IRA
Client took 126K in 2016 of taxable money and put into IRA. Not sure how the custodian let this happen. However, 126K was deposited into IRA. Account grew to 158K.
No deduction was taken for the contribution to the IRA.
Client took a withdrawal of 158K in 2020 upon the advice of the broker.
Client now has 1099-R for 158K with box 1 as gross distribution of 158K and box 2 as taxable distribution of 158K. Box 7 distribution code is 1 (early withdrawal).
Federal tax withheld of 31K and State tax withheld of 6700,
Any idea on how to correct this giant mess?
Permalink Submitted by Alan - IRA critic on Fri, 2021-03-26 18:06
Start through the 5329 process to determine the excess amount for each year. Client may have been eligible up to the contribution limit, slightly reducing the excess amount on which the 6% excise tax is calculated. Report the proper 6% excise tax. Client can file Form 8606 reporting a non deductible 2016 contribution, BUT ONLY up to the contribution limit of 5500/6500 catchup.
Carryover over excess from 2016 5329 to the 2017 5329, paying attention to whether any of the excess can be absorbed as a 2017 contribution. Follow suit for 2018 and 2019 5329 forms.
The 2020 5329 will report the distribution of 158k on line 11, and eliminate the excess. There is no excise tax due for 2020. For the income tax, report the distribution on Form 8606, applying the limited basis of 5500 or 6500 showing on line 2 and 3. It is important to note that the excess amount from the 2016 5329 (roughly 120k) is excluded from line 7, which will reduce the income tax. Broker erred about taking a distribution of 158k, since only around 120k was needed to eliminate the excess. The amount over 120k will be subject to tax and penalty. Note that no earnings are involved here since this is done well after the due date for the 2016 return. Earnings remain in the IRA, and this partially offsets the pain of 4 years of excise taxes.
I do not know if tax programs handle this correctly. Knowing the expected output will help check the accuracy of the tax program. An explanatory statement with the return will help.
I assume there were no other contributions or distributions from any TIRA during this period of time or the above figures will not be correct.
IRA custodian did client no favors by accepting such a large contribution in 2016 unless client told custodian this was a rollover. I’ll assume there was no distribution made that could have been rolled over in 2016.