Excess Roth IRA contributions

Submitted by Kumar Sun on Tue, 2017-03-21 15:20

I had an excess contribution in Jan 2016 which I withdrew immediately. But I did not withdraw any earnings at that time. Can I withdraw the earnings before I file my 2016 tax return and cancel out my excess contribution ? And if that is allowed, what is the computation period I use to calculate the Net Income Attributable for the computation period ?



Submitted by Alan - IRA critic on Tue, 2017-03-21 18:10

What happened with the earlier withdrawal? Did you just ask for a distribution of $X from the Roth without specifying to the custodian that it was a return of your 2016 contribution?  That would produce a 1099R without the corrective distribution coding of 8, and Box 7 would only show J. Is that what you have?  If so, how much was left in this Roth account on 12/31/2016?

Submitted by Kumar Sun on Tue, 2017-03-21 18:45

Yes, that is exactly what happened. I withdrew the contribution without informing the custodian and the 1099R has J in Box 7. On 12/31/2016, the Roth account had the amount from a previous IRA conversion which is roughly $1.5X where $X is what I withdrew.

Submitted by Alan - IRA critic on Tue, 2017-03-21 19:47

  • As it stands now, you either owe the 6% excise tax on the excess amount on a 2016 5329, and then if you will be eligible for a Roth contribution in 2017, you can apply the excess amount to 2017. If you have already contributed for 2017, there is no space to apply the excess unless you withdraw the 2017 contribution. Another option is to request the removal of the 2016 excess again, with allocated earnings since you have enough in your Roth to do that. Any earnings returned will be taxable in 2016 because you made the excess contribution in 2016. Your earlier distribution should not be taxable because it is a return of regular contributions. When determining whether to pay the excise tax OR undertake a new corrective distribution you should determine how much the earnings are on your contribution since the earnings will be subject to tax and penalty. If you pay the excise tax instead, then the earnings stay in your Roth.
  • Assuming you just own this one Roth IRA created by a conversion and then received your excess contribution, the earnings on your contribution is determined by this formula: http://retirementdictionary.com/definitions/netincomeattributablenia      Note that the distribution you took last year needs to be added back to determine the adjusted closing balance.  If your Roth has been invested in stock funds, it may have gained 20% since early 2016. Note that if you pay the excise tax for 2016, you still have to remove the excess before the end of 2017 to avoid a second excise tax. What year did you convert to Roth? This matters because if you have to remove a Roth conversion before 5 years, you owe a 10% penalty on the portion of the conversion that was taxable. Another question to consider – are you looking to get out of this for the least bottom line cost, or do you want to consider ease of reporting and number of transactions.
  • To get back to your first question – since you still have not removed the excess in the eyes of the IRS, the computation period to determine earnings starts when you made the excess contribution and ends when you remove it, so 14 months now. Is your excess contribution 5500 or was only a portion of your contribution excess?

Submitted by Kumar Sun on Tue, 2017-03-21 20:17

I cannot contribute to the Roth IRA in 2017, so carrying the excess forward is not an option.My Roth conversion was in 2016, so yes I am within the 5 year limit and subject to the 10% penalty. Because of this, I would prefer not to get a new corrective distribution since I would owe taxes on the earnings and a penalty on the earlier distribution.Instead,  can I now go and withdraw just the earnings for the period from the date of the contribution till now and have the combination of distributions now treated as an excess removal in the eyes of IRS ?

Submitted by Alan - IRA critic on Tue, 2017-03-21 22:14

  • No, because you would not be reporting according to the 1099R you already have, then you would get a new 1099R from the custodian for withdrawing a smaller amount in 2017, the amount you attribute to earnings. Therefore, your returns for two consecutive years would vary from the 1099R forms issued for those two years.
  • Another option is to recharacterize your 2016 contribution as a non deductible TIRA contribution. That would eliminate the excess contribution and the 6% excise tax, but it would result in your earlier distribution being subject to the 10% penalty since it would come from your conversion money. If you have no other non Roth IRAs you could convert the recharacterized contribution back to Roth tax free except for the earnings.
  • One issue with either removal or recharacterization is how the custodian would calculate the earnings to be either returned or transferred to the TIRA respectively. It should be done according to the link I posted above, but with these back room operations, you won’t know for sure until the transaction has been completed.
  • Another rather unlikely option – take a look at this Rev Ruling and see if you qualify for self certification of a late rollover of the first distribution – perhaps reason (a) if you think the custodian made an error in the first distribution: https://www.irs.gov/pub/irs-drop/rp-16-47.pdf

Submitted by Kumar Sun on Tue, 2017-03-21 22:40

Thanks, Alan. You have been very helpful.After analyzing all the options you presented, it looks like the only viable one is for me to request a new corrective distribution. Since the amount involved is less than my original conversion amount, I won’t have to pay the 10% penalty on my original distribution.

Submitted by Alan - IRA critic on Tue, 2017-03-21 22:57

Actually, you were correct before. If you request a new return of your 2016 excess, it will remove that contribution from consideration when you report the distribution you took before. Therefore, the earlier distribution will have to come from the conversion and be reported on Form 8606 and therefore would incur the 10% penalty. How much a gain do you have on the contribution and how much on the conversion? They would be the same if made at the same time. When were these made in 2016? 

Submitted by Kumar Sun on Tue, 2017-03-21 23:10

Both the contribution and the conversion happened in Jan 2016. The computed gain on the contribution is slightly less since the ratio is roughly 2:3.    As per Form 5329 instructions, line 1 (the taxable amount for Roth IRA distributions) comes from line 25 of Form 8606.  Line 25 of Form 8606 is (adjusted non qualified Roth distributions – Basis in Roth IRA conversions  ). This amount is less than 0 for me. I am using Turbotax and it too does not show any penalty.  Am I missing something ?

Submitted by Alan - IRA critic on Wed, 2017-03-22 00:02

Yes. Line 25 is 0 now, but if you were to remove the excess contribution it would change 2016 retroactively. That contribution would no longer exist and therefore the distribution you already took would have to come from your conversion balance. 10% penalty would apply. Looks like there is no good solution if you have about a 20% gain on both the regular contribution and the conversion.

Submitted by Kumar Sun on Wed, 2017-03-22 16:49

Going back to an earlier option — since I have already withdrawn the contribution, if I withdraw the earnings separately now. In tis regard, you mentioned the following  — 

  • No, because you would not be reporting according to the 1099R you already have, then you would get a new 1099R from the custodian for withdrawing a smaller amount in 2017, the amount you attribute to earnings. Therefore, your returns for two consecutive years would vary from the 1099R forms issued for those two years.”

      Can I file a form 4852 with the correct gross distribution and earnings plus the appropriate distribution codes and attach an explanation of the facts ? Is that something the IRS will accept ? 

Submitted by Alan - IRA critic on Wed, 2017-03-22 18:00

  • I have no idea of the odds that this would work, but Form 4852 is only to be used if an incorrect 1099R was issued and the issuer refused to correct it. That is not the case here. Further, as indicated above you will get another 1099R for 2017 for the new distribution, so the problem will carry over to 2017. There is also a warning on the 4852 form about a 5000 fine for a frivolous filing of the form. That’s another risk.
  • Turbotax probably got this right, but your 2016 conversion does NOT count in the MAGI for regular Roth contribution purposes. With that in mind how far over the phaseout range max for your filing status are you?

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