excess contribution to ESA
I have a taxpayer that made contributions to his 2 minor children’s Education IRAs for tax years 2007, 2009, and 2010. He realized in 2011 that his income was over the contribution limit in each of those years. He plans to withdraw the contributions in 2011.
I’m not sure if I understand the IRS Pub 970 correctly.
1. Do I fill out a Form 5329 for each year and pay the excise tax of 6% all ot once?
2. Since the money won’t be withdrawn until 2011, do I prepare a tax return for 2007, 2009, and 2010 to report the excess contribution and attach the 5329 for each child? There were no retuns filed previously since there were no income to these children.
3. Do I wait to file the returns after I receive a 1099 form from the financial institution?
4. Must the interest be withdrawn too, and taxable based on value at end of each of those years?
Geralyn S., Louisiana
Permalink Submitted by Alan Spross on Sat, 2011-09-24 00:34
This is handled in the same manner as an excess IRA contribution.
A 5329 should be filed for each year and can be done by itself without a 1040X. Start with 2007 and it will show the 6% penalty amount. Note that for each year, the excess contribution balance is reduced by either distributions taken out in that year OR by the amount of contributions that COULD have been made that were not made. For example, since there was no contribution made in 2008, the prior excess balance would be reduced by the amount that could have been contributed. Of course, if taxpayer’s income was too high in 2008 as it was in those other years, he could NOT have made a contribution for 2008.
Each year, the 6% excise tax is based on the lower of the amount of the excess OR the account value of all beneficiaries ESAs as of 12/31. With some bad market years in there, perhaps the year end balance is lower than the excess amount for one of more of those years.
A 5329 for each year starting in 2007 must be done for each beneficiary. They can be sent in together with a check for the total due, and the IRS may bill interest due to late payment of the excise taxes.
No need to wait for the 1099R, but you will need it to file the final 5329 for 2011. For 2011, there will be no penalty but the form will show that the 2010 cumulative excess amount has been withdrawn and the remaining excess balance is -0-. In other words, for each child there will be 4 5329 forms now plus the final 2011 form in the spring after receiving the 1099R. Since the corrective distribution is being done after the due dates for all these years, no earnings are distributed. Earnings stay in the ESA.
Permalink Submitted by Geralyn Suhor on Sat, 2011-09-24 12:06
This is really helpful. Do I also understand that for 2011 no income tax is due on the distribution even thugh the excise tax will be zero?
Geralyn S.
Permalink Submitted by Alan Spross on Sat, 2011-09-24 23:07
Good point.
Assuming that the beneficiary does NOT have qualified eduction expenses for 2011, the distribution would be partially taxable based on pro rating between the total amount of contributions made to the ESA (not just the excess contributions) and the earnings the account has generated. There are some examples outlined on p 49 of Pub 970.
Let’s say that 6,000 of excess contributions are being distributed, and the account is worth 7,000. 14.3% of the account value is earnings and therefore 14.3% of the distribution is taxable. That said, such a small taxable amount is not likely to cause the beneficiary to have to file a return if they do not otherwise have to file. There is no form to report the distribution on, but if there is a taxable amount and the beneficiary has to file a return, it should be entered on line 21 of Form 1040.
Permalink Submitted by Geralyn Suhor on Mon, 2011-09-26 11:54
That’s really helpful. Thanks so much.