Elimination of 6% Excess Roth Contribution Penalty

Submitted by Tom Cooper on Fri, 2012-12-14 23:38

A client of mine did a Roth conversion in 2009. Subsequently, he and his wife ended up filing taxes as Married Filing Separately, thus not eligible for the conversion. Unfotuntately, he left it in place and has paid the excise tax for three years. The account is slightly lower in value at this time than at conversion.

What are the options at this point?

1) Can it be recharacterized to a regular IRA?
2) If a distribution is taken, is that a taxable distribution as it was a “failed” conversion, or is it tax-free as a Roth.
3) Any other possibilities?



Submitted by Alan - IRA critic on Sat, 2012-12-15 00:24

  • No, the 2009 recharacterization deadline was 10/15/2010
  • The failed conversion is treated as a regular excess Roth contribution. It can be distributed tax free like a regular Roth contribution before year end to eliminate another year of 6% excise taxes. The distribution would be reported on Form 8606, best accompanied by an explanatory statement regarding the failed conversion.
  • This has been costly. A MFS return can be amended to a joint return, and his conversion would be valid and he could get back the excise taxes already paid. The deadline for that is 4/15/2013, but he needs to know right away so he can still withdraw the conversion funds by year end if necessary.
  • Note that as an excess regular Roth contribution after the due date, any earnings he has generated on the conversion get to remain in the Roth IRA. There is NO earnings calculation after the extended due date.

 



Submitted by mk foss on Sat, 2012-12-15 00:27

The IRS is issuing Private Rulings to people in these circumstances. Without a ruling of your own, I’m not sure how you would proceed. If the ruling is allowed, the client would have 60 days to undue the converstion by putting the money back in an IRA. The 6% penalty applies for every December 31 that the excess funds are in the account. The ruling involves a fee ($4,000 I think) to IRS plus professional time to write it up and get it through the IRS. Ed’s CPA practice probably handles these requests.If nothing is done, the Roth that he has is probably invalid. If the client was under 59.5 when he did the conversion, he’d owe a penalty for 2009 plus interest. He could file Form 843 for each year and request that the 6% penalty be refunded. Any earnings on the account would be taxable currently so amended returns for 2009-2011 would be involved as well. I’m just speculating about this because I haven’t seen the situation in practice but I can’t think of any other way it would be treated.



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