Tax calc for IRA distribution

Financial Planning Tax Strategies
1

In 2020 we took some distributions from my Traditional IRAs, this was the first time distributions were taken. I’m 63 so no RMD’s are required yet. The IRA’s have mostly pretax contributions but also a small amount of nondeductible/post tax contributions. We took more distributions in 2021. We are retired and have not made any new contributions to these IRAs for 3 or 4 years.

For the 2020 tax return our tax preparer filled out IRS Form 8606 and calculated the non taxable portion of the distributions by dividing the nondeductible tax contributions (“basis”) by the total value of my IRAs as of 12/31/2020. This resulted in about 3% of the 2020 distributions being “non taxable” (so 97% of the distributions were taxable). I believe this was correct.

For the 2021 tax return they used a different method to calculate the non taxable portion of the 2021 distributions. Here they divided the nondeductible contributions (“basis”) by the 2021 distributions (instead of dividing by the IRA account values as of 12/31/2021)and determined the non taxable portion of the 2021 distributions to be 62% (so only 38% of the distributions are taxable). I’m happy since the taxes are lower but I think the calculation method they used for 2021 is incorrect.

Is the 2021 calculation correct or incorrect?

Summary (sample amounts):

2020 $7,850 / 242,600 = 3.2% non taxable ( so 96.8% taxable x $12,330 =$11,935 taxable).

2021 $7,500 / $12,000 = 62.5% non taxable (so 37.5% taxable x $12,000 = $4,500 taxable).

Thank you,

2

Is the 2021 calculation correct or incorrect?

It’s incorrect. The correct calculation would be to figure the remaining basis and then divide it by the IRA balance on 12/31/21

In your example, the basis that you withdrew in 2020 was $395 ($12,330 - $11,935) so the basis remaining is $7,455 ($7,850 - $395) So divide $7,455 by the 12/31/21 balance of the IRA to get the percentage that had already been taxed on withdrawal. Let’s say the IRA balance was $250,000 so the percentage already taxed would be 2.982%

2.982% x $7,500 = $224 of the $7,500 distribution that was already taxed. So the taxable amount of the distribution would be $7,500 - $224 = $7,276 or 97.01% taxable.

AJ

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