The Obscure Tax Form That Could Save You Thousands: Why Form 8606 Matters More Than You Think
Avoid Paying Taxes Twice: What You Need to Know About Form 8606
If you’ve ever contributed to a traditional IRA without taking a tax deduction, used the backdoor Roth IRA strategy, or withdrawn money from a Roth IRA, Form 8606 is the unsung hero that keeps you from paying taxes twice on the same dollars. The problem? Most people don’t even know it exists. Here’s why this form matters and how it can protect you from costly tax mistakes.
If you’ve ever contributed to a traditional IRA but weren’t allowed to take a tax deduction, or if you’ve dabbled in the backdoor Roth IRA strategy, there’s a little-known tax form you need to know about: Form 8606.
Most people have never heard of it, but failing to file Form 8606 when required could result in paying taxes twice on the same money—and no one wants that. So let’s walk through what this form does, when you need it, and how it can save you from unnecessary tax headaches down the road.
Why This Matters: The Hidden Complexity of Traditional IRAs
Traditional IRAs are often described as tax-advantaged retirement accounts where you contribute pre-tax dollars, enjoy tax-deferred growth, and pay ordinary income tax when you withdraw the money. Simple enough, right?
But peel back a layer, and things get more complicated. If your income is above a certain threshold and you (or your spouse) have access to a workplace retirement plan like a 401(k), your ability to deduct traditional IRA contributions starts to phase out. If you contribute to a traditional IRA but don’t qualify for the deduction, your contribution is considered non-deductible—which is where Form 8606 comes in.
If you don’t file this form to document your non-deductible contributions, the IRS assumes all of your IRA dollars were contributed pre-tax. That means you could be taxed again on withdrawals of money that you already paid taxes on.
How Form 8606 Protects You from Double Taxation
Let’s say over the years, you contributed $50,000 to a traditional IRA but weren’t allowed to take deductions on those contributions. Your IRA balance grows to $100,000 thanks to investment gains.
When you start withdrawing money in retirement, only the investment growth ($50,000) should be taxable, while the original $50,000 of non-deductible contributions should be tax-free. But if you haven’t been filing Form 8606 to document those after-tax contributions, there’s no official record of it, and you could end up paying taxes on that money again.
Filing Form 8606 each year you make a non-deductible IRA contribution ensures that your “basis” (the portion of your IRA balance that’s already been taxed) is tracked properly. This means that when you withdraw money later, you’re only taxed on the gains—not the original contributions you already paid tax on.
The Pro Rata Rule: Why This Gets Tricky
If you have both pre-tax and post-tax dollars in your traditional IRA, things get more complicated. You can’t just withdraw your after-tax contributions separately; instead, the IRS applies the pro rata rule, which treats withdrawals as a mix of taxable and non-taxable funds.
Let’s say your IRA is worth $99,000 and that the balance breaks down this way: $33,000 were non-deductible contributions (i.e., contributions on which you already paid taxes), $33,000 were deductible contributions (i.e., contributions on which you paid no taxes), and the final $33,000 were earnings.
Assuming you’ve met the qualifications for penalty-free withdrawals, only two-thirds of your withdrawal from this IRA ought to be taxable; the rest should avoid taxation—it’s merely a return of dollars on which you already paid taxes.
If you haven’t kept up with Form 8606, parsing this out later could be a nightmare.
Form 8606 & the Backdoor Roth IRA
Another major use of Form 8606 is for the backdoor Roth IRA, a strategy used by high earners who exceed the income limits for contributing directly to a Roth IRA.
Here’s how it works:
You contribute to a traditional IRA (there are no income limits for traditional IRA contributions) but make a note to claim no deduction on the dollars you contributed.
You immediately convert that money to a Roth IRA.
If done correctly, you owe no taxes on the conversion because you never took a deduction on the traditional IRA contribution.
The problem? If you don’t file Form 8606 to document that your contribution was non-deductible, the IRS assumes your entire Roth conversion is taxable income, which completely defeats the purpose of the strategy.
Form 8606 & Roth IRA Withdrawals
If you take money out of a Roth IRA before age 59½, you won’t owe taxes or penalties on the amount you originally contributed. However, investment gains might be subject to taxes and penalties.
Since Roth IRA contributions are made with after-tax money, you need to document them to prove that the portion of your withdrawal representing contributions should be tax-free. Once again, Form 8606 is where that documentation happens.
What Happens If You Don’t File Form 8606?
Failing to file Form 8606 when required can lead to several problems:
Paying taxes twice on non-deductible IRA contributions
Incorrectly paying taxes on a backdoor Roth conversion
Messy record-keeping that makes retirement withdrawals more complicated
If you’ve forgotten to file this form in past years, it’s not too late to fix it. You can file a separate Form 8606 for each year you made non-deductible contributions to establish a proper paper trail.
Final Thoughts: Keep Your Paper Trail Intact
Taxes are complicated, and retirement savings rules don’t make them any easier. But Form 8606 exists to protect you from overpaying and to make sure you’re not taxed twice on the same dollars.
So if you’ve ever made non-deductible traditional IRA contributions, used the backdoor Roth IRA, or taken early Roth withdrawals, make sure this form is on your radar. Better yet—if you work with a tax preparer, ask them explicitly about Form 8606. If you DIY your taxes, check your tax software for it. Your future self will thank you.
