Children Non-Deductible Traditional IRA Contributions

[jeffreyeng]

Hi,

Do children (who are under the threshold of income required to file tax returns) need to file tax returns if they recieved non-deductible traditional IRA contributions?

[TaxGuyBill]

Did they "receive" or did they "make" IRA contributions?

Non-deductible Traditional IRA?  Are you sure they did not make a Roth contribution?  I think a Traditional IRA is automatically deductible unless you make an election to treat it as non-deductible (and I don't know why they would do that rather than make a Roth contribution).

[jeffreyeng]

The child recieved IRA contributions from her father. From my understanding, any non-deductible Traditional IRA contributions made would allow future distributions from the non-deductible contributions to be non-taxable.

Would the child still need to file tax return (specifically Form 8606) to report the non-deductible Traditional IRA contributions even if they are not required to file tax return for the year?

[TaxGuyBill]

A person can not "receive" an IRA contribution.  What EXACTLY happened?  Are you saying the father put in own money into an IRA account that had the child's name?  If so, it is treated as if the child "made" the contribution (he didn't "receive" it).

Did the have enough "taxable compensation" (such as W-2 wages or self employment profit) that he was allowed to make the IRA contribution?

[jeffreyeng]

Correct, her father put his own money into an IRA account under the child's name and yes, she had taxable compensation in excess of her contribution amount.

[TaxGuyBill]

In order for it to be treated as nondeductible (with Basis), a 8606 would need to be filed (it can be filed separately from the actual tax return).

However, it would make much more sense to have them "recharacterize" the contributions (which would mean they are a Roth contribution).  A Roth makes SO much more sense than a nondeductible Traditional.

[jeffreyeng]

Hi,

When you "re-characterize" the contribution are there any tax forms or steps that need to be followed?

[TaxGuyBill · Accepted solution]

Not for the tax preparer.  The taxpayer just needs to ask the IRA custodian to "recharacterize" the contributions (it is possible the IRA custodian will have some forms for them to verify that is what they want).

[sjrcpa]

"From my understanding, any non-deductible Traditional IRA contributions made would allow future distributions from the non-deductible contributions to be non-taxable."

That is incorrect for a nondeductible IRA.

It is correct for a ROTH IRA.

[jeffreyeng]

Ok, thanks.

[jeffreyeng]

Hi,

The TurboTx article here says otherwise though. It says that:

"Any money you contribute to a traditional IRA that you do not deduct on your tax return is a “nondeductible contribution.” You still must report these contributions on your return, and you use Form 8606 to do so.

Reporting them saves you money down the road. That’s because no individual’s money is supposed to be subject to federal income tax twice. Form 8606 gets it “on the record” that a portion of the money in your IRA has already been taxed. Later on, when you take distributions, a portion of the money you get back will not be subject to income tax."

https://turbotax.intuit.com/tax-tips/investments-and-taxes/what-is-irs-form-8606-nondeductible-iras/...

[TaxGuyBill]

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@jeffreyeng wrote:

Later on, when you take distributions, a portion of the money you get back will not be subject to income tax."

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"A portion of the money".  The original contribution will effectively be tax-free, but any earnings will be taxable.  Contrast that with a qualified Roth distribution (such as after retirement) that would be completely tax-free.

[IRonMaN]

"Later on, when you take distributions, a portion of the money you get back will not be subject to income tax"

The devil is always in the details.  Sometimes folks read what they want to see rather than what is really written.

[jeffreyeng]

Agreed, thanks.

[qbteachmt]

"would allow future distributions from the non-deductible contributions to be non-taxable."

It creates a pro rata relationship. The "portion" rule is a Roth IRA rule, but it's more specifically stated as a Pro Rata rule for a Trad IRA.

Roth IRA allows you to contribute an amount (always after tax) and later you can remove the specific and exact amount or portion that was this basis contribution. It has ordering rules. It also has various 5-year rules.

Trad IRA has one big pot. That means any distribution later would result in a % computation, so that the % of basis (post-tax money) is used against the entire account value, then that % is applied to the distribution, and that results in the non-basis amount is taxable. That is why and how it avoids double-taxation.

There really isn't much impact when the parents fund the child's IRA. It's like asking if the child can sell stuffed animals to fund their IRA, and as long as they additionally have qualifying earned income, the money going into the IRA is just money.

I agree with everyone else: it should be Roth IRA, since there is no intent or need to benefit from a deduction.