Roth ROE Question
Hello,
I have a client with the following scenario that I was looking for some feedback on:
Client made a contribution to their Roth IRA on 6/6/24 for $7,000. Later on in the year, lets say 8/8/24, the client requested a distribution of the $7,000. Now, the CPA is reviewing the client’s tax returns and realized the client’s 2024 contribution was ineligible.
Question: Typically we would recommend the client request a return of excess (including gains or loss), but they already processed a distribution. What is the best approach to correct the $7,000 excess contribution since the funds are no longer in the client’s account and we are well past the 60-day rollover period?
Thank you.
Permalink Submitted by Alan - IRA critic on Thu, 2025-03-13 11:48
The distribution was not processed as a return of excess, and an actual return of contribution must be requested to eliminate the excise tax. Any gain included in the return of excess will be taxable on the 2024 return, so unless client is filing an extension, the return of excess should be requested right away if the filing is to be completed before 4/15, so the CPA will know the amount of any gains that must be added to 2024 income.
However, if there is less than 7000 left in the Roth IRA to process the return of excess, please advise, and if so whether client has other Roth IRA accounts.
Permalink Submitted by Kevin O'Hearn on Thu, 2025-03-13 12:48
Thank you Alan. There is less than $7k left in the Roth IRA and they do not have any other Roth IRA accounts. The client removed all of their cost basis (the contributions) in 2024 because they are under 59 ½ and needed money without paying taxes and/or penalties. The remaining amount in the Roth is all of the earnings, which is less than $7,000.
Permalink Submitted by Alan - IRA critic on Thu, 2025-03-13 17:22
This is a very rare fact pattern. Apparently, the client has been pulling his Roth IRA contribution basis leaving only the gains in the Roth. Then, a 2024 excess contribution was made that was not removed correctly. If the excess is not removed properly by the due date, there will be a 6% excise tax on the 2024 return – Form 5329, but the excise tax for 2024 will not exceed 6% of the year end Roth balance if that balance is under 7000.
The Form 8606 Inst include a “regular Roth contribution worksheet – Line 22” which includes a footnote that returned contributions cannot be included in regular contribution basis. As a result, if the 2024 excess contribution is now returned in order to avoid the 6% excise tax, it will turn the 2024 distribution of 7000 into a taxable distribution of gains because line 22 will not have enough basis to cover the 7000. The excise tax will be less than the income tax if the reason for the excess was MAGI that was too high. If the excess was due to no earned income, then the income tax could be lower than the excise tax.
If client will have earned income in 2025, but MAGI that will allow a Roth contribution for 2025, the client could choose to absorb the excess on Form 5329 for 2025. That would eliminate the need to have the excess returned and would also eliminate the 7000 distribution taken last year from being taxable. All that would be owed is the 6% excise on the lesser of 7000 or the 12/31/2024 Roth balance. The Roth would still be mostly gains, but the gains would not have been distributed in 2024.
This might drive the CPA crazy, given the choices.