Which year to tax earnings on ineligible 60 day IRA rollover from 2 distributions | Ed Slott and Company, LLC

Which year to tax earnings on ineligible 60 day IRA rollover from 2 distributions

Took 2 IRA distributions in December 2016. They were from one Managed account, But at 2 different custodians.
I attempted to do an indirect 60 day IRA rollover without realizing that they had changed the rules on this and since they were from 2 custodians from the same original IRA, 1 of these IRA distributions would be ineligible to be rolled over. The ineligible IRA rollover was deposited the end of December 2016 at a brokerage firm into an IRA rollover. I didn't become aware of this ineligibility until March 2017 when I was attempting to do another one. I found out by researching this that one of these IRA distributions would be ineligible to be rolled over and that I would need to amend my 2016 Income tax return. I amended the 2016 return in Sept. 2017 and it was just processed the beginning of March 2018.

I received a 1099-R from where the ineligible IRA rollover was with a code P indicating I would need to amend my 2016 return again. The earning on this ineligible return were $2,800 on the $33,400 ineligible IRA rollover on the date I had them take this out in March 2017. But only a small amount of these earnings were achieved in 2016 since they had only been there since December 19th, 2016. Most of this $2,800 would have been from the market in the first few months of 2017. Is this correct that all of this $2,800 in earnings has to be reported by amending the 2016 return.

I called the brokerage firm yesterday asking them to change this code P to a code 8 for current year earnings (2017) but they said they follow an IRS formula and code P is how they report it. Can this be remedied somehow? If so, how? I then spoke to a very nice woman at the IRS and she saw my point. She suggested I contact my CPA firm which I did. He never heard of this. She also suggested I could write a letter to the IRS which would take more time. Meanwhile, if I delay amending the 2016 return, the clock continues to tick and more than likely more potential penalties and interest could result.

Here is what I read in a previous forum which is similar the following in correcting the code with their own tax software but I don't know if this permissabe or accurate that would fix the problem without creating more issues:

"Submitted by daveof203 on Tue, 2018-01-30 17:42

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IRA Discussion Forum
My wife made a 2017 IRA contribution during 2017 for $6,500 which she ultimately was ineligible to make as a deductible contribution. Brokerage firm returned $6,500 + $2,300 earnings in Jan. 2018. Form 1099-R for this transaction won't be issued until early 2019. She's under age 59.5, but we had medical expenses + medical insurance premiums in excess of the $2,300 (after reducing by 7.5% of AGI).

We need to recognize $2,300 in ordinary income for the 2017 tax year and appear to meet an exception to the 10% early distribution penalty because of the medical expenses. Using Turbo Tax, it's not clear what needs to be done.

What forms need to be completed and is a letter of explanation to the IRS necessary? Any help is appreciated. Thank you.

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No letter or explanatory
Submitted by Alan-iracritic@... on Tue, 2018-01-30 19:11

No letter or explanatory statement needed. File Form 5329 for her SSN, Part I and show exception code 05 on the indented line for line 2. That will override the penalty code 1 on the 1099R to the extent of the eligible paid medical expenses.
Don't know if your joint modified AGI was too high for a Roth contribution or not, but if the Roth contribution was allowable, it would have been better to have had the contribution recharacterized as a Roth contribution. It would have preserved the 2300 of earnings for her Roth and eliminated the tax bill for the earnings distribution. Or if modified AGI was also too high for a Roth contribution, it still would have been better to leave the 6500 in the TIRA as a non deductible contribution and the earnings would have remained in the IRA.
Don't know how Turbotax works to report the distribution. Some tax programs require you do issue a dummy 1099R to report the corrective distribution with code 8,1 in Box 7. Box 1 would be 8800 and 2a 2300.
Another question is whether the 2300 was calculated correctly. That amount reflects the % gain of the entire IRA account that held the 6500 contribution. That's a gain of 35.4% which is quite possible but well in excess of the market average over this period of time. Custodian sometimes mess up the calculation by incorrect inputs into their software."

It is an IRS rule that when an excess IRA contribution is returned with earnings, that the earnings are taxable (and subject to penalty) in the year that the contribution was made. See Pub 590 A, p 36.  Since the ineligible rollover was done in Dec, 2016, the earnings are taxable in 2016 even though they were generated in 2017. Code P is the code used to indicate that the earnings are taxable in 2016. The custodian did not explain this to you very well, and made it sound like this was some arbitrary procedure of that custodian, when it is an IRS rule that all custodians must follow. On the plus side, the return of this contribution does not affect your 2017 return. I hope the rest of the 1099R is correct. Box 2a should only show the 2800, and the Box 2b for "taxable amount not determined" should NOT be checked. It sounds like your custodian understood that this ineligible rollover needed to be treated as an excess regular IRA contribution if these two boxes check out.  Therefore, you will need to amend your 2016 return a second time. 

Thank you. I had a feeling this was what the reply might be.  

 

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