Excess Contribution to Roth and traditional IRA in same year

Submitted by Norene Hall on Fri, 2017-06-02 15:58

In 2015 married couple had contributed $3000 each to TIRA and $4000 each to Roth. In December of 2015 they learned they had erroneously thought the contribution limit applied to each type of IRA separately so they withdrew the $3000 TIRA contributions by the due date of the return and contributed an additional $1500 to their Roths.

They each received 2015 1099-Rs. The taxpayer’s 1099-R showed $3000 in Box 1 and 0.00 in Box 2a. Distribution codes in Box 7 were 8 and 1. The spouse’s 1099-R showed $3000 in Box 1 and Box 2a was blank. Distributions codes in Box 7 were also 8 and 1. (Both of these 1099-Rs were issued by the same company). There was no 1099-R reporting any earnings.

The 2015 Form 1040 was prepared showing neither of these distributions as taxable. The total distribution amount of $6000 appeared on Line 15a but not on Line 15b.

15 months later they have now received an IRS notice calculating income tax and the 10% penalty on these withdrawals. Both they and I assumed this was an error but as I researched online I finally found two non-IRS sources (including this website) stating that excess contributions must be removed from a Roth first. I still have not been able to find this stated anywhere on the IRS website.

This seems like an unfairly harsh consequence for a young couple who were just trying to do the responsible thing and save for retirement. Is there anything that can be done to help at this point?



Submitted by David Mertz on Fri, 2017-06-02 18:39

excess contributions must be removed from a Roth first.

  • That’s not true.  If the combined TIRA and Roth IRA contributions exceed the yearly limit, the excess is deemed to be in the Roth IRA (and the remainder of the excess in the TIRA if the TIRA contribution alone exceeds the limit).  However, the law does not require that an IRA contribution be an excess contribution for a return of an IRA contribution to be made, so it is permissible to make a return of contribution from the TIRA to reduce the combined total to at or below the limit, eliminating the excess contribution.
  • It’s odd that the IRS would be considering these to be taxable distributions since the Forms 1099-R clearly indicate that they are not; box 2b Taxable distribution not determined would not be marked on a code 81 Form 1099-R.  Perhaps their tax return did not include the required explanations for these returns of contributions, but that should only affect whether or not it can be determined that the distributions were sufficient to resolve the excesses; it would not affect whether or not the distributions were taxable.  With a zero or blank box 2a, it is not possible for the IRS to determine the amount of contribution that was returned from just the details of the Form 1099-R.  With the recent increase in the IRS scrutiny of nontaxable TIRA distributions, they seem to be issuing quite a few of these questionable notices.
  • The Forms 5498 from the TIRA should include in box 1 the contributions that were returned, substantiating that there was indeed a TIRA contribution made that was eligible to be returned and be excluded from income.

Submitted by Alan - IRA critic on Fri, 2017-06-02 18:50

  • If a taxpayer makes an excess contribution due to the total of TIRA and Roth contributions, up to the extended due date they can process a corrective distribution from EITHER IRA type of their choosing. This couple was allowed to remove the excess from their TIRA accounts and retain the Roth contribution which is what they did per the 1099R coding. The confusion lies in how these contributions would have been treated if the extended due date passed with no action taken. In that situation, the excess amount is deemed to apply first to the Roth contributions, and as such the excess must be withdrawn from the Roth IRA or absorbed per the Form 5329 rules. In other words, the TIRA contribution is counted first toward the allowed contribution amount for purposes of correcting an excess contribution AFTER the due date.
  • The IRS is incorrect to ignore the 1099R forms that indicate by their coding that 3000 plus earnings that happened to be 0 was removed before the extended due date. However, if the couple took a deduction for the 3000 each on line 32 of Form 1040, they are not allowed a deduction because they had this contribution returned to them. But I do not think a deduction is the issue here, rather the IRS has missed the implications of code 8 on the 1099R and box 2a being 0. This needs to be pointed out to the IRS along with the following paragraph from Pub 590 A: ” How to treat withdrawn contributions. Do not include in your gross income an excess contribution that you withdraw from your traditional IRA before your tax return is due if both of the following conditions are met. No deduction was allowed for the excess contribution. You withdraw the interest or other income earned on the excess contribution.”

Submitted by Norene Hall on Sun, 2017-06-04 21:42

Thank you so much for both of your responses.  In looking back at the two non-IRS sources to which I referred, the warning that excess must be withdrawn from the Roth first is at the end of each article and therefore I guess you infer that it is referring to just the preceding paragraphs that talk about excess contributions not withdrawn until after the extended due date.What you have both explained is how I understood it to be as well but the notice and then reading those two articles shook my confidence.  I appreciate this resource and the time you took to answer the question.

Submitted by Jim M on Tue, 2017-09-05 16:31

       BD, CPA suggests on this Slott comment that the IRS favors the withdraw excess from the Roth IRA first approach when you do it before the extended due date.  She calls it the “more conservative approach.”  She suggests that the IRA interpets the situation differently (inconistently) some times:https://irahelp.com/slottreport/you-contributed-both-ira-and-roth-ira-%E2%80%93-now-whatYou Contributed to Both an IRA and a Roth IRA – Now What?Monday, April 04, 2016    Has the IRS in several cases actually accepted returns that withdrew from the TIRA first before the due date ?  This is what I would like to do because the initial contribution was early in the year and was 50% TIRA -50% Roth ($3,250-$3,250) and the erroneous contribution was late in the year and went solely into the TIRA.                                       jimd  

Submitted by Alan - IRA critic on Tue, 2017-09-05 18:31

I cannot open the SLott report link, but I have not heard of any reports of the IRS not accepting the return of a TIRA contribution before the extended due date when a Roth contribution has also been made. That said, due to the return of contribution 1099R reporting rules, the IRS typically does not know whether the return of the TIRA contribution was done before the Roth contribution was made or not. Note that if a taxpayer made a 6500 TIRA contribution and a 6500 TIRA contribution, what is prevent that taxpayer from having the Roth contribution returned and also having the TIRA contribution recharacterized as a Roth contribution? Taxpayer is left with a Roth contribution and no TIRA contribution. Or taxpayer could have them both returned and then make a new Roth contribution by the due date?  In addition, since the IRS is not aware of the dates of various transactions, this question would normally be left to the actions of the IRA custodian who does know these dates. I also do not know of any custodians who interpret that any excess is deemed to be in the Roth IRA prior to the extended due date, and even IRA custodians are not aware of IRA accounts with other custodians. Accordingly, there is no reason not to request a return of your TIRA contribution. SInce it appears that both the TIRA contributions were made to the same TIRA account, the TIRA custodian must calculate the earnings and return from the last contribution(s) you made for the year. That would affect the amount of your net income gain or loss.

Submitted by Ben Meyer on Tue, 2017-09-05 18:49

  • Cleaning up the reference to the earlier Slott article:

https://irahelp.com/slottreport/you-contributed-both-ira-and-roth-ira-%E2%80%93-now-what

  • The article cites the following two regulations, giving rise to the conclusion that withdrawing the excess from the Roth is more conservative, even before the due date of the return, but withdrawing the excess from the TIRA is also acceptable. 
  • Reg. § 1.408A-3, Q&A3(d), Example 2.
  • Reg. § 1.408A-3, Q&A7.
  • The second regulation cited refers to a distribution of a contribution before the due date from a Roth IRA.  For a traditional IRA, section 408(d)(4) applies, and states that tax is not due on the distribution of any TIRA contribution taken before the due date of the return, if the earnings are also withdrawn and no deduction is claimed.  Withdrawal of the TIRA contribution in this manner should cause it to cease being a contribution, with the result that the combined TIRA and Roth contributions would not exceed the combined limit.  The IRS should respond favorably if the full facts are disclosed. 
  • As a very subtle implication, Q&A7 states “Any contribution that is distributed, together with net income, from a Roth IRA on or before the tax return due date (plus extensions) for the taxable year of the contribution is treated as not contributed.”  I could not find a similar statement applying to contributions from a traditional IRA that are properly distributed before the due date.  The regulations and Pub 590-A address the question of taxability of these distributions from traditional IRAs, but not the removal of the contributions from the contribution limit.  It would be highly unreasonable for the IRS to allow Roth contributions to be reduced by distributions before the due date and not count toward the limit, but not to allow the same thing for traditional IRAs.  It would be unreasonably harsh and is probably unlikely.

 

Submitted by David Mertz on Tue, 2017-09-05 20:10

  • The similar statement for traditional IRA contributions is contained in the instructions for Form 5329 Part III which state, “You can withdraw some or all of your excess contributions for 2016 and they will be treated as not having been contributed if:  …,” the same wording as is given in the instructions for Part IV for Roth IRA contributions.
  • It would be inconsistent to treat the money as not contributed for the purpose of determining if the traditional IRA contribution limit alone had been exceeded, but as contributed for the purpose of determining if the combined traditional and Roth IRA contributions had exceeded the limit.  In addition, the statement in CFR § 1.408A-3 Q&A-7 derives from the same § 408(d)(4) as applies to traditional IRAs, so there is no reason that a return of contribution from a traditional IRA would be treated any differently than a return of contribution from a Roth IRA with respect to treating the returned contribution as not having been made.  Nothing in § 408(d)(4) requires that a contribution be an excess contribution to be eligible to be returned.
  • Also, with respect to determining an excess contribution, §4973(b) explicitly states, “any contribution which is distributed from the individual retirement account or the individual retirement annuity in a distribution to which section 408(d)(4) applies shall be treated as an amount not contributed.”

Submitted by Ben Meyer on Tue, 2017-09-05 20:43

Good – thanks for finding the reference in the form 5329 instructions.  It is a little ironic that the IRS put this notice only on the instructions for form 5329 when the form doesn’t need to be filed for a distribution of contributions with zero earnings made by the due date of the return.  (Instructions for Part III, line 15.)  But it does resolve any possible questions.

Submitted by David Mertz on Tue, 2017-09-05 21:36

I do have one remaining question:  Whether or not § 408(d)(4)(B) means that only traditional IRA contributions that are not permitted to be deducted (without regard to the taxpayer electing not to deduct the contribution) are permitted to be returned.  I’m beginning to think that the only traditional IRA contributions permitted to be returned are those that are either excess contributions or those that are not deductible as a result of being an active participant in an employer plan.  (Roth IRA contributions are never deductible, so are always eligible to be returned.)  In some instructions is seems that the IRS interprets § 408(d)(4)(B) as referring to any contribution that is not deducted (Pub 590-A Chapter 3, in particular), and in other places as referring only to a contribution that is not allowed to be deducted.

Submitted by Ben Meyer on Tue, 2017-09-05 23:59

  • The IRS has softened the language of § 408(d)(4)(B) in the wording of Pub 590-A.  Where § 408(d)(4)(B) states “no deduction is allowed…” Pub 590-A states “[y]ou did not take a deduction for the contribution”.  (Pub 590-A (2016), p. 33.) 
  • Pub 590-A also allows the reversal of a contribution for any reason, not limited to withdrawal of an excess contribution.  Under the heading “Contributions Returned Before Due Date of Return” Pub 590-A states “If you made IRA contributions in 2016, you can withdraw them tax free by the due date of your return. …”   (Ibid.)  So the IRS will allow a distribution of an IRA contribution before the due date, along with any earnings, and in the absence of a deduction, for any reason desired by the taxpayer.  I doubt that any taxpayer would have reason to protest this IRS interpretation and bring the question into the forum of an appeal or Tax Court case.

Submitted by Alan - IRA critic on Wed, 2017-09-06 02:10

In the way of additional support for Benn’s last post, the following reflects the change made to Sec 408(d)(4) in 1988. Reference to “excess contributions” was eliminated in favor of merging the treatment of excess contributions into returned contributions. The deduction of the contribution was retained only to clarify that a returned contribution cannot be deducted. Here is what changed in 1988:

Subsec. (d)(4). Pub. L. 100–647, § 1011(b)(2), substituted “Contributions” for “Excess contributions” in heading, struck out “to the extent that such contribution exceeds the amount allowable as a deduction under section 219” after “individual retirement annuity” in introductory provisions, and substituted “such contribution” for “such excess contribution” in subpars. (B) and (C) and in last sentence.

Submitted by David Mertz on Wed, 2017-09-06 02:41

Thanks.  The lawmakers could have made it clearer if they changed the original word “allowed” to “claimed,” since that’s the present intent.  It had me wondering since I had never before made an effort to independently interpret § 408(d)(4)(B).  Glad to know that my original understanding of returned traditional IRA contributions is intact.

Submitted by Jim M on Wed, 2017-09-06 23:07

     Thank you all for your help on this perplexing question. There is a lot to dig into in the IRS Tax Code on IRAs. I see your point that the IRA does not know the transaction dates.        My TIRA contributions were all in one account from the same broker. I just have to withdraw the excess contribution and all income, pro-rated, from that account.                     Thanks,                     jimd                 

Submitted by [email protected] on Thu, 2017-09-07 17:53

Does it matter that it is not simply a “withdrawal” rather it is a formal request to remove excess contributions?  Use of proper forms, etc. would help ensure 1099s are correctly coded?  I don’t beleive a TP can simply do the math and take a withdrawal. -m

Submitted by Jim M on Thu, 2017-09-14 03:30

        I have to fill out a IRA distribution form that my broker sent me, which has sections like shown below.   It formally request that my broker take out a certain amount, equivalent to the excess contribution + pro-rated IRA earnings. IRA DistrrbutionBranr:hd ] – L o IRA Accounl f;I sttuPLr tRR n Inherited IRA114198I notn tRR f srplsRn-sEp tnRIRA 0wner f BeneficiarySection 1 – IRA Type: E Traditionat IRASection 2-Payee Information: 62NAMECITYRequired 0nly For Beneficiary: Tax ldentification Number – orSection 3-Reason for Distribution Request (select one)Under Age 59% (penalty may apply) 0ver Age 59]4D PrematureDistribution f] 72(t)SubstantiallyEqualPeriodicPayments(alsocompletesection6) I NormalDistributionOther-Additicnal Cocumentaticn Mby Be Requii’edI DeathofAccount0wner(CertifiedDeathCertificateandNotarizedAffidavitofDomicileandDebtsrequiredforinitialdistributiononly.NotrequiredforlnheritedlRA)Trust and Estate Beneficiaries must provide additional documentation (complete Section 7).I DirectRollovertoaQualifiedRetirementPlan(Attachqualifiedplanletterofacceptance)(For External Rollovers only, also provide Plan Name and Address below. Use this form for checks only)withdrawn with the excess contribution.) $Ll Qualified Charitable Distribution; Name of Charity:f] Disability I ExternalMoneyManagerFees(attachinvoice)Section 4–Payment Amount and Frequency (check all that apply)Payment AmountM GrossAmount $ 9999.99I AllAvailableCashI Dividend&lnterestfl Dividend, Interest & PrincipalD In-Kind (Use the grid provided below; altach additional sheets if needed)I AccountTerminationI tt tnis recuning payment is for AUT0-RMD, check this box and also complete Section 8.I Verbal Distributi0n Authorization (VDA),account or 3) cash or in-kind as an internal journal to the IRA owner’s —— nonretirement account. 

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