correcting excess Roth IRA contributions

Submitted by Arthur Dicker on Thu, 2010-01-14 21:12

Suppose taxpayer made maximum contributions ($6,000 – over age 50) to Roth IRA in 2005 through 2009. Spouse died in 2005. Taxpayer discovers today that he was not eligible to make Roth contributions in 2006 to 2009 because of lower income limits on single taxpayer. I know she can correct 2009 contribution by withdrawing it by April 15, 2010. What about 2006 to 2008? Is there any relief from Form 5329 penalty for inadvertent violation which taxpayer corrects upon discovery?



Submitted by Alan Spross on Thu, 2010-01-14 23:04

No, there is no relief provision for this.

Since the extended due date has passed for all 3 of these years, the contributions must be withdrawn under the different rules that apply after the extended due date.
Under these corrective procedures, only the contributions are withdrawn, but not the earnings. Unfortuneately, all these contributions incurred another 6% penalty as of 12/31/09, so there is no rush now to withdraw them until next December. Might as well leave them in and let them generate tax free earnings for the rest of 2010.

But the excise taxes must be paid. $360 for 2006, $720 for 2007, $1,080 for 2008 and $1,080 for 2009. Worse yet, the IRS will probably bill interest on these amounts based on the original due dates.

The 2009 excess can still be handled in the usual way with the earnings adjustment. However, 2009 can also be recharacterized to a non deductible TIRA contribution and this avoids any earnings distribution. This amount could then be converted in 2010 where there is no income limit for conversions. However, the pro rate rules apply if taxpayer has other pre tax IRAs, so the conversion might be mostly taxable. If no other TIRAs, only the earnings would be taxable in a 2010 conversion. This would be a way to replace some of the Roth assets that need to come out due to the excess contributions.

Note that if taxpayer is using a professional tax preparer, this should not happen because the Roth contribution should be entered each year into the software. In that case, the program would flag an excess contribution and it could have been corrected right away. This might be an indication if the taxpayer has a professional preparer…or not.



Submitted by Arthur Dicker on Tue, 2010-01-19 15:09

Thank you, Alan
Can the taxpayer file standalone Forms 5329 for years 2006, 2007 and 2008 to report tax on excess contributions, without having to file complete 1040X’s?
I assume the 5329 for 2009 is just attached to the 2009 Form 1040.



Submitted by Alan Spross on Tue, 2010-01-19 18:26

Yes, stand alone forms 5329 through 2008 are OK, and add the 5329 for 2009 to the 2009 return.



Submitted by Arthur Dicker on Fri, 2010-01-22 14:29

I understand that taxpayer has to remove 2009 contributions + earnings on it by filing deadline with extension.
How/where on Form 1040 does taxpayer report the earnings?
Does he report the earnings on 2009 tax return even though he removes them in 2010 and presumably will not get a 1099 from custodian until next year?
If so, how does he explain to the IRS next year that he is not reporting the 1099 info on the 2010 return?
Thank you Alan for your valuable input.



Submitted by Anonymous (not verified) on Fri, 2010-01-22 17:32

If earnings are generated for a contribution made in 2009 and removed in 2010 they must be reported on the 2009 return, as you stated correctly. The 1099R you will receive next year will have code “p” attached to it telling the IRS “prior year”. This will let them know to look if you properly reported the income in 2009. You will not need to do anything on your 2010 return, despite receiving a tax form in January 2011.

pmk



Submitted by Alan Spross on Fri, 2010-01-22 17:59

The 8606 Instructions request that an explanatory statement be included covering the contribution and corrective distribution details. This would help the IRS understand the tax filing when the 1099R has yet to be issued. That said, there is no doubt that many overlook the explanatory statement and postings here and on other boards do not seem to indicate that these taxpayers get a bunch of inquiries. It is likely that the IRS suspends activity until the 1099R forms are issued in the following year. These are the “P” coded forms pmk referred to. So if you neglected the explanatory statement I would not worry too much about it, but it is best to include one if possible.

Various tax software programs may not provide prompts for these statements.



Submitted by Arthur Dicker on Thu, 2010-02-04 20:58

Where do you file the 5329s for prior years (2006, 2007, 2008)?
I don’t see that in the instructions to 5329.
Thank you.



Submitted by mk foss on Thu, 2010-02-04 21:41

Forms 5329 are filed in the same place that you file your income tax returns. Since they’re a stand alone form, you need to sign them at the bottom. Many IRS campuses have one person that handles all of the 5329s. If you’re asking for a penalty waiver, it expedites things if you can send the forms to that address. If you owe a penalty and are sending a check, the standard address is sufficient.



Submitted by Arthur Dicker on Fri, 2010-03-05 14:36

Mary Kay and/or Alan and/or pmk and/or anyone else,
Where can I find out about the reasons to request a waiver of the penalty for excess contributions to a Roth IRA?
Can I file Forms 5329 for 2006, 2007, 2008 and 2009 (see previous discussion) without paying the penalty and ask for a waiver, or must I pay the penalty tax with the forms and ask for a waiver and a refund?
How likely is it that the IRS will waive the penalty?
Thank you again for your assistance and advice,



Submitted by Alan Spross on Fri, 2010-03-05 19:10

This is not one of the penalties that the IRS waives easily, like the excess accumulation penalty for failing to take RMDs or extending the 60 day rollover limitation.

It probably is not worth the effort unless you have had major health problems or some other excellent excuse for these contributions. Even if you do, an appeal faces an uphill fight, but if you are going to try, send in the forms with the IRA statement showing your current distribution of the excess amounts. Do not pay the excise tax up front, and complete the 5329 forms showing the amounts to be appealed on line 25. Make sure the IRS knows you removed the excess contributions as soon as you realized they were excess, as that will show good faith self reporting and correction.

If your excess contributions led to earnings, do not withdraw them, but you might offer the IRS a partial payment equal to the earnings attributed to your excess contributions. It may be worth a try, but I would not count on a favorable ruling.



Submitted by John Smith on Sun, 2010-03-07 21:40

The IRS contradicts what I have read here – I’m very confused and my CPA is not available until after tax season. After getting 4 different answers over the phone, I requested a written response from the IRS and what I got is shown below. The IRS says that earnings made on excess contributions in prior years such as 2005, 2006, etc., also need to be withdrawn in addition to the original contribution (which was mistakenly in excess). I don’t want to withdraw the earnings since I’m already getting slammed with the 6% excise tax. Can anyone point to the portion of the tax code that says the earnings can stay in?

THANKS!

Letter from IRS:
IRS Email Tax Law Assistance
Tue, March 2, 2010 1:07:50 PM
From:
“[email protected]”
Add to Contacts
To: [email protected]

Our response to your tax law question appears below. For your reference, you can also research our website for general tax law topics at: http://www.irs.gov. Please do not use your “reply” button to respond to this message. This E-Mail address is non-returnable and will not accommodate replies because of current limitations to our system. More helpful information is provided at the end of this message.

Dear Taxpayer,

Thank you for your inquiry dated February 26, 2010. We apologize for any delay in your response.
I assume your question is if you made excess contributions to a Roth IRA in a year to avoid or stop paying the 6% excess contribution penalty must you also withdraw the earnings.

The following information is quoted from the Internal Revenue Code Section 4973(f).

(f) Excess contributions to Roth IRAs.
For purposes of this section, in the case of contributions to a Roth IRA (within the meaning of section 408A(b)) the term excess contributions means the sum of-
(1) the excess (if any) of-(A) the amount contributed for the taxable year to Roth IRAs (other than a qualified rollover contribution described in section 408A(e)), over (B) the amount allowable as a contribution under section 408A(c)(2) and (c)(3), and (2) the amount determined under this subsection for the preceding taxable year, reduced by the sum of- (A) the distributions out of the accounts for a taxable year, and (B) the excess (if any) of the maximum amount allowable as a contribution under sections 408A(c)(2) and (c) (3) for the taxable year over the amount contributed by the individual to all individual retirement plans for the taxable year.
For purposes of this subsection, any contribution which is distributed from a Roth IRA in a distribution described in section 408(d)(4) shall be treated as an amount not contributed.

The following information is quoted from the Internal Revenue Code Section 408(d)(4).

(4) Contributions returned before due date of return. Paragraph (1) does not apply to the distribution of any contribution paid during a taxable year to an individual retirement account or for an individual retirement annuity if- (A) such distribution is received on or before the day prescribed by law (including extensions of time) for filing such individual s return for such taxable year. (B) no deduction is allowed under section 219 with respect to such contribution, and (C) such distribution is accompanied by the amount of net income attributable to such contribution. In the case of such a distribution, for purposes of section 61, any net income described in subparagraph (C) shall be deemed to have been earned and receivable in the taxable year in which the contribution was made.

In summary, according to the referenced Internal Revenue Code an excess Roth IRA contribution under section 4973 will include any excess contribution for that taxable year plus the amount of excess in the account for the preceding taxable year(s). It also states to avoid the excess contribution penalty any amount withdrawn by the due date of the return for a taxable year that includes the amount of excess contributions plus earnings will not be considered as if not contributed. It also states that any earnings on the amounts distributed will be considered earned and taxable in the year the excess contribution was made. This means that the excess contribution penalty is a carryover penalty and will continue until the excess contributions plus earnings for the current and previous years are distributed.

Your question was taken over the telephone and it was either highly abbreviated or somewhat unclear. In this case, the transcribed question would not be meaningful to you. For this reason and because we were unable to provide an answer by telephone as planned, your question has not been included in our response.

This answer is based on our understanding of the facts you presented in your question. Omission of facts may affect the answer provided.

IRS forms and publications may be accessed and ordered through our web site at the following address: http://www.irs.gov or through our toll-free forms line at:
800-829-3676
Expect delivery within 7-10 days.

Other useful toll-free numbers include:
800-829-1040 IRS Tax Help Line for Individuals
800-829-4933 Business and Specialty Tax Help Line
800-829-1954 Refund Hotline

Here’s a tip for navigating the IRS web site. Use the “search” button at the right side of the web page. Enter key words or phrases for your topic in the entry box.

EMPLOYEE ID: 59-08106 Ms. Downer Tel.:(800)829-1040 msg#: 3198135



Submitted by Alan Spross on Sun, 2010-03-07 22:59

The IRS letter is citing 408(d)4 which clearly only applies to corrective distributions made before the extended due date for the year of contribution. 408(d)5 is the provision that applies to excess contributions returned AFTER the extended due date, which means that the 6% excise tax has also been incurred. Below I have copied the two provisions and you will note that 408(d) 5 says nothing about the return of any earnings. The corresponding situations are covered in Pub 590 on p 48, and the withdrawal of earnings is ONLY mentioned in corrective distributions made BY the due date for the return. The return of earnings and the 6% excise tax are mutually exclusive. It is one or the other, but never both, depending on the date of the distribution:

>>>>>>>>>>>>>>>>>
(4) Contributions returned BEFORE due date of return
Paragraph (1) does not apply to the distribution of any contribution paid during a taxable year to an individual retirement account or for an individual retirement annuity if –
(A) such distribution is received on or before the day prescribed by law (including extensions of time) for filing such individual’s return for such taxable year,
(B) no deduction is allowed under section 219 with respect to such contribution, and
(C) such distribution is accompanied by the amount of net income attributable to such contribution. In the case of such a distribution, for purposes of section 61, any net income described in subparagraph (C) shall be deemed to have been earned and receivable in the taxable year in which such contribution is made.
* * * * * *
(5) Distributions of excess contributions AFTER due date for
taxable year and certain excess rollover contributions
(A) In general
In the case of any individual, if the aggregate contributions (other than rollover contributions) paid for any taxable year to an individual retirement account or for an individual retirement annuity do not exceed the dollar amount in effect under section 219(b)(1)(A), paragraph (1) shall not apply to the distribution of any such contribution to the extent that such contribution exceeds the amount allowable as a deduction under section 219 for the taxable year for which the contribution was paid –
(i) if such distribution is received after the date described in paragraph (4),
(ii) but only to the extent that no deduction has been allowed under section 219 with respect to such excess contribution. If employer contributions on behalf of the individual are paid for the taxable year to a simplified employee pension, the dollar limitation of the preceding sentence shall be increased by the lesser of the amount of such contributions or the dollar limitation in effect under section 415(c)(1)(A) for such taxable year.
>>>>>>>>>>>>>>>>>>>>>



Submitted by Anonymous (not verified) on Sun, 2010-03-07 23:27

Also, the 8606 Instructions page 5 implies that no earnings come out in the example for the Traditional IRA. Further evidence that there is that distinction:
[u]”Example. You are single…..”[/u]
http://www.irs.gov/pub/irs-pdf/i8606.pdf

pko



Submitted by John Smith on Sun, 2010-03-14 18:27

Thanks everyone – pursuing this again with IRS.

John



Submitted by Anonymous (not verified) on Mon, 2010-03-15 02:14

I would not even fight that fight through that channel.

File according to the recommenations in this thread. This is a very common issue and I am sure when properly filed it will be accepted. My experience with these direct inquiries is usually very bad, because the IRS in that support function is poorly trained with IRAs.

pko



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