Excess IRA Contributions - Too Much of a Good Thing
By Sarah Brenner, IRA Analyst
Follow Us on Twitter: @theslottreport
You can have too much of a good thing. A contribution to your IRA is a great way to save for retirement, but there are limits. If you exceed those limits you will end up with an excess IRA contribution and a tax mess. This was the fate of two taxpayers in a recent court case, where mega IRA contributions resulted in excess contributions and penalties. [Wu v. U.S., No. 16-1660, 7th Circuit Court of Appeals, August 29, 2016]
$200,000 IRA Contributions
The story began back in 2007, when Michael and Christina Wu sold their home and each deposited $200,000 of that money into their respective traditional IRAs. Tax problems ensued for the Wus because in 2007, the maximum each of them would have been allowed to contribute to an IRA would have been $4,000. Each $200,000 IRA contribution created an excess contribution for 2007.
The Wus faced the 6% excess contribution penalty along with penalties for filing their tax returns late, interest on the late payment, and penalties on the late payment. The 6% excess contribution penalty would continue to apply for each year the excess contribution remained in the Wu’s IRAs.
Finally, in 2010, the Wus realized their mistake, informed the IRS, and corrected the problem by withdrawing the excess contributions from their IRAs. The Wus conceded liability for 2007 and 2008, but they each sought a refund for tax year 2009 arguing that they had avoided the 6% excess contribution penalty for that year by removing the excess contribution before the April 2010 filing deadline for their 2009 tax return. The IRS disagreed with the Wus and they went to court representing themselves. The District Court sided with IRS and the Wus appealed.
The Court’s Decision
The Appeals Court agreed with the District Court and the IRS and held that the Wus owed the 6% penalty for 2009. According to the Court, the Wus made their excess contributions in 2007, so for that tax year they could have avoided incurring the 6% penalty on excess contributions by withdrawing the excess before the return-filing deadline for that taxable year. That did not happen. But for any later year, the Wus could avoid the annual tax only by taking the distribution before the taxable year ended. To avoid the penalty for 2009, the Wus would have had to remove the excess contributions by December 31, 2009.
Watch Out for Excess Contributions
Have you contributed too much to your IRA? Examples of excess IRA contributions include contributions that exceed the maximum annual contribution dollar limit for the year (e.g., $5,500 for someone under age 50 for 2016), and rolling over an amount that isn’t eligible for rollover (e.g., a required minimum distribution or a rollover after the 60-day clock expired).
As the taxpayers in this court case learned, excess contributions can result in a tax nightmare that will not end until the excess is corrected properly. This is a complicated process. If you have concerns about excess contributions in your IRA, your best bet is to take action as soon as possible. Consult with a knowledgeable financial advisor and avoid years of penalties.
Content Citation Guidelines
Below is the required verbiage that must be added to any re-branded piece from Ed Slott and Company, LLC or IRA Help, LLC. The verbiage must be used any time you take text from a piece and put it onto your own letterhead, within your newsletter, on your website, etc. Verbiage varies based on where you’re taking the content from.
Please be advised that prior to distributing re-branded content, you must send a proof to firstname.lastname@example.org for approval.
For white papers/other outflow pieces:
Copyright © [year of publication], [Ed Slott and Company, LLC or IRA Help, LLC - depending on what it says on the original piece] Reprinted with permission [Ed Slott and Company, LLC or IRA Help, LLC - depending on what it says on the original piece] takes no responsibility for the current accuracy of this information.
Copyright © [year of publication], Ed Slott and Company, LLC Reprinted with permission Ed Slott and Company, LLC takes no responsibility for the current accuracy of this information.
For Slott Report articles:
Copyright © [year of article], Ed Slott and Company, LLC Reprinted from The Slott Report, [insert date of article], with permission. [Insert article URL] Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article.
Please contact Matt Smith at email@example.com or (516) 536-8282 with any questions.