Earnings on Roth Excess, after tax filing

Submitted by Kevin O'Hearn on Wed, 2023-04-19 13:01

Hello,

My question is related to earnings on an Roth excess contribution that remain in an IRA because the contribution was removed AFTER the tax filing deadline. See below. Its clear the earnings portion are taxable when distributed.

The definition of a qualified Roth IRA distribution provides that any distribution of an excess contribution plus earnings will never be treated as a qualified distribution. [ I.R.C. §§408(d)(4), 408A(d)(2)(C)] That means that the earnings being distributed in a corrective distribution will always be taxable, even when the distribution would otherwise satisfy the definition of a qualified distribution (see Q 4:15).

My questions are:

1. If the taxable earnings are left in the Roth, is the growth that accrues on this amount distributed as a qualified or non-qualified distribution?

2. If earnings were $1,000 would they just pay taxes on the $1,000 when distributed down the road? Or would the continued growth on the $1,000 also be taxed as a non-qualified distribution?

Any feedback would be greatly appreciated. Thank you.



Submitted by Alan - IRA critic on Wed, 2023-04-19 17:07

  1. If the Roth is already qualified, those earnings would also be qualified and tax free. If the Roth is NQ, then those earnings would be treated the same as other Roth earnings and would be taxable and subject to the usual Roth IRA ordering rules for distributions where earnings come out last.
  2. Continued growth is ignored and becomes just a portion of other earnings in the account. If the Roth is qualified, all such earnings are non taxable. 
  3. When the 6% excise tax is due because an excess was not corrected by the due date, any gains remain in the Roth and are no longer tracked. In other words, when the excise tax is due, separate distributions of gains does not occur, so the excise tax is mutually exclusive with either the removal or taxation of gains. 
  4. When the investment in the Roth has substantial gains, a taxpayer may intentionally NOT correct the excess by the due date to eliminate taxation of the earnings. So if an excess contribution of 6k has gained 1500, in order to avoid distribution and tax on that 1500, the excess is not removed until just after the due extended due date (10/15 of the following year). While an excise tax of $360 will be due, ordinary income tax on the 1500 is avoided which might be more than 360, and the earnings remain in the Roth. 


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