March 28, 2018

Establishing Tax Basis in IRA Contributions

Houston Tax Attorney Blog

Houston Tax Attorney

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Contributions to IRAs are deductible.  If not deductible, the taxpayer has basis in his IRA so that this amount is not taxable when taken out of the IRA.  The idea is that the taxpayer probably paid income taxes on the money prior to putting it into the IRA and should not be taxed on it again when the money is taken out.  So how does a taxpayer establish the amount that was put into the IRA–especially when the contributions may have been made one or more decades in the past?  The court recently addressed this in Shank v. Commissioner, T.C. Memo. 2018-33.

Facts & Procedural History

The facts and procedural history in the case are as follows: The taxpayer established an IRA in 1990.  The taxpayer was not able to deduct the contributions as his high earnings limited the deduction.  The taxpayer transferred the IRA to two other custodians during the course of the next twenty years.  In 2014, the taxpayer withdrew the IRA funds.

The custodian that held the funds at the time of the distribution issued the taxpayer a Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.   The Form 1099-R reported the value of the account as a normal distribution and noted that the taxable amount was not determined.

The taxpayer did not report the distribution on his personal income tax return.  The IRS’s computer matching system noted the omission and, eventually, the taxpayer was issued a notice of deficiency.  Litigation ensued.

No Record of IRA Contributions

Tax basis for IRA contributions is usually established by providing the IRS with copies of the custodian’s records and the Forms 8606, Nondeductible IRAs, filed with the taxpayer’s income tax returns.  With the exception of one monthly statement issued by the custodian for one month, he taxpayer did not have these records in this case.

The IRS was not able to locate copies of the tax returns that were filed, so it could not determine the amount of the contributions that were not deducted in the past.

The IRS was able to locate summaries of the Forms 5498, Individual Retirement Arrangement Contribution Information.  These forms showed the account value at the end of each year.

The IRS concluded that this evidence was not sufficient to establish that the IRA distribution consisted on contributions that had not previously been deducted.  The court agreed, in part.

The Court Accepts Testimony and Other Evidence

The court considered the taxpayer’s testimony that he was a high earner in the years in which the contributions would have been made.  The court accepted this testimony to conclude that any amounts contributed during these years were not deducted and, as such, the taxpayer did not have to pay income tax on this amount with the distribution in 2014.

The court relied on the Forms 5498 to conclude that no contributions were subsequently made.  Given this information, the court concluded that the balance of the IRA account at the time of the distribution represented earnings on the nondeductible contributions.  These earnings had not yet been taxed, so the court concluded that they were subject to tax at the time of the distribution.

Using an Affidavit and the IRS’s Transcripts

While not conclusive, this case suggests that an affidavit from the taxpayer and the IRS’s transcript information may be used to report less than the full amount of an IRA distribution when the taxpayer is not able to establish his tax basis in the IRA.  This may provide some comfort to taxpayers (and their tax preparers) who struggle with determining how to report non-taxable IRA distributions.

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