Excess Contribution 5 years old.
An Enrolled Agent came to me with a client’s problem. 5 years ago he put $25,000 in a brokerage account, and accidentally filled out an IRA account and the custodian opened it as such. He is now age 70. He recently took a distribution of the whole account, which if I remember correctly is not with the original custodian–I think he rolled it over about two years ago. What does he do now? Does he file a 5329 for each year and pay the 6% penalty for each year? He got no deduction for it so I assume he would pay no income tax except for on earnings, if any? Does he file a form 8606 to establish it was after tax money? If so does he file only one for the year it was contributed? Anything else?
Thanks so much,
Lee
Permalink Submitted by Alan Spross on Thu, 2011-11-10 21:37
lee,
FIrst time I recall hearing of this exact problem, and it can really become a quagmire. It also can become even more complex depending on what OTHER TIRA contributions and distributions have occurred since the excess contribution.
According to the Inst for Form 8606 p 4, after the extended due date passes a taxpayer cannot receive a tax free return of an excess contribution unless 3 conditions are met. He meets 2 of them, but fails on the one that requires the excess contribution NOT to be more than what is allowed for that year. 25k far exceeds what was allowed, so a fully tax free distribution per the 1099R to be issued is not possible. Apparently, the IRS considers contributions that exceed the statutory limit to be flagrant. Therefore, taxpayer will have to resort to the 8606 commingling of basis of ALL his TIRAs just to get some of the distribution to be tax free. Earnings on the excess amount are then immaterial because this is reported as just a regular TIRA distribution subject to any 8606 basis.
But prior to filing an 8606 for the original 25k, the 5329 forms should be completed to see if any of the excess can be applied as regular contributions the taxpayer was eligible for in later years but did not make. This would reduce the 6% excise taxes. Even a spousal contribution could apply if taxpayer was retired. During this process, if it turns out that CY 2008-2010 would allow application of some of the excess, another decision could be made. That decision would be whether to try to amend those open years to take a deduction or to keep things simple by leaving the returns alone and considering the entire 25k as non deductible. Once the 25k is determined to be non deductible, then the 8606 can be filed for the year of the contribution and part of the distribution would be tax free. If 2011 is an RMD distribution year, the distribution taken would also count toward the RMD since it cannot be considered a return of a specific excess contribution.
When filing the 8606, the taxpayer needs to explain why this “rollover” should be accepted as an after tax contribution. That may require a copy of the check statement to show that the 25k came from his taxable account rather than from a non reported TT transfer from another IRA. Taxpayer may also have to show that there was NO 1099R issued from any retirement plan or IRA for that time period, and therefore the 8606 is valid. Without such documentation, the IRS should be concerned that the 25k contribution was from a pre tax source and taxpayer is trying to claim non existant basis in the IRA. The key here is therefore to get the IRS to accept the 8606 as correct, even though the distribution taken this year will be subject to the 8606 pro rate tax rules.