A client hands you a Form 1099-R with code 1 in box 7, a $7,000 nondeductible contribution slip, and a Social Security statement. Three separate rule sets collide on one Form 1040.
An individual retirement account (IRA) is a retirement savings account the taxpayer owns personally. The 2025 contribution limit is $7,000, plus a $1,000 catch-up at age 50 or older. The limit applies across all of a taxpayer's traditional and Roth IRAs combined, not to each account.
The two types are taxed differently when money goes in, while it grows, and when it comes out:
A Roth IRA distribution that fails the qualified test is nonqualified. Nonqualified distributions from Roth IRAs come out in a fixed order, and the order limits the damage because already-taxed dollars come out first.
- Regular contributions come out first, always tax-free and penalty-free.
- Conversion amounts come next, oldest first. Within each conversion, the taxable portion comes out before the nontaxable portion.
- Earnings come out last. They are taxable and subject to the 10% additional tax unless an exception applies.
Common mistakes
- Cherry-picking basis. Treating a $14,000-basis account as if its withdrawals were taxed on their own. All traditional, SEP, and SIMPLE IRAs combine for the pro-rata fraction.
- Skipping Form 8606. If nondeductible contributions are never reported, the client pays tax twice on the same $7,000.
- Rolling over before planning. A 401(k)-to-IRA rollover kills the separation-at-55 exception, turning a $0 penalty into 10%.
Bottom line
- IRA limit 2025 is $7,000 plus a $1,000 catch-up at 50; basis is tracked on Form 8606 and recovered pro rata across all traditional IRAs.
- Conversions are income but penalty-free; conversions cannot be recharacterized, though regular contributions still can.
- RMDs start at age 73, first one deferrable to April 1; shortfall excise tax is 25%, cut to 10% on timely correction.
- QCD cap is $108,000 for 2025, age 70½, IRAs only, counts toward the RMD, no deduction.
Exam shortcut
Read box 7 first. A code 1 means the stem wants an exception hunt; a code G means the answer is zero income. Any stem naming both an IRA and a nondeductible contribution is a Form 8606 pro-rata computation, and the distractor is always the amount you get by ignoring the other accounts.
The full lesson (about 3,280 words, 22 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
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