Any precedent for appealing 6% excise tax on excess Roth IRA contribution for foreign income earners?
I moved overseas 10 years ago and blithely continued to contribute the maximum amount of after-tax earnings to my Roth IRA account in the proceeding years, assuming that since I was still well under the 114000 income limit for contributions, that there was no issue. I did not realize that foreign earned wages exempted by the foreign income exclusion rule are NOT considered income when determining ROTH IRA eligibility, and thus with 0 eligible income, I was in violation of ROTH IRA contribution rules. I would like to withdraw the erroneous contributions and correct my mistake, but since so much time has passed, and because of the 6% yearly accumulative penalty on my principle, making the correction will effectively decimate my retirement savings. Is there any way to negotiate with the IRS for leniency, considering that mine was an honest mistake and not due to any desire for tax evasion or avoidance?
Permalink Submitted by Alan - IRA critic on Fri, 2014-07-11 17:46
I am not aware of any template for approaching the IRS on this issue, and there is no statute of limitations for excess IRA contributions. You face a tough decision. If 2013 was such a year, you can still request a return of excess contribution for 2013 and avoid the 6% for that contribution, although you will have to withdraw earnings and pay tax and penalty on the earnings. If you choose to correct the earlier contributions, you would just withdraw the excess amount and leave the earnings in the Roth. The 6% penalty and earnings distribution are mutually exclusive, ie when you pay the 6% for a year the earnings stay in the Roth. You rarely hear of the IRS going back 10 years to collect the 6% penalty but of course they can. And since the IRS clearly has all the information to detect the excess and notify the taxpayer before several years of penaltes accrue, their failure to do so on a timely basis may affect their decision in cases like this. Maybe they feel complicit to some degree for the violation.
Permalink Submitted by Bennet Tarng on Sat, 2014-07-12 01:35
Thanks for your reply. I was indeed considering just taking back my 2013 and 2014 contributions and assuming that since the IRS had not informed me of anything amiss over the past decade, that they were willing to give me a free pass on my mistake. However, the case of Robert Paschall, in which the IRS went after him for excise taxes by successfully arguing that because Paschall neglected to file Form 5329 they were unaware of his excess contributions, makes me wary of leaving my mistake uncorrected. Does the IRS get notified when an individual makes a Roth IRA contribution? If so, I might argue that they knew from my annual 1040 filings that I was ineligible for Roth contributions and should have informed me.Another option I’ve been considering is, in addition to withdrawing 2013/2014 contributions and earnings, to withdraw all prior year Roth contributions to avoid continuing to accrue penalties, but instead of reporting it as excess contribution and back filing 5329’s for the past 10 years, to instead treat it as a simple basis withdrawal. Then leave it to the IRS to see if they have an issue with this treatment. My worry would be that this might be construed as an evasion that the IRS would not look kindly upon.
Permalink Submitted by Alan - IRA critic on Sat, 2014-07-12 02:35
Yes, the IRS and yourself receive copies of Form 5498 in late May stating contributions made for the prior calendar year. In theory the IRS could simply match the 5498 with your tax return and determine if the taxpayer is eligible for such contributions. However, IRS effectiveness in this area has never been good. With respect to withdrawing all the ineligible distributions for years prior to 2013, that would cap the excise taxes with the amount accrued through 2012, but there is no statute of limitations with no 5329 filing, and interest on the unpaid 6% taxes would continue to pile up should the IRS recognize the excess contributions in the future. The IRS has never knowingly waived the penalty to my knowledge but all appearances suggest they lack proper computer matching tools.
Permalink Submitted by Bennet Tarng on Tue, 2014-07-15 01:38
Thanks for the information, much appreciated. It’s good to know the possible motivations behind different tax rules and how the IRS may or may not go about interpretation and enforcement.