Client put too much in last year’s IRA
I just picked up client who admitted that he put an extra $100 into his (Traditional) IRA last year (2010). His mutual fund company didn’t notice it and let him put $6,100 into his IRA. He didn’t notice it until recently so he didn’t correct the mistake by tax day. Is it too late to make a correction for last year? What are the consequences for this mistake, and when would they take effect (or does he just wait for an audit, if it comes, to catch the mistake)?
Permalink Submitted by Alan Spross on Tue, 2011-07-12 02:25
It is not a good idea to wait for an audit because there is no statute of limitations for excess contributions unless a 5329 is filed; therefore the IRS could catch this several years from now and levy a penalty for each year plus interest. Of course, the excess amount is only $100, but it is easy to correct it and he can then put the issue to rest. There are two choices for him to use that will correct this and he can make the choice:
1) Assuming he filed his return by 4/18, he can still request the custodian to return the excess contribution plus any earnings. The earning are taxable IN the year he made the final $100 contribution. I assume that he did not deduct more than 6,000 or if he could not deduct it, that he filed an 8606 for only 6,000. If the contribution was made IN 2010, he would have to amend his return.
2) To avoid a full amended return and having to contact the custodian, he can simply file a 5329 for 2010 and pay the 6% penalty – only $6. Then for 2011 he can contribute $100 less and file a 5329 with his 2011 return that applies the carryover $100 to 2011. No distribution and no further tax or penalty.
Since the amount is so small and the amount of work is much less, in this case I think Option 2 is preferable. It avoids a distribution of earnings along with the $100 and avoids an amended return in exchange for a simple 5329 that he can file on a stand alone basis with a brief explanatory note.
Permalink Submitted by mk foss on Tue, 2011-07-12 02:30
Did he deduct $6,100? Most software packages would not allow a $6,100 deduction – if the return was prepared manually the extra $100 could have shown up on the front page of the return. If he only deducted $6,000 on the return, IRS will not pick it up quickly. If he actually deducted, $6,100 the return should be amended.
There are two choices with the excess – if he made the contribution in 2011 for 2010. He could notify the mutual fund company that the extra $100 was for 2011 and asked them to indicate that in their records. The other choice is too take out the excess – see next paragraph.
If he made the contribution in 2010 (or decides to do this for a 2011 contribution), he needs to remove the extra $100 plus the earnings on it as soon as possible but no later than December 31, 2011. A 6% penalty applies for every 12/31 where there is an excess contribution.
The mutual fund company issues Form 5498 to the IRS and to the IRA owner by May 31 each year. The Form 5498 shows the contributions received but doesn’t attribute them to a year. The IRS could find an error by comparing a couple of years’ Forms 5498. This is not a penalty that can be waived by the IRS – he needs to deal with it and not wait around for the IRS to audit.