QUESTION:
I made several after-tax contributions to my solo 401k this year. Do I need to file Form 8606 to report these contributions or will you guys file this form for me?
ANSWER:
Good question and the answer is no Form 8606 does apply to solo 401k voluntary after-tax contributions. This form only applies to IRAs not defined contribution plans such as a 401k plan. When after-tax funds are contributed to an IRA, they must be reported on IRS Form 8606, Nondeductible IRAs. By reporting such amounts on Form 8606, the IRS knows certain funds in the IRA have already been taxed, which prevents them from being taxed a second time when they are later distributed. On the other hand, voluntary after-tax contributions to solo 401k plans are not reported on any tax return; however, once they are converted to a Roth solo 401k designated account or a Roth IRA, they are indirectly reported on Form 1099-R but the basis is not taxable, just the earnings.
After-tax funds can be added to an IRA in one of two ways; either via nondeductible IRA contributions or via rollovers of after-tax retirement funds that were previously held in an employer plan, such as a 401(k). Once inside an IRA, after-tax funds can generally only be withdrawn under the pro-rata rule, where each dollar withdrawn is partially taxable and partially tax free, based on the percentage of after-tax money in the account. This pro-rata calculation is also done on Form 8606. The pro-rata rule applies separately to owned IRA accounts and inherited IRA accounts.
If IRA account holders deposit after-tax money to their IRA during the year, they must file Form 8606 to report those additions. Filing the form is not optional, but even if it was, it would be in a client’s best interest to do so anyway. There is actually a $50 penalty for failing to file Form 8606 when required (though in reality, it’s almost unheard of for IRS to enforce it).
