August
Focus: Upcoming
Deadline for Correcting Excess IRA
Contributions
IRA
owners who contribute more than the statutory
limit to their IRAs for the 2008 tax year have until their
tax filing deadline, including extensions, to correct those
excess contributions. Individuals who file their tax return or
file for an extension by their tax-return due date receive an
automatic six-month extension. This would make October 15,
2009 the deadline for calendar year filers. Failure to correct
the excess by this deadline will result in the IRA owner owing
the IRS a penalty of 6% of the amount of the excess
contribution. This penalty will continue to apply for each
year the excess remains in the IRA.
How
Excess Contributions Occur
In
most cases, excess contributions occur because the IRA owner
made a mistake and sent in too much to fund their IRA.
However, excess contributions can also occur in other cases
such as when an individual rolls-over
amounts to the IRA that are not rollover
eligible, or when an employer makes an excess SEP
contribution to an employee's SEP
IRA. Regardless of the source of the excess, it must be
removed by the aforementioned deadline in order to avoid the
6% penalty.
Removing
by the Deadline Vs Not Removing by the
Deadline
If
the excess is removed by the deadline, it must be accompanied
by any net
income attribute (NIA) to the excess. The NIA, which can
either be earnings or losses, is determined by use of a
special formula. Earnings are added to the excess and losses
are subtracted from the excess, and the net amount is removed.
The formula for computing the NIA can be found
here http://www.retirementdictionary.com/definitions/netincomeattributablenia
. The IRA owner should inform the IRA Custodian that the
distribution represents a return-of-excess contribution, so
that the Custodian completes the 1099-R
correctly.
If
the excess is not removed by the deadline, it is treated as a
regular distribution when it is removed, and is not
accompanied by any NIA.
Who
Calculates the NIA
Some
IRA Custodians will calculate the NIA. If your Custodian does
not provide that service, you will need to compute the amount
before submitting your request. You should clearly indicate
the excess amount separately from the NIA as these amounts are
processed and reported differently by your IRA Custodian. If
you are unable to compute the NIA, you can consult with a
tax-professional or retirement plan consultant for
assistance.
Tax
Treatment of Distribution of Excess
Generally,
the excess amount that you remove is nontaxable if it is
removed by the deadline. If any earnings accrued on the
amount, the (earnings) amount would be taxable in the year
that you made the contribution, which may not necessarily be
the year you make the withdrawal. In addition, you may owe the
IRS a 10% early
distribution penalty on the earnings if you are under age
59 1/2 when the distribution occurs, unless you qualify for an
exception.
Your IRA custodian
is required to indicate the year for which the earnings are
taxable on your Form
1099-R.
If
you fail to remove the excess by the deadline, it could result
in the amount being double-taxed if it exceeds the statutory
contribution limit for the year. It could also be subject to
the 10% early distribution penalty, unless an exception
applies. All this would be in addition to the 6%
penalty.
Conclusion
This
is just a high level overview of the excess contributions as
they apply to IRAs. As with most other rules that apply to
IRAs, there are exceptions to the general rule. Review your
IRA statements and your Form
5498 for 2008 to determine if you have an excess
contribution. If you do, talk to your IRA custodian about
their correction policies & procedures, and consult with
your tax professional to ensure that you take the proper
corrective steps.
