Nondeductible Traditional IRA reported but Roth IRA funded

Submitted by Cathy Attig on Tue, 2014-01-28 20:47

This may be an unusual scenario –

Client indicated they funded traditional IRAs for the last few years. Based on their income level and active participation in a qualified plan, their IRA contributions were not deductible and were reported as such on Form 8606.

This year the client indicated that the funds have actually been going directly into a Roth IRA but they are not eligible to make Roth contributions to due to their income level. [I am not sure why the broker did not question their income level as they are well above the threshold].

Client does have a SIMPLE IRA that is all pre-tax that would impact income for a Roth conversion of the traditional account.

Any potential solutions to this issue other than reporting excess Roth contributions for each year, paying penalties and withdrawing the funds?

Thanks,
Cathy



Submitted by Alan - IRA critic on Tue, 2014-01-28 23:46

No easy solution. Procedures to correct this are below and assume that NO distributions have been taken from the Roth and that there were NO years during this period where their modified AGI was low enough to permit a Roth contribution:

  • Revise incorrect 8606 forms from the past that incorrectly reported basis. Unlike missing 8606 forms, I am not sure that the IRS will waive the penalty for overstating basis, but if client self corrects by revising the incorrect forms, there is a decent chance the penalty will not be levied.
  • Recharacterize Roth contributions for 2013 and 2014 (if contributions made) as non deductible TIRA contributions. Incorporate these contributions with a correct 8606 total for 2013. 2012 and earlier.
  • Prior to year end, request distribution of the total Roth excess contributions for 2012 and earlier. The Roth custodian should simply be asked to distribute a dollar amount, no mention of excess contributions or earnings should be made. The earnings get to stay in the Roth as client will be charged a 6% excise tax for each excess contribution per year. Since there will not be another excise tax until 12/31, client can leave the contributions in to generate more earnings and then withdraw the contributions before year end.
  • Form 5329 will have to be filed for each year of excess contributions and the 6% paid. IRS might also bill late interest. 2013 5329 charge will be based on excess contributions from the beginning through 2012. 2013 will be recharacterized so a new excess amount for 2013 will not be added on. IRS wants a 1040X with each year’s 5329, but client could try to file these by themselves with a statement that the rest of those returns are not affected and may get a pass on the 1040X.

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