Undoing Roth contribution made with “unearned income” in 2023
Follow up question please — My 22 yr old son received $13,000 in 2023 as a pre-employment “bonus” which you stated wasn’t considered “earned income” in my previous question. Thank you for your help. He had no other income in 2023. He is currently employed and earning income in 2024.
Since it’s not “earned income”in 2023, what does he do to correct the Roth contribution that he made and invested in stocks in 2023. Can he open a Traditional IRA now in 2024 with earned income (or would it be considered a 2023 Traditional IRA if he is recharacterizing from a 2023 Roth and is he ineligible for a TIRA because he had no “earned income” in 2023?) and recharacterize the Roth to the TIRA?
He has an extension on tax filing until October 15th, 2024–while we are figuring out what to do.
If he is ineligible for a recharacterization, would he just sell the stocks that were bought and remove the total amount–contribution and earnings and enter the earnings as income for tax purposes. Is there a special process so as not to be considered an early distribution with penalties? Also what tax year would the Roth undoing and earnings on the stocks sold be considered for –the original 2023 contribution or when it’s “reversed” in 2024??
Please advise. Thanks so much.
Permalink Submitted by Alan - IRA critic on Mon, 2024-04-15 00:16
There are two options to address the 2023 excess contribution. Recharacterization cannot be used to change the year of a contribution:
He has until 10/15/2024 to request a return of the excess contribution adjusted for gain or loss. Any gain distributed will be taxable on the 2023 extended return because that was the year in which the contribution was made. If requested, some custodians will apply the original contribution as a 2024 contribution, but there will still be a 1099R issued next January showing that any gain is taxable on the 2023 return. The gain would be returned and is subject to income tax but no penalty.
If these investments had a large enough gain while in the Roth IRA, he could pay the 6% excise tax on the excess contribution and assign the contribution to 2024 on Form 5329. This avoids any distribution or tax on gains and contacting the custodian. But unless the gain is large and his tax rate is high enough for the tax on the removed gains to be higher than the excise tax, this is not a good solution and the contribution should be removed and the excise tax avoided. And it’s unlikely that he has a large enough gain on a contribution that has only been in the Roth IRA under 4 months for this option to be viable.