Removing Excess Contributions from Roth IRA
I discovered that my mom has been contributing to a Roth since 1998. In 2004 she changed her filing status to married filing seperately not realizing that if she made AGI over 10k that she was not allowed to contribute. I have studied up a bit on how to correct the error and am looking for someone to possibly agree that this will work.
Over Contributions
2004-3,000
2005-4,500
2006-5,000
2007-5,000
2008-none
Since I have started to do her taxes for 2008 on Turbo Tax Premium I noticed that the software allows me to enter the over contribution in 2007 and it automatically fills out the 5329 for her. Before I file her taxes[b] I have instructed her to have 17,500 taken out of her account [/b]as a normal qualified distribution (no earnings, she over 59.5 in age). That will remove the excess contributions…now the fun part is the 5329. I have printed off a [b]5329 for years 2004 thru 2006 and will fill them out for her and have her mail them in with the 6% excise penalty and a letter requesting a waiver of the penalty[/b]. I will tell her not to mention anything about interest on the penalties and hope the IRS cuts her some slack. Do you know if the IRS is pretty good about returning the penalties if the client discovered the problem, fixed it, and paid penalties without the IRS bringing the problem to her attention. I wonder if they would ever realize what occured if she didn’t bring this up ?
Question 1
Once she has taken out the 17,500 and filed a 5329 and paid excess penalty for each year she overcontributed…..is this the end of this nightmare ??
Question 2. The 5329 that Turbo Tax created (for the 2007 excess contrib) was for 2008 but doesnt’ it need to be on a 2007 form ?
I worry that not many people realize that if you file “married filing seperately” that you can not make over 10k in AGI AND contribute to any IRA.
this website and forum has been a great help so let me say THANK YOU !
Permalink Submitted by Alan Spross on Thu, 2009-03-12 00:12
You have a pretty good handle on the situation. Have you compared the possibility of amending to joint returns for 2005-07 and comparing the results with the 6% penalties? Too late for 2004 to be amended.
The various 5329 forms carry over to the next year, so you must start with 2004. Assuming amending to joint is not practical, then the carryover excess is added to the new excess amount each year, causing the 6% penalty to be applied to ever greater amounts until the corrective distribution is taken. Unfortuneately, even though no new 2008 contribution was made, there is still a 6% penalty on the full 17,500 for 2008 since the corrective distribution was not taken prior to 12/31/2008. The cumulative amount of contributions over all these years subject to 6% equals 58,000. TTax would have to know that she began 2008 with 17,500 in prior excess contributions from the 2007 5329.
Would the IRS catch these excess contributions on their own? Actually, their record is extremely spotty, as it is with many of the facets of IRA contribution and corrective distributions. In addition, if and when they do catch something that they could have stopped by catching it the first year, there is no particular sensitivity to the argument that they could have stopped the damage by being prompt, so they are partly responsible.
Waiver of the 6% penalty is not something the IRS will routinely agree to like the waiver of the excess accumulation tax of 50%. Perhaps it is because the factor is so much less. But due to the meltdown in retirement account values, this is probably the best year to appeal this penalty. While worth a try, I still would not be too hopeful the IRS will go for it.
Note that the 6% penalty is not applied to more than the year end balance of all Roth IRAs, so if the 12/31/08 value is less than 17,500 due to losses, the 6% would be applied to the lower amount.
You might want to complete the 2008 return without addressing any of this. It is probably more efficient to handle all the 5329 issues together in the proper order, and although interest could still be accruing, there is no new penalty until 12/31/09. Any earnings on these contributions stay in the Roth, so positive earnings would probably offset the interest charges if IRS even bills it.
Bottom line, the IRS reaction is probably a luck of the draw with respect to the penalty waiver and/or the interest waiver, and how many years back they would go if they caught this error. I do not know if excise taxes are treated differently from ordinary income taxes where they consider years closed after 3 years lacking signs of fraud.
Permalink Submitted by Brian Shupe on Thu, 2009-03-12 15:34
Alan,
Thank you again for answering our questions. I have talked to my mom about amending but she is pretty much against it even thou it takes away her option to fund a Roth. I have printed out the 5329 for all the years in question and will have her mail those in. She will also include a 1040-V for each year and payment for that year’s excise tax. I will ask her to not mention any penalties for filing late or for accured interest on the taxes that haven’t been paid. Let the IRS figure that out and come and ask for it. I agree that filing her 2008 return without a 5329 would be best. I will help her do all those at once and at least it gives her time to make a bit of money (hopefully) in her account before removing the excess contributions. Your comments on the IRS never discovering this are probably correct but she would rather take care of it now than give them any reason whatsoever to come back on her. I’ve yet to answer the question about what I would do in this situation but we all take risks that we wouldn’t want our parents to take so maybe this is the best way for her.
If I could post one more question..
What is a non deductible IRA ? She made 27,000 in 2008 and files “married filing seperately” so can she still contribute 5000 into a IRA for 2008 and then submit a form 8606 for 2008 that will track the basis, making it a non deductible IRA ? (quess that was two questions)
I am not sure if a “non deductible” IRA is simply just a tradtional IRA that is made a non deductible by adding the form 8606 to it. All of her contributions have not been used for any deductions. My plan is to have her fund 08 and 09 if she is allowed to (on a non deductible status) and then convert it to a ROTH in 2010 if that option is still available. This Congress is making it hard for me to make any long term plans involving retirment plans. Thank you again for your help as I see this issue being taken care of soon (at least her part…IRS may still have something to say about it).
Permalink Submitted by Alan Spross on Thu, 2009-03-12 20:23
A non deductible IRA is a term often used to simply describe a non deductible contribution to a traditional IRA. You are familiar with that and the 8606 filing that is required to document this with the IRS. The total of non deductible contributions applies to all TIRAs of a taxpayer, not just to the account which receives the contribution.
As you indicated, next year and thereafter Roth conversions are allowed without regard to income or marital filing status. If she converts then, the 8606 basis is prorated against the total TIRA values to determine the taxable portion of the conversion. She will need Parts I and II of the 8606 to report the conversion, so this process is much easier if past 8606 forms have been filed and are up to date.