60 day rollover taxes

Submitted by Ryan Smith on Mon, 2017-04-03 13:03

A client took a premature distribution from a traditional IRA of $20,000. The financial institution withheld 10% for fed and 4% for state taxes. The client returned the full $20,000 within the 60 day period and in the same calendar year. The financial institution characterized the portion of the refunded contribution associated with the taxes withheld as a current year contribution instead of a rollover/refund. Is this correct? It seams that this would make that portion subject to the 10% penalty. Also, what if the ira holder is not eligible for a current year contribution.



Submitted by Alan - IRA critic on Mon, 2017-04-03 16:43

The IRA custodian is incorrect unless the client rolled over the 2,000 withholding amount at a different time than the rest of the rollover and failed to report it as a rollover contribution. The client clearly has the option to use his other money to replace withholding to complete 60 day rollovers. Further, even if the rollovers were completed at different times within the 60 day period, there is no violation of the one rollover limit because the 20,000 was distributed in a single distribution and the one rollover rule is measured by the distribution.

Submitted by William Tuttle on Mon, 2017-04-03 18:11

  • First, the IRA witholding is a default, but not required. The client could have requested no withholding, but did not. Most custodians make this pretty clear in their distribution process either online or by paper. Then as alluded to by Alan, the rollover/contribution error could possubly be due to the client specifying the withheld amount as a contribution instead of as a rollover.
  • If the custodian made the error, they should correct be able to correct it and since the custodian had the funds within the 60 day window, I do not even think the new self-certification rule would be needed. I don’t know if the custodian can or would be willing to correct it if it is the client’s error.
  • If the client made the error, the custodian is unable or unwilling to correct it and the client is not eligible for the contribution, the correction depends on what you mean by not eligible. If they were not eligble to make the contribution, because they do not have compensation, then this is an excess contribution and must be removed. This will be subject to the 10% penalty and taxed as ordinary income.
  • If they have the necessary compensation and it is because they are an active participant in an employer retirement plan and they exceed the income limits for a deduction, they should have three possible options. They could remove the excess contribution (pay 10% penalty and ordinary income taxes), if they are below the Roth IRA contribution limit they could recharacterize it as a Roth contribution, or if they have no pre-tax IRA assets they could do a backdoor Roth contribution which would entail leaving it as a non-deductible contribution and converting it to a Roth IRA.

Submitted by Ryan Smith on Tue, 2017-04-04 10:46

Thanks, very helpful. 

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