enables the tracking of IRA basis for the total of all owner's IRAs. Once after-tax basis is in an IRA, Form 8606 is to be completed until all the IRAs are closed. The form enables the IRA owner to determine the increases in basis as contributions of after tax are made to an IRA and once distributions begin, the amount of basis included as part for each distribution.

For example, if the IRA Holder takes a distribution of $5,000 from any of the above IRAs, the basis is calculated using the Form 8606 by dividing the total of the basis in all the IRAs ($12,000) by the total balance of all the IRAs ($46,000) and then multiplying that ratio by the total distribution for the year ( $5,000): $12,000/$46,000 x $5,000 = $1,304.35.

IRS form 8606 completes the steps in tracking the basis by subtracting the distributed basis of $1,304.35 from the total basis of $12,000 to arrive at the new basis of $10,695.65.

Why does the tracking of the after-tax basis need to be done by the IRA owner?
In his example, the institution that distributed the funds would have no knowledge of the correct total basis amount to begin the calculation and thus will not be able to adjust the basis appropriately when the $5,000 is withdrawn. In addition, the two other institutions that were not involved with the distribution would generally have no knowledge that there was any change in the basis. Finally, the IRA owner usually doesn’t even know about this calculation until they file the Form 8606 with their Form 1040 for the year of the withdrawal and of course there is no requirement for the IRA owner to inform any institution of other IRAs with basis or that the basis has changed.

Since none of the institutions would know of each other, at this point, all three institutions would have incorrect tracking of the basis. An institution could attempt to track the non-deductible amount, though it would require a disclaimer indicating that the IRA owner would have to inform the institution, each year in which there was a change in the basis. As this is not practicable, almost all IRA trustees/custodians/issuers do not track the IRA basis.

Attached are an IRS Form 8606 and the Form 8606 Instructions.

Bill Grossman, QPA