Lessons from the Tax Court: Finding tax basis for IRAs

If you contribute to an IRA, the contributions may be fully deductible above-the-line. However, deductions for IRA contributions are phased out if you (or your spouse) actively participate in an employer-based retirement plan and your adjusted gross income (AGI) exceeds an annual limit.

For 2018, the phase-out occurs between $63,000 and $73,000 of AGI for a single filer who is an active plan participant and $101,000 and $121,000 for joint filers ($189,000 and $199,000 for you if your spouse is a plan participant but you are not).

On the receiving end, the portion of distributions representing deductible contributions and earnings within the IRA are taxable. But any part of the payout consisting of nondeductible contributions (i.e., its basis) is exempt from tax. Good recordkeeping is important.

New case: A taxpayer who opened an IRA with an investment account in the 1990s had spotty records from that time. However, he convinced the Tax Court that he was an active plan participant and a high wage-earner and therefore wasn’t able to deduct his initial IRA contributions.

After moving the account to a different firm, the taxpayer withdrew the entire balance of $27,745 in 2014. According to the paperwork from the new investment firm, this was a normal distribution and required the taxpayer to determine the taxable amount.

HR Forms D

When the taxpayer filed his 2014 return, he didn’t report any part of the $27,745 IRA distribution. Alerted by its computers, the IRS audited his return and claimed that the full amount of the IRA distribution was taxable. Reason: It said that the taxpayer had failed to establish his basis in the account.

Although the documentary record was sparse, it did contain a few useful clues. The taxpayer produced a 2006 summary statement for his IRA showing a total portfolio value of $21,406. This statement indicated that the assets in the account were initially purchased for an aggregate cost of $4,760.

Given that more than 20 years had elapsed since the taxpayer made his initial IRA investments, the Tax Court acknowledged the difficulty in establishing his basis in the IRA. It also found the taxpayer’s testimony to be credible. Absent any other records, the Court limited the taxpayer’s basis to $4,760 and determined that the remainder of the distribution was taxable. (Shank, TC Memo 2018-33, 3/20/18)