2010 Roth IRA Excess Contribution

Submitted by Joshua DeArmitt on Tue, 2011-07-19 16:05

My wife and I have been contributing to our Roth IRA accounts for several years, and I recently realized that I was not eligible to contribute to a Roth IRA for 2010. However, In December 2010, my wife and I each had made a partial contribution of $1,200 to our Roth IRAs. Our AGI was 197k, so we were not, in fact allowed to contribute anything. (I also went back and checked prior years’ AGI, and we were under the limit for all years, except in 2010).

We filed our taxes in April, and didn’t realize the mistake then. Now, we have Excess Contributions in our Roth IRA accounts.

1) Do we need to withdraw the $2,400 plus earnings, or just the $2,400, and should we do that now?

2) Do we need to go ahead and amend our 2010 tax return to take care of this, or, since the distribution will occur in 2011, can we just wait and take care of everything on our 2011 taxes, with Form 8606 and 5329?

Help would be appreciated.



Submitted by Peter Lingane on Tue, 2011-07-19 16:21

The solution is to “recharacterize” the contributions to the Roth IRAs as contributions to traditional IRAs before mid October 2011.

The 2010 contributions to the traditional IRAs may or may not be deductible; see Pub 17 for details. If the contributions are deductible, you will want to amend your 2010 tax returns.

Come January 2012, you can convert the traditional IRAs to Roth IRAs. If the 2010 contributions were not deductible, you will pay tax on the earnings only.



Submitted by Joshua DeArmitt on Tue, 2011-07-19 17:10

So if I recharacterize as a non-deductible Traditional IRA contribution for 2010, what tax filings would I need to do?



Submitted by Alan Spross on Tue, 2011-07-19 20:46

You actually have 3 choices here, but identifying the best one depends on various circumstances, such as the amount of earnings on your excess contributions and whether you have other traditional IRA accounts at this time or not. Also, since the excess amounts are small, you may also want to consider the mechanics of reporting each option:

1) Option 1: Recharacterizing the contributions as traditional IRA (TIRA) contributions. This option is better if you have no other TIRAs or if you do have other TIRAs, whether you made prior non deductible contributions to them as reported on older Form 8606 forms. To do this, just contact the IRA custodian and have them recharacterize the contributions to a TIRA. If you don’t have a TIRA now, you would have to open them. If even one of you is covered by a retirement plan at work, the contributions could not be deducted and you would have to file an 8606 for 2010 reporting the non deductible contributions. You can do this with stand alone 8606 forms without a 1040X. You could then convert these accounts to a Roth IRA right away, but there would be taxes due if you have other TIRA accounts. The conversion would be reported on your 2011 taxes. You do not have to convert, eg if you have other TIRAs with extensive pre tax amounts, you could just leave the recharacterized contribution in the TIRA.

2) Option 2: Remove the excess contribution – tell the IRA custodian that you have an excess contribution that you want returned with allocated earnings. The earnings amount would be taxable in 2010 and you would have to amend your return to include the earnings income. There is also a 10% penalty on the earnings. Include an explanatory statement on the 1040X what you did.

3) Option 3: If you expect your income to allow you to contribute at least this much to a Roth IRA for 2011, you can leave the contribution alone and file a 5329 to pay a 6% excise tax for the 2010 excess amount. Then contribute 1,200 less than you are eligible for in 2011 and file a 5329 for 2011 which applies the 1,200 (each) to 2011. You do not have to contact the custodian for this option, as it is all handled with your tax returns. If you have real good earnings, this option may work well because the earnings stay in the Roth and are not taxed. You can also file the 2010 5329 on a stand alone basis.

Note: The IRS may charge you interest for any amounts due for 2010, since they are being paid late
Also, the deadline for Options 1 and 2 is 10/17/2011. If you miss that deadline, you are left with Option 3 or having to remove just the contributed amount (no earnings) before 12/31/2011.



Submitted by Peter Lingane on Tue, 2011-07-19 21:07

You and your wife each need to file a Form 8606 for 2010 once the recharactreerization is complete. Download the instructions from the IRS website and pay particular attention to pages 3/4. There are no changes to your 2010 federal return and there will be no mention of the recharacterization on your 2011 federal return.

It may be a bit messy to calculate the gains/losses that must be transferred from the Roth to the traditional IRA but I suspect that your custodian is up to the challenge. There is a link in the Form 8606 instructions if you want to do the calculation yourself.

I suspect that a professional would have identified the excess Roth contributions in the course of preparing your 2010 returns. Forewarned, you could have been able to complete the recharacterization before filing the returns and could have included the Form 8606 with the returns. Consider hiring a professional to help with the recharacterization since you or I or Alan may have neglected to mention something important. There are probably state filing requirements to consider as well.



Submitted by Peter Lingane on Tue, 2011-07-19 21:24

Alan is correct that you do not need to wait till January 2012 to convert your recharactrerized traditional IRAs to Roth IRAs. There is no minimum holding period between recharacterizing a Roth contribution and converting the resultant traditional IRA to a Roth IRA.



Submitted by Joshua DeArmitt on Wed, 2011-07-20 15:06

There are no other Traditional IRA Accounts, so it looks like Option 1 would be best.

1) Do I just need to re-characterize the $1,200 for each of us? What about the earnings?

2) If I’m understanding right, the steps are
1) Contact custodian to re-characterize;
2) File 2010 8606 as stand-alone form;
3) Convert Traditional IRA to Roth IRA;
4) Report conversion on 2011 taxes (which will be done by a CPA)

3) Am I correct in assuming that the conversion to the Roth will be a reportable, but non-taxable, event, due to having no other Traditional IRA accounts?

Thanks again for all of your help.



Submitted by Peter Lingane on Wed, 2011-07-20 15:25

Since you plan on hiring a professional to assist with your 2011 taxes, why not hire them now to oversee the recharacterizations? I’d hope that the incremental cost would be minor.

If you plan to do it alone, you need to reread the 8606 instructions and the prior posts since some of your planned steps do not conform to the instructions and/or what has been said.

Good luck!



Submitted by Alan Spross on Wed, 2011-07-20 16:18

[quote=”[email protected]“]There are no other Traditional IRA Accounts, so it looks like Option 1 would be best.

1) Do I just need to re-characterize the $1,200 for each of us? What about the earnings?

Yes, ask the custodian to recharacterize the entire $1200 contribution as a traditional IRA contribution. The custodian will do the earnings calculation and the adjusted amount will be transferred to your TIRA account. Since you do not have a TIRA now, you will have to open one. It is easier to use the same custodian, but not a requirement.

2) If I’m understanding right, the steps are
1) Contact custodian to re-characterize;
2) File 2010 8606 as stand-alone form;
3) Convert Traditional IRA to Roth IRA;
4) Report conversion on 2011 taxes (which will be done by a CPA)

Yes, an 8606 will be needed for each of you. The form is individual and holds only one SSN. Since you have no other TIRAs, you should convert the non deductible TIRA right away, and it will be tax free as long as you have filed the 2010 8606 for each of you. The 2011 conversion will be reported on an 8606 for 2011, which will pick up the prior year 2010 basis of $1200 each from the non deductible contribution.

3) Am I correct in assuming that the conversion to the Roth will be a reportable, but non-taxable, event, due to having no other Traditional IRA accounts?

Yes. If you feel you need assistance to complete one or more of these items, go ahead and locate someone. But you may be able to handle it yourself and you are the best judge of that.

[/quote]



Submitted by Lee Martinson on Fri, 2011-07-22 17:40

IS the reason it is “reportable, but non-taxable, event” also because his income is too much to qualify for a deduction under the TIRA, and so it is funded with after tax money anyway?

And is the fact that is is not taxable due to having no other TIRA’s because of the pro-rata rule that would be in place if he had other TIRA’s that had been funded with deductible dollars?

Lee



Submitted by Alan Spross on Fri, 2011-07-22 18:15

Probably, since most people take the deduction if they are eligible. Most people who do not qualify to make a regular Roth contribution due to high income also cannot deduct a TIRA contribution. However, a taxpayer can ELECT not to deduct the TIRA contribution even when they are eligible to deduct it. In that case, if they deduct it, but then convert in the following year, they have transferred taxable income from the first year to the second year. Conversely, if they DO NOT or CANNOT deduct the TIRA contribution, then there is no transfer of taxable income from one year to another.

Second question – Yes, the conversion is tax free ONLY if there are no other TIRA, SEP or SIMPLE IRA accounts holding pre tax dollars. You can sometimes eliminate those pre tax amounts by rolling them into a current employer plan, leaving behind only the non deductible contributions in the TIRA. You can then convert the TIRA without paying tax on the conversion. This strategy is sometimes referred to as a “backdoor Roth contribution”, ie a way to get funds into your Roth IRA (without paying taxes) when you are not otherwise able to make regular Roth contributions.



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