excise tax relief from Roth contribution timing?
In mid-2005 I retired at age 55 without any kind of IRA. In both 2006 and 2007 my only income was from a pension and miscellaneous investments, the sum of which was within IRA MAGI limits. Thinking that simply being within the limits was sufficient qualification, I established a Roth IRA just prior to the April 15, 2007 tax deadline funding it with $10,000 split equally between 2006 and 2007. Very recently I realized that, since almost none of my income qualifies as “earned”, only a small portion of what I contributed was actually eligible and now need to undo this mistake. I understand the 2007-designated portion of my contribution can be returned to me without assessment of tax or penalty if withdrawn according to IRS “timely basis” conditions. However, does the fact that the 2006-designated portion of my contribution was actually made in 2007 provide any relief from the 6% excise tax? Furthermore, if I do need to pay the excise tax on the 2006 portion and assuming I clear up this matter prior to my 2007 tax filing, will I need to pay the 6% assessment for one year or two? If earnings factor into this matter, the investments in this account have produced only negative earnings to date.
Permalink Submitted by Alan Spross on Wed, 2008-03-05 20:56
It appears you understand how to correct the 07 excess contribution, since that can still be done on a timely basis, and if done prior to filing your return, can be explained on the return with a statement. With negative earnings, there is no income to report.
The 06 excess contribution will take some extra work and expense. Since the recharacterization deadline for it has passed, you have incurred the 6% excise tax for both 06 and 07. The 06 can be paid by filing a stand alone 5329 and paying the $300 due (6% of 5,000 or somewhat less if you did have some taxable comp). The IRS may bill you interest on the late payment of that amount as well.
You will also need to attach a 5329 to your 07 return and pay that same amount again, since you did not correct the excess from 06 by 12/31/07.
There is no relief from the penalty due to your not having actually made the 06 contribution until 07, because the contribution is deemed to have been made on the last day of 06. If the value of the account has dropped below the amount of your excess contribution from 06 on 12/31/07, your penalty would be based on that lower value.
OK – now it’s 08 and you have a decision to make. Has your investment loss erased the portion of your 06 contribution that was allowed? If not, do you wish to continue your Roth with that very small amount, or just close the account altogether?