what to do about ineligible roth ira conributions
Hi. My clients contributed the maximum at the end of 2013 to new ROth IRAs. The said their income would be around $150k. Now in early Feb of 2015 it is past the recharachterization date of Oct 15 of 2014, but it turns out their income for 2013 was $189K – so they were not eligible for a full contribution. What do we have to do to correct the error? Thanks.
Permalink Submitted by Alan - IRA critic on Fri, 2015-02-20 00:29
First, be sure the 189k reflects modified AGI. If it does, their MAGI exceeds the max of 188k to make ANY Roth contributions, so the entire contributions are excess contributions. First, they need to file a 1040X with a 2013 Form 5329 for each spouse to report the 6% excise tax. With the 2014 return, they will also include a 5329 but if they are eligible and did NOT contribute for 2014, the 5329 will apply as much of the excess as possible to 2014. But if they are again not eligible, they will owe another 6% for 2014. This same situation exists for 2015, but if they feel they will qualify to apply the excess in 2015 they should not withdraw it. A new excise tax is incurred every year end, but they have 10 months now to either withdraw the excess or apply it to 2015. This is all done on Form 5329. The IRA custodian is not involved unless they need to withdraw the excess. Note that any earnings on the excess contributions get to remain in the Roth IRA so they might want to wait until late in the year to withdraw the excess if they have to and let the contribution generate more earnings in the Roth before withdrawing closer to year end.
Permalink Submitted by Ronald Birnbaum on Fri, 2015-02-20 11:56
Thanks for your reply. Just want to make sure I understand. Looks like their income was too much in 2014 too. The contributions were originally made on the last day of 2013. They still need to file a 2013 5329? You mention 6% – 6% of what – the entire contribution? So it is the same amount in 2014 as well – 6% of the original contribution? THey will probably not qualify for 2015 as well. So what is needed to witthdraw in 2015 – the original contribution again? But you didn’t mention withdrawing anything for 2013 and 2014 – I guess because it is too late to do that, but since we are in 2015 they have until October to withdraw the original contributions and leave the earnings? And that gets reported on Form 5329. Do I get it? Thanks!
Permalink Submitted by Alan - IRA critic on Fri, 2015-02-20 17:01
Yes, a 2013 5329 is needed no matter when they made the 2013 contribution because they were not eligible for a Roth contribution. The 6% excise tax is due on the full amount of the excess contribution for 2013 and for 2014 since they could not apply any of the excess in 2014 either. This year if they expect to be over the income limit again, they need to withdraw the excess contribution from 2013 by year end, not by 10/15, although they could do it now if they just want to get this over with. For 2015 if they withdraw the excess contribution amount (no earnings), they will need an 8606 to report that distribution, but it will be tax free because it comes from regular Roth contributions. And they need a final 5329 which will show that the excess they entered 2015 with has now been distributed and it will show that no excess remains. There will be no 6% excise tax for 2015 as long as this is done by the end of the year. They need to do the oldest 5329 first since each year brings forward the excess remaining on the 5329 to the following year, until it is gone (2015).
Permalink Submitted by Ronald Birnbaum on Fri, 2015-02-20 20:10
So the excise is only on the original contributions. Earnings are not counted. But taxes will be due on the earnings but they can be left in the IRA. They may be able to qualify for 2014 as I think they can do a SEP which will lower their income enough to be able to do the Roths. We don’t know that for sure yet. IF all this makes sense I have all I need! Thanks again.
Permalink Submitted by Alan - IRA critic on Fri, 2015-02-20 20:25
The excise tax and earnings distributions are mutually exclusive. So if you owe the 6% tax, the earnings are not distributed and remain in the Roth IRA where they eventually could be tax free. I would not remove the excess before December while a good chance exists that their MAGI will be low enough this year to apply the excess to 2015.