IRA Digital Reference Manual - September 2024 - 327

Chapter 13 - Taxes & Penalties
Generally, once nondeductible contributions or rollovers of after-tax funds from a WRP
or repaid QRDs have been made to any Traditional IRA, every distribution a Traditional
IRA owner receives from any of his Traditional IRAs is prorated to consist partly of basis.
[Schmalzer v. Comm., TC Memo 1998-399; Notice 87-16, section III, D2] Thus, until the
IRA owner's entire basis has been returned, tax-free, every Traditional IRA distribution
(other
than the withdrawal of certain excess contributions, recharacterizations, or
distributions rolled over to a WRP), will be partly taxable and partly nontaxable.
Note: Generally,
the financial organization does not determine the taxable and nontaxable portions of the
distribution. The IRA owner calculates the nontaxable amount by filing Form 8606. [Notice 87-16, section III, Q&A D11;
Form 1099-R Instructions] (See Chapter 11, 2023 IRS Form 1099-R Box-by-Box Instructions)
For federal income tax withholding purposes, the financial organization treats most
amounts distributed as taxable. [Notice 87-16, Part VI] An exception exists for excess
contributions removed before the applicable deadline. (See Chapter 7, Reporting the
Withdrawal By the Applicable Deadline) The IRA owner or beneficiary calculates the true
taxable amount.
If a Traditional IRA distribution contains any return of " basis, " the individual files
Form 8606 with his Form 1040 or Form 1040A to calculate the nontaxable portion of the
distribution. [Form 8606 Instructions; Notice 87-16, section III & D2 and D3]
Essentially, the formula used to determine the nontaxable portion of his Traditional
IRA distributions (including conversions) is as follows:
Basis
Value
× Distribution = Nontaxable Portion
* Basis is defined as the total nondeductible contributions, after-tax rollovers from a
WRP, or repaid QRDs made to all Traditional IRAs of an individual, less any amounts
distributed in prior years that were attributable to basis. Also, the transfer of part or all
of a Traditional, SEP or SIMPLE IRA to a spouse incident to divorce or legal separation
can also result in a change of basis (increase or decrease).
* Value is defined as the value of all Traditional (including SEP and SIMPLE) IRAs
maintained by the Traditional IRA owner as of the last day of the calendar year in which
the distribution occurred, increased by the amount of all distributions, not including
amounts that are subsequently rolled over to a Traditional IRA unless such rollover is
an outstanding rollover (i.e., an amount that is distributed during the year but not rolled
over until after December 31 of the year of the distribution). [Notice 87-16, D1 & D2]
This information can be found on the fair-market-value statements and the Forms 1099R
provided by the Traditional IRA sponsors.
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IRA Digital Reference Manual - September 2024

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