Excess Roth contributions past 3-4 yrs from too much income
I am an investment advisor, and I have a new client with joint income of $300k+/yr. He files taxes himself and has made Roth contributions in 2004, 2005, and 2006. He has not made a contribution for 2007. I discovered the problem during our initial consultation.
Thus, he has 3 years of excess contributions of $4k per year. All 3 years are past the filing deadline including 6 month extension. His age is mid-30s.
In reading Pub 590 (v2006 p29), it sounds like recharacterization is not an option since he is past the filing deadline including extensions. However, I have also read at Investopedia and elsewhere that “non-timely corrections do not apply to Roth IRAs… Roth IRA excess contributions removed after the deadline are treated as regular Roth IRA distributions, which means that the amount is tax- and penalty free”.
Three questions:
1) Is there a way for him to recharacterize excess amounts that are not timely corrections (past extension deadline)?
2) What are the negative consequences of recharacterizing? Is it just being careful with contaminating non-deductible Traditional IRA contributions with regular deductible contributions?
3) If recharacterization is an option, it seems that amending his returns (or having his them reviewed) is not necessary related to this issue, although it might uncover other errors that he has generated. True?
Thanks a lot for your help.
Permalink Submitted by Alan Spross on Thu, 2008-01-31 06:23
1) You were right – there is no longer a way to recharacterize.
2) Not applicable because he cannot recharacterize past the extended due date.
At this point he owes the 6% excise tax for 2004, 05, 06 and 07 on the various cumulative amounts and those taxes would be reported on Form 5329. The IRS will likely assess interest on the 04-06 amounts.
The correction process is a regular early distribution of the contributions and is reported on Form 8606. These should be tax and penalty free. The good news here is that by incurring the 6% excise tax, the earnings are allowed to stay in the Roth and need not be distributed. The bad news is that the Roth will then be short 12,000, and his taxable account will be short the 6% tax X 4,000 for 04, X 8,000 for 05, X 12,000 for 06 and X 12,000 for 07. In fact, since he does not incur another penalty until 12/31/08 he could delay his correction until year end with no additional penalty, but would have additional interest accruing. But any earnings on that 12,000 for the next 10 months would stay in the Roth eventually tax free.
Permalink Submitted by [email protected] on Thu, 2008-01-31 14:29
OK, thanks.
So, it looks like he has to file one form 5329 for each year… thus 4 forms for 2004-2007). Does he have to amend his tax returns for those years as well? At first blush it seems like no since Roth is after tax money. But Part IV of form 5329 mentions amended returns.
Permalink Submitted by Alan Spross on Thu, 2008-01-31 17:41
Unless there is another need for the 1040X, these prior year 5329 forms can be filed stand alone. Each year’s edition should be used and since they are cumulative, the oldest year should be completed first. Of course, for 2007 the form can just be included with the 2007 1040.
For 2008 when the corrective distribution is taken, an 8606 will be required to report the distribution and a final 5329 will also be needed to show that there are no longer any remaining excess contributions. There will be no penalty for 2008. Too bad the correction could not have been made prior to 12/31/07 as it would have eliminated the 2007 excise tax on the $12,000.