The tax code is complex. It’s easy to forget or overlook the steps and actions related to taxes, but the opportunity hasn’t been lost forever if you ignored some tax deductions. You can still claim deductions for the annual contributions you made to your traditional individual retirement account (IRA) in previous years.
Deductible Contributions to an IRA
You have two options when it comes to IRA accounts. Your contributions can be either tax-deductible or non-deductible.
Non-Deductible Contributions to an IRA
You can also make non-deductible contributions to a traditional IRA. These contributions do not reduce your taxable income, but they will grow tax-free until you retire. The contributions for which you did not claim a deduction will come back to you tax-free when you start withdrawing money.
Roth IRA Accounts vs. Non-Deductible IRA Accounts
Many people prefer to contribute to Roth IRA accounts rather than make non-deductible contributions to traditional IRA accounts. Contributions are not tax-deductible with a Roth IRA, and they also grow tax-free until you retire. Withdrawals are entirely tax-free, including any interest and growth, when you start taking money from a Roth IRA, as long as you meet all the requirements.
The Decision You Need to Make
You need to decide how you want your IRA to be taxed if you forgot to claim the deduction in previous years. You can claim the tax deduction now and receive some money back as an additional tax refund, which will then be taxed later when you retire and withdraw the funds. Or you can forget about the tax deduction now and take the money tax-free later.
What if You Do Nothing?
The IRS will treat your contributions as deductible if you do not make a decision. The money will be taxed when you withdraw it during retirement as it was deductible when you contributed it. You can avoid that by taking an extra step.
If You Want to Deduct Now
File amended tax returns for any years still open for amendment according to the statute of limitations defined by the IRS. This period is usually three years from the date you filed the return or two years from the date of your last payment on the return, whichever is later.
Claim the tax contributions for the IRA contributions on your amended returns. You may receive some additional tax refunds for each of those years. You can submit your amended returns before the tax deadline for the current year; otherwise, the tax refund may exceed the statute of limitations. In that case, the IRS will not send you a check.
If You Want Tax-Free Withdrawals
File IRS Form 8606 to declare your IRA contributions as non-deductible if you want tax-free withdrawals. You must submit Form 8606 for each year you contributed to the traditional IRA but forgot to take the deduction.
Then direct your investment broker to convert your traditional IRA to a Roth IRA. The conversion may be partially taxable or completely tax-free, depending on how much your initial investments have grown.
Converting to a Roth IRA
Follow the same procedure if you contributed three years ago. Submit Form 8606 for each year.
You cannot receive additional refunds from the IRS for tax returns over three years old, so you will not receive any tax benefit for claiming deductions for those IRA contributions at this stage. Just submit Form 8606 to confirm that these contributions are non-deductible so that you are free to convert the funds to a Roth IRA.
Do
Does filing Form 8606 expose me to audit risks?
“Although Form 8606 is typically filed with the timely submitted Form 1040, the IRS will accept late-filed Form 8606, even if it is submitted after the regular three-year statute of limitations for claiming a refund,” said Jesse Wheeler, an IRS spokesperson. “Form 8606 can be filed without Form 1040 if there is no need for it. If the form is filed alone, it must be signed on page 2 directly under the certification, the written declaration that verifies that the return, statement, or other document is prepared under penalties of perjury.”
This will be appropriate for taxpayers who made non-deductible traditional IRA contributions. Filing the form establishes your basis in the IRA, which will help prove that income tax should not be paid on those contributions when the funds are withdrawn.
At the very least, taxpayers who fail to file or forget to file Form 8606 should expect to receive an inquiry from the IRS, asking them to explain and verify their non-deductible contributions. Avoiding such an inquiry or audit is a good reason to file the form.
A $50 penalty may be imposed under the provisions of Section 6693 (b) (2) of the Internal Revenue Code for failing to file Form 8606 unless the failure was due to reasonable cause.
Frequently Asked Questions (FAQs)
Do I need to report non-deductible contributions to my IRA on my tax return?
In most cases, yes. Use Form 8606 to report all non-deductible contributions to your IRA so you and the IRS can track the portion of your account that has already been taxed.
Can I contribute to my IRA for the previous tax year?
The IRS allows contributions to the specific tax year IRA to extend beyond the end of the calendar year. Its website states that you can make contributions for 2022 to your IRA until April 18, 2023.
What happens if I claim an IRA contribution higher than what I actually made?
You can use Form 8606 to correct this type of mistake as well. There is a $100 penalty for excessive non-deductible amounts unless you can show reasonable cause.
Source: https://www.thebalancemoney.com/forgot-to-claim-ira-deduction-3973979
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