Mistakenly deducted traditional IRA contribution in prior tax year

Submitted by Natalie White on Mon, 2020-04-20 13:40

I just discovered that I was ineligible to deduct my traditional IRA contribution from my taxable income in 2016. I had contributed the maximum, $5,500, and deducted the full amount unaware that I did not qualify. I am curious if there is a penalty for this type of ineligible contribution to an IRA, and if so, what is the penalty? I know that the penalty for contributing more to an IRA that the annual limit, by income, triggers a 6% fee for each year you allow the excess funds to remain in the IRA, but I have not been able to find out if this fee also applies to a case in which there was not an excess contribution, but an ineligible deduction. I am also curious if I can resolve this past mistake by rolling the balance of my traditional IRA over to a Roth IRA? This way, I will pay taxes on the tax-deducted funds (in effect correcting for the contribution that should not have been deducted).

So, in summary, I have two questions:
1) what is the penalty for deducting a traditional IRA contribution, when you are not eligible to take a deduction
2) and two, can you simply roll-over the traditional IRA to a Roth to correct for the mistake?

I would appreciate help anyone can provide.



Submitted by Alan - IRA critic on Mon, 2020-04-20 16:05

If you had enough earned income in 2016 to make this contribution, it is not an excess contribution. It was an allowed contribution that you should not have deducted. However, if you filed your 2016 return by the due date in April, 2017, the 3 year statute of limitations for the IRS to send you a tax due notice has just expired. Therefore, you have no obligation to do anything. Do NOT file a Form 8606 to report your contribution as a 2016 non deductible contribution.  If you filed 2016 late or under extension, the 3 year statute does not expire until 3 years from the date you filed the return.

Submitted by William Tuttle on Mon, 2020-04-20 16:10

  1. As you surmised, the 6% excise tax penalty is only due for excess contributions, which this was not. However, the deduction was ineligible, resulting in you paying less than the correct tax liability for 2016. You will need to file an amended 2016 tax return not claiming the deduction and with Form 8606 to report the non-deductible traditional IRA contribution. If you made additional non-deductible traditional IRA contributions and/or Roth conversions in subsequent years. You will have file a Form 8606 for each year to update any non-deductible basis and an amended tax return for any year with a Roth conversion as there would have been pro-rata taxation.
  2.  No, see above. Not to mention any pre-tax balances in any traditional, SEP and SIMPLE IRA account will cause such a Roth conversion to be subject to pro-rata taxation. The only way around this is to rollover any such pre-tax IRA balances to a 401k, 403b or 457b plan that accepts IRA rollovers by 12/31 of the year you wish to do a Roth conversion of the non-deductible basis and any earnings after the rollover(s). That should result in little to no taxation.

Submitted by William Tuttle on Mon, 2020-04-20 16:31

Since any time sensitive action due on or after 4/1 is postponed until 7/15. Would the SOL posponment only apply to a taxpayer trying to get a refund or would it also apply to a return with taxes due. 

Submitted by David Mertz on Mon, 2020-04-20 16:43

Submitted by Natalie White on Mon, 2020-04-20 17:17

I had found this IRS notice, explaining the deadline to file for a 2016 refund is extended to July 15th 2020:  (4th paragraph)  https://www.irs.gov/newsroom/irs-extends-more-tax-deadlines-to-cover-individuals-trusts-estates-corporations-and-others From this I had thought that I could then still amend the 2016 return and pay the taxes due.  Is this in conflict with Q&A 22 at https://www.irs.gov/newsroom/filing-and-payment-deadlines-questions-and-answers

Submitted by William Tuttle on Mon, 2020-04-20 23:53

  • But, I would point out thst Those Q&As have not been updated for notice 2020-23. Case in point, in Q&A 16 still says the second quarter estimated tax payment is due 06/15, when that has clearly been extended to 7/15.
  • And but, your last post in this thread is correct and thus it is moot.

Submitted by Alan - IRA critic on Mon, 2020-04-20 17:06

  • Good point. Notice 2020-23 does provide the IRS additional time to perform certain acts, however p. 9 appears to limit “affected taxpayers” to a few who have actual cases pending or active reviews. It does not appear that the SOL is broadly extended in the case of OP if the IRS has not already initiated some action.
  • https://www.irs.gov/pub/irs-drop/n-20-23.pdf

Submitted by Natalie White on Mon, 2020-04-20 18:10

If, in fact, it is too late to amend the return and the SOL is not extended, can I assume I am safe from facing penalties, in terms of the taxes owed or penalties for the ineligible IRA deduction?  And this being the case, is there any harm in rolling the balance of my traditional IRA over to Roth, using an accurate basis from my 8606?  (Note that I am aware of the pro-rata taxation on the rollover.  I had been planning to roll over the balance of my traditional IRA to Roth regardless. My only hesitation was whether I should amend the 2016 first, to correct for the ineligible deduction.)  Thanks for the help!

Submitted by Alan - IRA critic on Mon, 2020-04-20 18:53

No reason not to convert if you wish, as a conversion is totally unrelated to the deduction or loss of deduction on that contribution. If you haven’t received any tax due notice from the IRS yet, you aren’t going to get one now. I think the SOL has run it’s course in your case, but am not 100% sure of that.

Submitted by William Tuttle on Mon, 2020-04-20 19:33

I suggest not filing the required Form 8606(s) until after 7/15.

Submitted by Natalie White on Mon, 2020-04-20 19:41

Got it. Thanks all. This was a big help. 

Submitted by David Mertz on Mon, 2020-04-20 21:51

Having claimed the deduction on your 2016 tax return, if you do not amend that tax return and pay the additional tax due, the duty-of consistency doctrine says that you cannot now take what would be a contradictory position that that contribution added basis in nondeductible traditional IRA contributions.  If you do amend, you’ll have to pay the additional 2016 tax liability (plus any penalty and interest).

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