Return of IRA Contribution with Earnings – Taxation

Submitted by David Diamond on Tue, 2018-01-30 22:42

My wife made a 2017 IRA contribution during 2017 for $6,500 which she ultimately was ineligible to make as a deductible contribution. Brokerage firm returned $6,500 + $2,300 earnings in Jan. 2018. Form 1099-R for this transaction won’t be issued until early 2019. She’s under age 59.5, but we had medical expenses + medical insurance premiums in excess of the $2,300 (after reducing by 7.5% of AGI).

We need to recognize $2,300 in ordinary income for the 2017 tax year and appear to meet an exception to the 10% early distribution penalty because of the medical expenses. Using Turbo Tax, it’s not clear what needs to be done.

What forms need to be completed and is a letter of explanation to the IRS necessary? Any help is appreciated. Thank you.



Submitted by Alan - IRA critic on Wed, 2018-01-31 00:11

  • No letter or explanatory statement needed. File Form 5329 for her SSN, Part I and show exception code 05 on the indented line for line 2. That will override the penalty code 1 on the 1099R to the extent of the eligible paid medical expenses. 
  • Don’t know if your joint modified AGI was too high for a Roth contribution or not, but if the Roth contribution was allowable, it would have been better to have had the contribution recharacterized as a Roth contribution. It would have preserved the 2300 of earnings for her Roth and eliminated the tax bill for the earnings distribution. Or if modified AGI was also too high for a Roth contribution, it still would have been better to leave the 6500 in the TIRA as a non deductible contribution and the earnings would have remained in the IRA. 
  • Don’t know how Turbotax works to report the distribution. Some tax programs require you do issue a dummy 1099R to report the corrective distribution with code 8,1 in Box 7. Box 1 would be 8800 and 2a 2300.
  • Another question is whether the 2300 was calculated correctly. That amount reflects the % gain of the entire IRA account that held the 6500 contribution. That’s a gain of 35.4% which is quite possible but well in excess of the market average over this period of time. Custodian sometimes mess up the calculation by incorrect inputs into their software.

Submitted by David Mertz on Wed, 2018-01-31 02:18

In this case the dummy 2018 Form 1099-R would have codes P and 1 because the contribution was in 2017 but the return of the contribution was in 2018.  (The same result can be accomplished with a dummy *2017* Form 1099-R with codes 8 and 1, but the actual 2018 Form 1099-R will have codes P and 1.)  An explanation statement *is* required for the return of contribution.

Submitted by Alan - IRA critic on Wed, 2018-01-31 03:17

DMx, I think the dummy 1099R to make the earnings taxable in 2017 will have to be a 2017 1099R, so would be coded 8,1. While the real 1099R will be a 2018 form with code P, 1 as you indicated, that P would just mean the earnings must be reported on the 2017 return, which was already accomplished with the 2017 dummy 1099R.Of course, if it was possible to make the dummy 1099R on a 2018 form, then the coding would be the same as the actual one will be, but I don’t think it is possible to submit a 2018 1099R with a 2017 return.

Submitted by David Mertz on Wed, 2018-01-31 03:44

2017 TurboTax supports entering the form with codes P and 1 and indicating that it’s a 2018 Form 1099-R.  The result is the same as if a 2017 Form 1099-R with codes 8 and 1 is entered, except in the unusual case where box 4, 12 or 15 shows tax withholding.

Submitted by David Diamond on Wed, 2018-01-31 13:44

Alan, Thanks for your quick and clear responses.  Wife has 1099 earnings (and individual 401k plan) as well as W-2 earnings; AGI ~ $150k, so under Roth limit.  I didn’t think of the Roth conversion angle.  Could she (1) return the $8,800 back into her account (<60 days since distribution), then (2) recharacterize same $8,800 (further adjusted for earnings as needed) into her Roth?  Permanently saves taxes on earnings portion.By the way, $2,300 calc. is fine - most of her IRA$ is in an int'l small cap fund which returned over 35% during investment period.

Add new comment

Log in or register to post comments