Form 8606 is an IRS form filed with the United States tax agency to report any nondeductible contributions made to an individual retirement account (IRA). Taxpayers with a cost basis above zero for IRA assets are responsible for completing Form 8606 in order to properly calculate the taxable versus nontaxable distribution amounts associated with their IRA distributions.

IRAs are sought-after savings vehicles due to their tax-deferred status and numerous contribution options. Traditional IRA contributions are often tax deferred, allowing taxpayers to reduce their tax liability in the year they are made, while contributions to Roth IRAs are made with post-tax dollars, allowing withdrawals to be taken tax-free later in life.

For those considering contributing to both traditional and Roth IRAs, it is advisable to first fully fund a Roth IRA before making contributions to a traditional IRA. Doing so not only makes the most use of the Roth IRA’s tax-free benefit, but for taxpayers who have already made nondeductible IRA contributions and thus have an accumulated cost basis in their IRA, it also helps to minimize the taxes associated with withdrawal of IRA funds.

That is why filing Form 8606 is so important — it is the way taxpayers report their nondeductible contributions to an IRA. Taxpayers need to fill out Form 8606 in order to determine the amount of their distributions that must be included as income when they begin taking withdrawals. It is also used to calculate any taxes owed on income associated with those distributions.

When completing Form 8606, taxpayers need to provide information on the total amount of their nondeductible contributions to an IRA, their taxable income, and the total value of their IRAs. Form 8606 also requires taxpayers to calculate their basis (or cost basis) for their IRAs. In addition, taxpayers who have taken distributions from their IRA must report those amounts, along with any related withdrawals from accounts held in the same name.

The bottom line is that Form 8606 is an important form with big implications. If taxpayers fail to file it, they may be required to pay taxes (and possibly penalties) on money that should be tax-free. As such, taxpayers should plan to file Form 8606 with their Form 1040 or 1040NR by the due date (including any due dates for extensions).