Question about Excess Roth IRA contribution that hasn’t been covered here!

Submitted by Jonathan Levitt on Thu, 2014-12-25 11:11

I live and work in Beijing China. For my 2013 taxes which I filed in January 2014 I took the foreign earned income exclusion. I then opened a Roth IRA in Feb of 2014 and contributed for 2013 5500$. I later found out that since I had zero income that I was not eligible to open an IRA. I liquidated my IRA account 3 days ago. Vanguard asked whether I want 10% withheld for Federal Taxes so I agreed. The remaining money is now in my account.

I called the IRS yesterday, and speaking to one of their agents.

He mentioned that I would only be charged 6% excess contribution tax.

He told me that the early disbursement rule does not apply to me since I wasn’t supposed to have had the account to begin with so the whole thing is an excess contribution.

He told me I would need to file form 5329.

The issue I have now come across that I need clarification on is the following:

On the 2014 Turbo Tax when I open this form it asks for excess made for 2014 and has nowhere to enter that this was an excess made for 2013.

So does this mean I have to amend my 2013 tax return? ( I opened the roth IRA after I submitted my tax return for 2013)

If so then what about the 5500+ 550 ( earnings) that I made, does that get reported on 2014’s TAXES?

Is the 6% figure correct and is that based on the principal or the principal + earnings?

The fact that Vanguard has 10% for federal tax, if my total tax is only 6% then will I be able to claim a credit for my taxes?

I hope there is some simple way out of this!

Thanks for any help!

Jonathan



Submitted by Alan - IRA critic on Thu, 2014-12-25 21:50

Before getting to your question, we need to know whether you specifically requested a return of your 2013 contribution (a corrective distribution) or whether you asked to close the entire account. Your 1099R will be coded to reflect how your request was worded. You will not get the 1099R for another month, but you may be able to check your Roth statement or on line account to see how this was processed. If it was not processed correctly, you need to have them change this to a return of your 2013 contribution. We need this done to know what the 1099R will say before a proper filing is done that reflects the 1099R. 

Submitted by Jonathan Levitt on Fri, 2014-12-26 08:55

Thanks for responding. I looked on my vanguard account. I have the following to provide. They have my closing out of my IRA as a:Beginning balance 330.33012/23 Early roth distribution $ -5,446.48 $ 18.32 -330.330 .000 Federal withholding -605.17 I also noticed that they issued back in May they issued a 2013 form 5498 that has it listed as a 2013 contibution to Roth IRA.So since they are characterizing it as an early distribution, I should ask them to recharacterize it as a return of my 2013 contribution, is that what you are advising?  ThanksJonathan  

Submitted by Alan - IRA critic on Fri, 2014-12-26 19:39

  • Yes. Your account info is not conclusive, but does not mention a specific return of your 2013 contribution, so it appears that it was not processed as such. The 1099R coding is different. You should call them and ask them if the 1099R will have a code of 8 in Box 7. The distribution amount would have been the same, so all they have to do is code the distribution as the return of an excess contribution rather than just a general distribution. This is the only way you will avoid the 6% excise tax for 2013. There is no regular income tax either way because you only received your regular Roth contributions back and you did not deduct the contribution on your 2013 return.
  • If the 1099R is coded 8, you will avoid the 5329 for 2013 (amended return) and the excise tax. But you will owe tax and penalty on the earnings amount on your 2014 return, or because of your exclusion maybe no tax due, just the 10% penalty on the earnings. That is far less than the 6% excise tax. Once this is resolved and you know what the 1099R will show, you can do your 2014 return. By the way, why do you file these returns so early? It hardly gives time for Intuit to get all the bugs out of their 2014 tax software, and even without that you should wait until you get the 1099R unless you are positive of all the codes and numbers in each box. That would delay the return for another month.
  • I assume that you did not make an IRA Contribution for 2014.

Submitted by Jonathan Levitt on Sun, 2014-12-28 03:55

Thanks for your response once again. I have contacted Vanguard via email and they will get back to me by Tuesday regarding the question about recoding. One thing the IRS told me on the phone call whch i recorded, was that I cant avoid the 2013 6% penalty since I contributed for 2013, and if I wanted to avoid the penalty I wouldve had to remove it by July which was 6 months after I filed my return, even with a 3 month extension since I am overseas, that wouldve brought me to October, so He said that it was good that I got it out before the new year or else I wouldve had 2 6% penalties to deal with. Any thoughts? I’ll let you know what Vanguard says. I appreciate the help. Jonathan

Submitted by David Mertz on Sun, 2014-12-28 12:28

Yes, this agrees with what I provided in my reply below.  It’s too late to avoid the penalty for 2013, but distributing $5,500 from the Roth IRA corrects the excess for 2014 and beyond.

Submitted by David Mertz on Fri, 2014-12-26 19:51

  • Since the distribution was 3 days ago, this could not have been a return of a contribution for 2013.  The details suggest that this is a regular distribution.
  • As the IRS indicated, you have an excess contribution of $5,500 for 2013.  Assuming that your 2013 tax return does not already show the excess contribution, you need to amend your 2013 tax return (or perhaps send Form 5329 stand-alone if this is all they requested) to report the excess contribution on 2013 Form 5329 Part IV, resulting in a 6%, $330 penalty that you will need to pay with this.
  • On your 2014 tax return you will need to report the distribution that you made from the Roth IRA.  $5,500 of the distribution will be a nontaxable return of the basis in your Roth IRA(s).  Assuming that you have no other Roth IRA accounts to which you have made contributons, unless you roll the $551.65 of earnings back into a Roth IRA within 60 days of the distribution, the earnings will be subject to ordinary income tax and a 10%, $55 early-distribution penalty (assuming that you are under age 59½).  Without rolloing over the earnings, the entire distribution will appear on Form 1040 line 15a but only the earnings portion of the distribution will appear on line 15b. The early distribution penalty will be calculated on Form 5329 Part I and appear on Form 1040 line 59.
  • Since the earnings themselves are not an excess contribution, they are eligible for rollover; rolling over the earnings will avoid the tax and early-distribution penalty on the earnings.  If you roll over the earnings, Form 1040 line 15a will show the entire distribution but line 15b will show a zero and the word ROLLOVER.  Form 1040 line 59 will show zero since you will no longer have an excess contribution or an early distribution.
  • Whether or not you roll over the earnings, line 23 of Form 5329 Part IV will show that you no longer have an excess contribution in a Roth IRA because the distribution of $5,500 after the due date of your 2013 tax return has resolved the excess.
  • You will be credited on your tax return with any taxes that were withheld from the distribution.  If the total amount withheld and paid in estimated taxes throughout the year from all sources exceeds yoru overall tax liability, you will receive a refund of the excess taxes withheld or paid.

Submitted by Jonathan Levitt on Sun, 2014-12-28 04:05

Thanks for your reply.  If I understand correctly I could roll it over, but that would mean that I would still have to have income to contribute this money right? I have income this year from capital gains, but zero earned income for The foreign earned income exclusion. So you’re idea is that I roll over the earnings 550$ and then I wont have to pay the 10% and then I can keep the excess 550$ in my roth IRA. If I only have capital gains can I still contrinute to an IRA, or is only earned income considered. I see on the IRS website they separate the two.I am also working on getting Alan the answer about recoding the distribution as a removal of excess.I’ll let you know. Thanks for the helpRegards Jonathan 

Submitted by David Mertz on Sun, 2014-12-28 13:03

  • Because you paid (or will pay with an amended 2013 tax return) the 6% penalty for 2013, any earnings attributable to the original $5,500 excess contribution are not excess.  The earnings are allowed to remain in a Roth IRA the account, which is why you can roll the earnings over to another Roth IRA account within 60 days (or back to the original Roth IRA account, if it still exists).  You can roll over only the $551.65 of earnings, not the original $5,500 that was an excess contribution.
  • An eligible rollover made within 60-days of the distribution does not require income.  A rollover is not a new regular contribution.
  • Presumably you are under age 59½.  Expect the code in box 7 of the Form 1099-R to be J.  Any other code would indicate that Vanguard made an error in the handling of this distribution.
  • The simpler way that the correction of the excess could have been handled would have been to have distributed only $5,500 from the Vanguard account, with no tax withheld.  The $551.65 that I’m suggesting that you can now roll over could have remained in the original account.

Submitted by Jonathan Levitt on Mon, 2014-12-29 12:18

Ok so if I get this straight.1. rolling over the earnings avoids the 10% 55$ tax2. File an ammended return for 2013 showing that an excess contribution was made in 2013 for 5500 on form 53293. file form 8606 as ALan suggested for 2014 taxes showing a distribution and the rollover of the earning part only within 60 days as you mentioned DMxDid I get the above right? I am also a bit confused that since  I filed my taxes in January 2014 and made an excess contrbution for 2013 and owe 330$ on this because of the 6% penalty. Since I owed tax and didnt pay it will I have to pay a tax on top of that? The IRS told me on the phone I will just have to pay 6%So my next questions are With the 10% I had vanguard withold ( see my initial post), can I use that to pay for my 2013  6% tax on my excess contribution on my 2014 taxes?If yes how do I do that, if No how do I get that money back?Or will I have to pay that separately and use the tax they witheld as a 2014 credit for whatever I owe this year?You both are a great help and I really appreciate the time youve spent on this.Regards Jonathan

Submitted by Alan - IRA critic on Mon, 2014-12-29 15:58

  • 1) Yes, rolling over the earnings avoids both tax on the earnings and a 10% penalty on the earnings.
  • 2) Yes, file a 1040X with Form 5329 and pay the 6% excise tax on the 2013 excess contribution. The IRS could bill you interest later on the late payment, but they probably will not as they indicated to you. It would be very little even if they did bill you.
  • 3)  Your withholding on the recent distribution is 2014 withholding and can only be applied to your 2014 tax bill. If you have no tax liability for 2014 you will have to file a return to get a refund of this withholding. You cannot apply it to pay the 6% excise tax.

Submitted by Alan - IRA critic on Sun, 2014-12-28 19:33

Jonathan, in your original post I overlooked that your distribution had just occurred, so as Dmx indicated it is too late for a specific corrective distribution of a 2013 contribution. The rest of the postings are correct, and you should roll over 551.65 that represents the earnings before withholding within 60 days of when you received the distribution. That will eliminate tax and early withdrawal penalties on these earnings and preserve the earnings in your Roth IRA. You would only have to pay the 6% excise tax for 2013 plus the IRS could bill you late interest on the excise tax you are paying late with Form 5329. You will also have to file an 8606 for 2014 reporting the distribution. If you roll over the earnings, only report on line 19 of Form 8606 the amount of your original contribution of 5500 (even though you received in the distribution less due to withholding). There will be no tax generated. Show “rollover” next to line 15b if you complete the rollover and of course remember to claim credit for the withheld amount on your 2014 return. Finally, make a note to yourself if you do the rollover that your Roth IRA has no basis (unless you made contributions or conversions before 2013) and the amount in your Roth is all earnings. You will need to know that if you every take another Roth distribution. Again, sorry for the error and hope you did not spend too much time trying to get VG to recode the distribution, because they will not do so.

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