Dear Dr. Don,

What is the basis of a nondeductible IRA?

— Framroze Foundation

Dear Framroze,

I’m not a tax historian, but my general sense is that the government wanted every taxpayer to have the ability to contribute to an IRA, but didn’t want everyone to be able to get a tax deduction on the contributions. According to IRS rules, investment earnings on the nondeductible contributions grow tax-deferred, which is one benefit of funding an IRA with nondeductible contributions.

There are limitations on whether a taxpayer can make tax-deductible contributions to a traditional IRA account, but taxpayers can make nondeductible contributions up to the contribution limits for that account. IRS Publication 17, “Your Federal Income Tax (2009)“:

Nondeductible Contributions

Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA up to the general limit or, if it applies, the spousal IRA limit. The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible contribution.

Make sure to report nondeductible contributions on IRS Form 8086.

Taxpayers can make nondeductible contributions to a traditional IRA account and then convert the traditional IRA to a Roth IRA. IRS Publication 17, “Your Federal Income Tax,” presents this change:

A 2010 rule change means the modified AGI and filing status requirements for converting a traditional IRA to a Roth IRA are eliminated. Also, for any 2010 rollover from an IRA other than a Roth IRA to a Roth IRA, any amounts that would be included as income will be included in income in equal amounts in 2011 and 2012. You can choose to include the entire amount in income in 2010.

Work with your tax professional if you’re uncertain about whether it makes sense for you to make nondeductible contributions to an IRA account.

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