Internship complicates Roth IRA contributions

Submitted by Charles Armanetti on Wed, 2017-02-15 23:49

On Feb 6, 2017 a $5500 contribution to a 4 year old (2013) Roth IRA was made for the 2016 tax year based on expected earned income of $7393 from two income sources. The first source provided a W-2 for $1651 earned income. Two days later, I received a late 1099-MISC with a box 3 entry from the second source, an educational internship, reporting that which I expected to be earned income instead as an award(not for services) of $5742. The institution commented that the internship did not provide services to the University so a W-2 was not issued.

On Feb 14, 2017 I contacted my Roth trustee and requested two transactions.

Transaction 1: A return of excess contributions plus earnings from the Roth including $3849 plus $48.30 earnings. This was executed on Feb 15, 2017.

For Transaction 1, I am expecting the following reporting documentation will be issued by the trustee:.
A 2017 Form 1099R will be issued in Jan 2018 for the gross distribution in box 1, the taxable amount in box 2a, and with Box 7 indicating code 8J. Date of Distribution was February 15, 2017.

I am unsure if I should report transaction 1 as follows:

Option 1. Report a Distribution on 2016 IRS Form 5329 and 2017 IRS Form 1040, Line 15a, Line 15b and Line 59 and provide a statement of the transaction, or
Option 2. Report a Distribution on 2017 IRS Form 5329 and 2017 IRS Form 1040, Line 15a, Line 15b and Line 59 and provide a statement of the transaction, or
Option 3. Provide a statement on the transaction for 2016 and Report a Distribution on 2017 IRS Form 5329 and 2017 IRS Form 1040.

I also wonder if I can take an exclusion for qualified education expenses for books (08) in Part 1 box 2 of the IRS Form 5329 to offset the 10% penalty on earnings even though the Roth is only 4 years old or would you advise against it as it may open a can of worms for the sake of a small gain?

Transaction 2: A Recharacterization of $1651 in contributions plus earnings of $20.72 from the Roth to a new traditional IRA for tax year 2016. This was also executed on Feb 15, 2017. This was done to offset the taxes owed because of the reduction in Standard Deduction due to the unexpected reduced earned income.

For Transaction 2. I am expecting the following reporting documentation will be issued by the trustee:.
A 2016 IRS Form 5498 will be issued in May 2017 which will reflect a Roth IRA Tax Year 2016 contribution of $1651 on 2/6/2017, next
A 2016 IRS Form 5498 will be issued in May 2017 which will reflect a Traditional IRA Tax Year 2016 contribution of $1651 on 2/6/2017, and finally
A 2017 IRS Form 1099R with Box 7 indicating code N will be issued in Jan 2018 showing a Distribution for contributions plus earnings for the 2016 Recharacterization of funds plus earnings to the Traditional IRA.

I am unsure if this is how I should report transaction 2:

Do not report a Distribution on 2016 IRS Form 5329 and 2016 IRS Form 1040, Line 15a, Line 15b and Line 59. but do provide a statement of the transaction.
Reporting an IRA Contribution for a deduction on 2016 IRS Form 1040, Line 32 as long as all contribution limits are met.

I guess my question is mostly based on the proper way to report this.

Thanks,
Ltca



Submitted by Alan - IRA critic on Thu, 2017-02-16 01:09

  • 2016 return – you would claim the deduction on Form 1040 due to the recharacterization of part of the Roth contribution. Otherwise, the removal of the excess contribution and the details of the recharacterization are ONLY reported in explanatory statements with the return. The purpose of the statements is to let the IRS know that you no longer have an excess contribution and you have a TIRA contribution instead of a Roth contribution. They would not otherwise know since the 1099R forms will not be issued until next January.
  • Because the earnings on the return of excess contributions are taxable IN the year contributed, that will be your 2017 return. Your option 3 is correct. The penalty waiver requires that you have at least $48 of qualified HE expenses paid in 2017. You would put exception code 08 on Form 5329 for 2017. Claim the exception if you qualify for it. Books must have been required by the school, you must be a half time student etc.
  • Transaction 2 – The 5498 will report your full 5500 contribution not adjusted for the two transactions. Another reason for the explanatory statements. The 1099R will report the return of contribution, another 1099R the recharacterization transfer out of the Roth and a companion 5498 showing receipt of the former by the TIRA, but will not show which year it was for.  Report the recharacterization only with explanatory statement with 2016 return and IRA deduction on Form 1040 just as you said. I think the recharacterization 1099r/5498 should not be reported on your 2017 line 15 at all because it does not apply to 2017. Line 15a should only be filled if the transaction both occurs in the year AND applies to that year.

Submitted by Charles Armanetti on Thu, 2017-02-16 12:55

Thanks for the clear, rapid and complete response. You can’t imagine the amount of conflicting advice I have recieved on transaction 2. I guess more examples with variations in pub 590 would be helpful, or a clearer definition of when and when not to report on line 15a.Thanks again,Ltca

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