Recharacterizing 2007 Roth Contribution
I need some advice for a situation that has just come to my attention. We have a client who made a 2007 Roth IRA contribution in January of 2008. The clients 2007 MAGI was over the limit for a Roth Contribution. The clients 2008 MAGI was also over the phaseout for Roth contributions. From what I understand this client is past the deadline to recharacterize this contribution to a Traditional IRA and she will be charged a penalty for each year this contribution stayed in her Roth (2007 & 2008). I am hoping to get some kind of clarity on this situation– if anyone has ever encountered this problem before. I would ideally like to know the steps going forward as far as paying that penalty and getting the money out of the Roth before she will be charged a penalty for 2009. Any help and insight would be greatly appreciated!
Amelia Clifford
[email protected]
Permalink Submitted by Alan Spross on Thu, 2009-11-19 23:42
You are basically correct on your observations here. The excess from 2007 could have been applied to 2008 or to this year if they were eligible and did not otherwise contribute separately. I will assume that they will not be eligible for a Roth contribution in 2009 either, and therefore the best procedure is to get the excess contribution out of the account before incurring a third 6% excise tax for 2009. Here is what needs to be done under those circumstances:
1) Prior to year end 2009, request an early distribution from the Roth custodian equal to the amount of the 2007 excess. No earnings are involved here because the extended due date for 2007 corrections is long past. No need to tell the custodian what the distribution is for, and it will be coded as an early distribution on the 1099R. This will prevent a third excise tax for 2009.
2) Tax return issues – File stand alone 5329 forms for 2007 and 2008 showing the correct numbers in Part IV of the form. Do 2007 first, since the excess carries over to the 2008 form. The excise tax is 6% of the contribution amount for each year. The IRS will likely bill interest on the late payment of these fees. For the 2009 return, a final 5329 will need to be filed and it will show that the excess was distributed, leaving no further excess and no 6% charge for 2009. Also, for 2009 the early distribution is reported on Form 8606. This distribution should be coming from the balance of regular Roth contributions and is therefore tax and penalty free.
I am assuming that there were no other contributions or distributions during this period. If there were, the above instructions would need to be changed. If she will be eligible for a Roth contribution for 2009, removal of the excess is not needed, and can just be applied to 2009 on Form 5329. If she ended up in the income phaseout range in any of these years, a partial application of the excess would apply.
Permalink Submitted by Amelia Clifford on Fri, 2009-11-20 14:43
Alan, thank you so much for your help. The client actually will be under the Roth IRA thresholds for 2009. The client’s income was higher than usual in 2007 & 2008 because of a stock option exercise, but their 2009 income should be below the $95k- 110k income limit (single). Does this information change the scenario? I would think that the client will still need to file a 5329 for 2007 & 2008 and pay the applicable penalties, but can the Roth contribution then be recharacterized for 2009?
Permalink Submitted by Alan Spross on Fri, 2009-11-20 20:19
Being eligible for a full Roth contribution for 2009 will eliminate the need to ask for a distribution from the IRA custodian. You are correct that nothing changes regarding 2007 or 2008, but the 2009 5329 will show the eligible contribution they could have made for 2009 on line 19. That figure is subtracted from the excess amount and would result in -0- showing on line 22. There would be no excise tax for 2009.
There would also be room to contribute an extra $1,000 for 2009 because the limit is 5,000 vrs the 2007 limit of 4,000.
Again, the change is that nothing needs to be distributed or reported to the IRA custodian. This correction is between the IRS and the client per the client’s tax return. With no distribution, there is no need for Form 8606 with the 2009 return either. Just the correct 5329.