Individual retirement accounts are designed as tax-advantaged savings plans. Complications can arise from the different types of contributions that fund the accounts: before- or after-tax payments. After-tax contributions, such as Roth contributions or non-deductible traditional IRA contributions, contribute to the cost basis of an IRA. Calculating and reporting the cost basis of an IRA can ultimately save money on your taxes.
When you make non-deductible IRA contributions to your traditional IRA account, this money is non-taxable when you withdraw it, unlike other deductible contributions to your traditional IRA. The non-deductible contributions must be reported on Form 8606. This recognizes the non-deductible contributions as having already been taxed. Reporting the cost basis on your traditional IRA in this case will reduce your tax bill when you distribute money from the IRA.
If you are converting a traditional IRA to a Roth IRA, you will pay taxes on the complete amount that you convert, unless you have made non-deductible contributions to your traditional IRA. By reporting the cost basis of your IRA, you can avoid paying taxes on any non-deductible contributions that you decide to convert to a Roth IRA, reducing your tax bill on the conversion.
You are required to file a Form 8606 whenever you make a non-deductible IRA contribution, and report the cost basis of your IRA account. If you do not file a Form 8608, you will be fined $50 for each year that you do not file, as of publication. The penalty may be waived if you can show a good reason why you did not file the form.
If you do not report the cost basis of your IRA contributions to your traditional IRA, reporting your non-deductible contributions, all of your contributions will be considered taxable, and your IRA will have no cost basis. This means that all of your traditional IRA distributions will be taxed when you take the money. You will have paid taxes twice at this point on your non-deductible IRA contributions.
Claiming an IRA Loss
Normally, traditional IRA account losses are not deductible on your income tax, because deductible IRA contributions have no cost basis. IRA losses must have a cost basis for a loss to be deductible. By reporting your cost basis with your non-deductible traditional IRA contributions, you may later claim part of any loss in those accounts as a miscellaneous itemized deduction if you liquidate the account.