How can you prove your client has IRA basis (after-tax funds) when it hasn’t been reported to the IRS? If the IRA basis cannot be proved or reconstructed, then those after-tax IRA funds (the basis — which should come out tax-free), will be taxed when withdrawn, and this will result in a double tax on those assets. A recent case might provide some insight.
The U.S. Tax Court ruled that hardship distributions from a 401(k) and an IRA were taxable and subject to the 10% early distribution penalty. The court also allowed the IRA owner to claim a portion of his distribution as a tax-free return of basis, even though he had never reported his IRA basis to the IRS. (Gustavo E. Morles v. Commissioner, T.C. Summ. Op. 2015-13, Feb. 23, 2015)
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