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** **When you take withdrawals from your traditional IRA, you probably understand they are “taxable.” But what does “taxable” really mean? Good question. Here are the answers.

**Step 1: Figure out how many traditional IRAs you have**

If you have several traditional IRAs, you must add them together and treat them as one account to determine the federal income tax consequences of taking withdrawals from any of them.

Don’t forget to count any rollover IRAs set up to receive distributions from former employers’ retirement plans.

Also count any SEP-IRA or SIMPLE-IRA set up in your name.

These types of accounts are all treated as traditional IRAs for purposes of determining the tax consequences of withdrawals from any one of them.

Finally, if your spouse owns one or more traditional IRAs, they don’t affect how withdrawals from your traditional IRAs are taxed. Your spouse’s IRAs stand on their own.

**If you only have one traditional IRA**

In this scenario, there are only two possibilities: (1) you’ve not made any nondeductible contributions to your traditional IRA or (2) you have.

*No nondeductible contributions*

In this case, all withdrawals are 100% taxable, and you must include them on lines 4a and 4b of your Form 1040 for the year you take them. If you take any before age 59½, they will be hit with a 10% early withdrawal penalty tax unless an exception applies. For the list of exceptions, see this previous Tax Guy column.

*Some nondeductible contributions*

Nondeductible IRA contributions create tax basis in your accounts. Then each withdrawal from any of your traditional IRAs will include some amount of basis. That amount is tax-free. The remainder is taxable. Taxable amounts are handled in the manner explained in the preceding paragraph.

To calculate tax-free basis amounts and taxable amounts, you create a fraction. The numerator equals your cumulative nondeductible contributions as of the end of the year. The denominator equals your IRA balance on that date plus all withdrawals taken during the year. Then multiply your withdrawals by the fraction. The result is the amount of tax-free withdrawals of basis. The rest of your withdrawals are taxable.

**Example:** As of 12/31/21, you’ve $12,000 in nondeductible contributions to your one traditional IRA. During 2021, you withdraw $20,000. On 12/31/21, the account is worth $60,000. Your fraction is .15: $12,000/($60,000 + $20,000). Now multiply your withdrawals by the fraction. The result is $3,000 ($20,000 x .15). The $3,000 is the amount of tax-free basis included in your 2021 withdrawals. The remaining $17,000 ($20,000 – $17,000) is taxable in 2021. Enter $20,000 (total withdrawals) on line 4a of Form 1040, and enter $17,000 (taxable withdrawals) on line 4b.

If you owe the 10% penalty tax, fill out Form 5329, *Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Plans*, and enter the penalty on the appropriate line of Form 1040.

**If you have several traditional IRAs**

Once again, there are two possibilities: (1) you’ve not made any nondeductible contributions or (2) you have.

*No nondeductible contributions*

Regardless of how many traditional IRAs you have, all withdrawals from any of them are 100% taxable, and you must include them on lines 4a and 4b of Form 1040. If you take any withdrawals before age 59½, they will be hit with a 10% penalty tax unless an exception applies.

*Some nondeductible contributions*

To calculate tax-free basis amounts and taxable amounts, you create a fraction. The numerator equals your cumulative nondeductible contributions to all your IRAs as of the end of the year. The denominator equals the combined balances of all your IRAs on that date plus all withdrawals taken during the year. Then multiply your withdrawals by the fraction. The result is the amount of tax-free withdrawals of basis. The rest of your withdrawals are taxable.

**Example:** As of 12/31/21, you’ve made $18,000 in nondeductible contributions to your two traditional IRAs. You also have a rollover IRA that was funded with a distribution from your former employer’s 401(k). During 2021, you withdraw $28,000. It doesn’t matter which account (or accounts) the money came from. On 12/31/21, the three accounts are worth $272,000. Your fraction is .06: $18,000/($272,000 + $28,000). Now multiply your withdrawals by that fraction. The result is $1,680 ($28,000 x .06). The $1,680 is the amount of tax-free basis included in your 2021 withdrawals. The remaining $26,320 ($28,000 – $1,680) is taxable in 2021. Enter $28,000 (total withdrawals) on line 4a of Form 1040, and enter $26,320 (taxable withdrawals) on line 4b.

If you owe the 10% penalty tax, fill out Form 5329 and enter the penalty on the appropriate line of Form 1040.

###### The **IRS knows what happens**

Early next year, you will receive a Form 1099-R from your IRA trustee or custodian if you take any IRA withdrawals this year. The Form 1099-R will show the total amount of withdrawals, and this is the amount that you must report on line 4a of your 2021 Form 1040 when the return is filed next year. If you don’t report the withdrawal(s), the IRS will be on your case, because a copy of any Form 1099-R gets sent to them. While the IRS audits a pitifully small percentage of tax returns, failing to include income reported on a Form 1099 will almost certainly get you busted.

**The bottom line**

As you can see, the tax rules get complicated if you’ve made nondeductible contributions. However, all the calculations explained here are handled on Part I of Form 8606 (Nondeductible IRAs). If you’ve made any nondeductible contributions, include that form with your return for any year you take withdrawals. Y

ou should also include Form 8606 for any year you make nondeductible contributions (whether or not you take any withdrawals). Then keep the form with your permanent tax records so you’ll know the amount of cumulative nondeductible contributions when you take future withdrawals. Otherwise, you’ll wind up paying taxes on amounts you should have treated as tax-free.