Foreign Income and Roth Contributions

Submitted by JENNIFER CLARK on Fri, 2018-01-05 22:56

If a person is a US citizen living abroad, all income is excluded from income tax under the foreign income exclusion, yet they have been making Roth contributions annually, what is the best course of action? Clearly they do not qualify for these contributions. They had a Roth IRA before they moved out of the country and didn’t know that they were not able to contribute to it anymore.

Would it be best to pull out all contributions made while living abroad as soon as possible? Or leave things as they are, discontinue any contributions as long as they are out of the country, and move forward?



Submitted by Alan - IRA critic on Fri, 2018-01-05 23:31

There is no statute of limitations for excess contributions, so they could be tagged with 6% for many years on the accumulated excess amount. Therefore, they should remove 2017 excess amounts in the usual way with earnings, and all prior years without earnings, and file Form 5329 to pay the accumulated excise tax of 6% starting with the earlier year of the excess. 

Submitted by JENNIFER CLARK on Sat, 2018-01-06 00:05

Thank you for your quick response.  I’m concerned about the excise tax, obviously.  It will be a significant cost to them.  They want to take care of this and be forward with IRS about the mistake, but I’m concerned that the fees will be so high that it will be a financial burden to them.  Have you heard of the IRS offering any abatement of the penalties based on lack of knowledge?  Also, they had a financial advisor during this time who was facilitating these contributions.  Is there any case to be made against them for their neglect?

Submitted by Alan - IRA critic on Sat, 2018-01-06 01:02

  • There is no recommended procedure for requesting waiver of the excise taxes and I have not heard of any successes, but they could always try. There is also a possibility of a work around if a foreign housing exclusion was also involved that they could opt out of by amending a return to create earned income, but then they would owe taxes on the housing exclusion. Another possibility is a spouse with earned income that supports a spousal contribution for this person. Any chance of that?
  • Any 2017 contribution can still be returned with allocated earnings, but the accumulated excess amount brought into 2017 just incurred an additional excise tax by still being in the Roth after 12/31/2017.
  • One technical problem is that qualifying for a Roth contribution is like threading a needle. Any foreing earned income or housing exclusion must be added back in to determine MAGI even though it does not count toward earned income. Therefore, the range of income that qualifies for a Roth contribution is very small if the taxpayer has some eligible income. In other words, if they do have the earned income to contribute, the exclusion might make their MAGI too high to qualify for the contribution. 

Submitted by William Tuttle on Sat, 2018-01-06 02:13

  • There is a subsection under IRC Section 4974 that specifically provides for a waiver of the additional tax on  Excess Accumulation in Qualified Retirement Plans (Including IRAs) and this is specifically outlined in the instructions for Form 5329.
  • There is no subsection under IRC Section 4973 providing for a waiver of the Additional Tax on Excess Contributions to Roth IRAs and others and no mention of such in the instructions for Form 5329.
  • I also seem to remenber an anecdotal report of someone requesting a waiver of excess contribution additional taxes and penalties. The IRS waived the penalties, but said they had no authority to waive the additional tax.

Submitted by JENNIFER CLARK on Sat, 2018-01-06 18:15

Thank you for all of your responses.  Does the 10% early withdrawal penalty come into play here?

Submitted by Alan - IRA critic on Sat, 2018-01-06 20:29

  • The only place it would come into play is if the person made 2017 excess contributions that they are withdrawing with allocated earnings. In that case, the penalty would apply to the earnings. For all other withdrawn older excess contributions, there is no tax or penalty other than the 6% excise tax, plus possibly late interest if the IRS cares to bill that. The withdrawn excess contributions are from regular Roth contributions so are not taxable. When the excise tax is due for a particular year, the earnings on that contribution STAY IN the Roth IRA, so the excise tax and earnings removal are mutually exclusive. With no earnings removal there would be nothing to tax or penalize. 
  • Any chance the person is married to someone with non excluded earnings that could be used for a spousal contribution for this person?

Submitted by JENNIFER CLARK on Mon, 2018-01-08 16:38

Unfortunately, not.  They both live overseas with the foreign income exclusion on all of their income except for a couple thousand dollars of investment income.  They did not make any contributions in 2017. I’m also wondering what, if any, action can be taken against the investment advisor whom advised them to continue to contribute.  The amount of penalties they are facing is significant.

Submitted by Alan - IRA critic on Mon, 2018-01-08 17:06

Perhaps, but they better have excellent documentation. Can they show that the advisor knew that any type of IRA contributions were being made and never mentioned the FEIE exclusion?

Submitted by JENNIFER CLARK on Tue, 2018-01-09 22:18

That may be worth a try.  I appreciate your expertise, thank you!

Submitted by JENNIFER CLARK on Thu, 2018-01-11 18:59

Are there any penalties and interest associated with the excise tax back to 2006?  Also, are you aware of any Private Letter Rulings or court cases related to this matter?

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