IRA – Big Mess
Hello:
I am wondering if I can get some guidance regarding a particular situation – I have a client that deposited 175K into an IRA in 2007 marking rollover contribution. However, the money was not a rollover but from a nontable legal settlement. During 2007 she pulled out 30k and received a 1099R with box one checked no known exceptions under 59 1/2. In 2008 she pulled the rest out and was told by the bank that she would receive another 1099R in 2009 for 2008 distributions with box one checked.
I am wonderig how to clear this up since really a mistake and never should have been deposited into IRA and 1099R if anything should have reported as excess distribution code.
Any help would be appreciated.
Thank you.
Permalink Submitted by mk foss on Mon, 2008-11-24 22:47
Someone else may have another take on this but I would do the following:
File Form 1040-x for 2007, explain that there was no rollover and that the 175k was nontaxable. File From 5329 and pay the 6% penalty for over contribution on the 12/31/07 balance of the 175K.
For 2008 show that she received the 1099r income and back it out explaining that it was 2007 nontaxable income and not IRA funds. Attach explanations to the return of everything that happened.
IRS is likely to send notices when it matches the 1099s with the returns and its easier to send a letter that says “here is the explantion attached to the original return filed”.
Permalink Submitted by Jose Morales on Mon, 2008-11-24 23:12
If the client requested that these funds be deposited into an IRA account as a rollover when they were not eligible then this would be an excess contribution in 2007 for the full amount of $175K minus any amount that the client was eligible to contribute to an IRA in 2007. There is a 6% tax penalty due for any excess contributions not removed (including earnings attributable) by the individual’s tax filing deadline, including extensions.
If the client could have made a full contribution to an IRA in 2007 then $171K would have been considered an excess contribution and $4K would be considered a contribution that could be deemed an excess if the client wished to not make the contribution.
As things stand the client withdrew $30K in 2007 which they will have to report to the IRS as an excess contribution correction. This will not match what is on the 1099R that was given them but that is not the fault of the issuing financial institution if they were not aware that these funds were not eligible for rollover to an IRA. Your client can try to have them issue a corrected 1099R for the distribution but being that they have an obligation to accurately report transactions on IRA accounts based on the information they have at the time they technically did not issue an incorrect 1099R.
For 2007 your client may have to amend their tax return to show the distribution as an excess contribution correction. The earnings attributable to the $30K should have been removed as well, as that portion would be subject to tax and penalty, but they weren’t. Since it is past the tax filing due date plus extensions for 2007 the client should reported an excess contribution of $141K that would be subject to a 6% tax penalty. The additional 4K would be considered the client’s 2007 IRA contribution, unless they were not eligible to make that contribution, in which case the excess subjec to the 6% penalty would be $145K.
For 2008 you still have time to make the financial institution aware of the excess that occurred in 2007. The client needs to remove either $141K or $145K by the tax filing deadline in order to avoid paying an additional 6% tax penalty. Since the financial institution will now be aware of the excess in 2007 the 1099R for any amounts taken so far should be coded as an excess contribution correction. Any earnings above the $141K or $145K that are removed will be treated as a dististribution and coded based on the individual’s age as either premature or normal.
Hopefully you are not thoroughly confused by now.