Calculating Tax on IRA Withdrawals

Did you withdraw money or property from your IRA in 2022? Chances are it will be taxable, but it might not be. The taxation of an IRA withdrawal depends on the type of IRA, your age, your contribution history, and accurate tracking of basis. The portion that is taxable must then be added to your taxable income for the year. Whether that will increase the amount of tax you have to pay for 2022 depends on your withholding elections, your other taxable income, your filing status, and your tax bracket.

You may want to consult your tax advisor for assistance with claiming IRA withdrawals on your tax return to make sure you are claiming the correct amount and filing the correct forms. In the meantime, this information may be helpful in understanding how IRA withdrawals are taxed and what forms you may need to file.

 

Did You Withdraw From a Traditional, SEP, or SIMPLE IRA?

Traditional, SEP, and SIMPLE IRAs hold tax-deductible contributions and tax-deferred earnings, which means that distributions from these IRA assets have not yet been taxed and must be included in your taxable income when you file a tax return for the year. The only exception is if you have made nondeductible contributions or rolled over after-tax contributions from an employer plan to your Traditional IRA. If those assets, referred to as basis, are in your IRA, your withdrawal will be partially tax-free. Each IRA withdrawal consists of a pro rata portion of basis and taxable assets based on all your Traditional, SEP, and SIMPLE IRA balances combined. For example, if the basis in your IRA at the time of withdrawal equaled 20% of your total (non-Roth) IRA balance, you’ll have to include only 80% of your withdrawal in your taxable income for the year.

 

Did You Make a Withholding Election?

Your IRA custodian is required to withhold 10% of your IRA withdrawal as pre-payment of your federal income tax liability on the withdrawal unless you waive withholding or elect to withhold a different amount. If you waived withholding on your 2022 IRA withdrawal, you may owe taxes when you file your tax return because that withdrawal increased your taxable income, but you didn’t increase your tax withholding accordingly. But IRA withdrawals are not taxed separately – your overall tax liability for the year is calculated after taking into account all your taxable income and any deductions and tax credits.

Your IRA custodian will send you a copy of Form 1099-R by January 31 to remind you of the gross amount distributed from your IRA and any amount withheld (which may still be taxable income even though it was sent to the IRS).

 

Did You Withdraw From a Roth IRA?

All Roth IRA contributions are considered basis, so they are never taxable coming out. If you take a qualified distribution1, your Roth IRA investment earnings are distributed tax-free as well. The earnings in your Roth IRA are only taxable if withdrawn as part of a nonqualified distribution. But a nonqualified distribution may still be tax-free because of the Roth IRA “ordering rules.” These rules ensure that your Roth contributions are deemed distributed first, followed by any conversion dollars. When those are all depleted, the investment earnings are the last to leave the Roth IRA. If you only withdraw up to the amount you have contributed and already paid tax on, the withdrawal will be tax-free regardless of whether it is qualified.

If you took a nonqualified withdrawal including investment earnings in 2022, you’ll include just the earnings amount in your taxable income. You need to track your Roth IRA contributions and conversions to know whether your withdrawals are dipping into your earnings in the Roth IRA. These contributions are not tracked with your tax return, but your tax preparer may be tracking them for you. Alternatively, you may want to look back through all your Forms 5498 to calculate your Roth IRA basis.

 

Are You Younger Than 59½?

To discourage individuals from using tax-qualified savings before retirement, the IRS assesses an additional 10% early distribution tax on IRA withdrawals taken before the day you reach age 59 and six months. This additional tax will be assessed on the taxable portion of the withdrawal, unless you meet one of the IRS-approved exceptions (e.g., disability, higher education expenses, etc.).

 

What Forms Need To Be Filed?

There are two IRS forms you may need to file with your tax return to report IRA contributions or distributions.

Form 8606, Nondeductible IRAs – Form 8606 is used to track nontaxable assets in your IRAs. File Form 8606 with your tax return if you made a nondeductible contribution for 2022, or to calculate the nontaxable amount of a withdrawal if you have basis in your IRA(s), if you transferred an IRA with basis to a former spouse, withdrew from an inherited IRA that has basis, converted assets to a Roth IRA, or took a nonqualified withdrawal from a Roth IRA.

You’ll want to track your IRA basis properly, so you (or your beneficiaries) don’t end up paying tax twice on those assets. The IRS can assess a $50 penalty for not filing Form 8606 when required and a $100 penalty for overstating your basis without a reasonable cause.

Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts – Form 5329 is filed with your tax return to pay the 10% additional tax on a withdrawal taken before age 59½, or to claim an exception to the tax. It is also used to pay the excise tax for missed required minimum distributions.

 

More Information 

The tax rules for IRA withdrawals can be complex – consulting a financial professional or tax advisor may help in your withdrawal and tax return processes. For answers to commonly asked questions about IRAs, visit our Self-Directed IRA Knowledge Center. Our team of self-directed IRA experts is also available to help answer any questions you may have regarding your IRA.   

 

1To take a qualified distribution from a Roth IRA, you must have had a Roth IRA for at least 5 years and be age 59½ or older, disabled, buying a first home, or a beneficiary of a Roth IRA.

Tags: IRA, IRA rules, IRA tax laws, IRS Reporting, Roth IRA, SEP IRA, SIMPLE IRA, Traditional IRA, withdrawal