Excess Roth Contribution
A client made a 2007 Roth contribution in January 2008. Her 07 AGI was too high for a Roth contribution. The $5000 contribution now has a value of $3500. She appears to be past the recharacterization time frame. Her option appears to be to withdraw the balance from the Roth.
Question 1. Is that her only option?
Question 2. If so, would dividends/cap gains from the funds be considered earnings that would be reportable for tax purposes?
Question 3. Would the 6% penalty apply to the original contribution or the current balance?
Thanks for your help.
Permalink Submitted by Alan Spross on Tue, 2009-03-03 15:53
Corrective options are reduced now that the extended due date of 10/15/2008 has passed.
If the client qualified for a Roth contribution for 2008 that she did not make, the excess amount from 2007 is automatically applied to 2008, but Form 5329 should be filed for 2007 to pay the 6% excise tax for 2007 and also for 2008, either to apply the excess to 2008 or to again include another 6% charge for 2008.
SInce excise taxes are due, the earnings or losses on the contribution are no longer a factor. If the excess cannot be applied to 2008 or 2009, the amount of the excess contribution (not adjusted for losses) should be withdrawn from the Roth. If that happens in 2009, a 2009 5329 will also be needed to report the elimination of the excess amount. That would eliminate the penalty for 2009. An 8606 would also be needed to report the ordinary tax on the distribution, but since the distribution will almost certainly come from regular contributions, there will be no tax due for the actual corrective distribution. The total tax bill would be either one or two 6% charges plus any IRS billed interest for late payment of the 2007 excise tax.
The 6% excise tax is applied to the smaller of the amount of the excess contribution OR the value of all Roth IRA accounts as of 12/31 of the respective penalty year. Therefore, if this was client’s only Roth IRA and it dropped to $3500 as of 12/31/08 and the excess could not be applied to 2008, the 6% levy would be applied to 3500 and not 5000. The 2007 excise tax however would be based on the lesser of 5,000 or the value as of 12/31/07.