2020 and 2021 excess contribution
Hello. This website is a great resource. I am hoping someone can provide a few suggestions regarding excess IRA contributions.
My spouse and I file a joint tax return. In the fall of 2021, we realized that our contributions to our Roth IRAs in 2020 and 2021 were in excess of the amount allowed by the federal tax code based on our AGI. We requested a withdrawal of the 2020 and 2021 contributions ($10,500 for me and $9,700 for my spouse) to the IRAs from the brokerage. We did not withdraw any earnings on the excess contributions because we were unaware we needed to do so. For 2021, we each received a 1099-R form from the brokerage. Box 2b (“taxable amount not determined”) is checked and “J” is in box 7 (“distribution code(s)”).
I now need to figure out how to report the distributions correctly to the IRS. We received an automatic extension to file our 2021 return. I assume that for 2020, we need to file a 1040X with a form 5329. Do we need to (a) calculate and withdraw the earnings on the excess 2020 contributions first, and include the earnings in the amount reported on the 5329, or (b) just report the excess contributions exclusive of earnings?
For 2021, should we essentially ignore the 1099-R forms from the brokerage and complete a 5329 for the 2021 excess contribution and include it with our 2021 return?
Thanks very much in advance.
Permalink Submitted by Alan - IRA critic on Mon, 2022-04-18 23:51
The corrective distribution process was not done correctly, as your 1099R forms are not coded to reflect the distribution of any specific year’s contributions. They are coded as regular distributions from your overalll Roth balances. While they are probably non taxable, they still leave you with the excess contributions and the excise tax for the first year, and of course it is too late to roll back those distributions.
For the 2020 Roth contributions, assuming your joint MAGI was over the phaseout range (no Roth contribution permitted), you will need to file a 1040X, with a Form 5329 for each spouse, and pay the 6% excise tax on the amounts you contributed for 2020. That’s the easy part.
For 2021, there are serveral options, and much complexity. For the 2021 contributions that added to your excess contribution balance, you will also have to file a 5329 each with your 2021 extended return, but the distribution you each received can be used to reduce the excess balance from 2020, but not for 2021. You should download a Form 5329 to see how this works. Lines 18-25 incorporate your excess amounts carried over from 2020, then on line 22 the form will eliminate the excess from 2020 by subtracting the amount of these 2021 distributions. But the form will not allow you to reduce your 2021 excess amount since you have to wait until the following year for a distribution to reduce a prior year excess. The 2021 distribution cannot reduce your 2021 excess contributions because it was not done correctly, but you still have time to correctly request a return of your 2021 contribution and the custodian will calculate the earnings using their software. You have until 10/15 to have this processed. At that point you will have eliminated the excise tax for 2021, but you will owe tax and penalty on any gains distributed with the return of your 2021 contributions.
One real problem is that you have already withdrawn 2 years of contributions in 2021, and if you want to avoid the 2021 excise tax on that’s year’s excess, you will have to request a return of your 2021 contribution with any earnings, which should have happened in the first place.
There is another alternative if you overall Roth generated large gains since your 2021 excess contributions were made. For large gains, you probably need have been invested heavily in stocks and done so early in 2021. If these gains, which you might have trouble calculating are large enough you could benefit from paying the 2021 excise as that would be less than ordinary tax and penalty on the gains. When you pay the excise tax, any gains get to remain in your Roths.
Finally, for the income tax (not excise tax) part of this you will have to report your 1099R distributions on Form 8606 for each spouse. You cannot ignore them. Since those contributions came from your regular contribution balance, they will be tax and penalty free, but you still need to file an 8606 for each spouse.
For more specifics, please advise the 2020 and 2021 contributions for each spouse separately, and I can give you the figures for the 2021 5329 for you, and from those you can see what your spouse’s amounts should be.
How sure are you that your 2022 MAGI will also be over the limit, or will it be under the limit? Phaseout range for 2022 is 204k to 214K.
Permalink Submitted by joe taxpayer on Tue, 2022-04-19 13:00
Thank you for the detailed response. The 2020 contributions were $6000 per spouse, and the 2021 contributions were $4500 and $3700. I am fairly confident our 2022 MAGI will be over the phaseout range.
Permalink Submitted by Alan - IRA critic on Tue, 2022-04-19 14:52
YOUR 2020 5329 lines 18-25: All lines blank except lines 23 and 24 6000; line 25 the smaller of 360 or 6% of your Roth IRA value on 12/31/2020.
YOUR 2021 5329: Line 18 6000; 19 0; 20 and 21 10,500; 22 0; 23 and 24 4,500; 25 the smaller of 270 or 6% of your Roth IRA value on 12/31/2021. However, you can eliminate this 270 excise tax IF you now ask the custodian to return your 2021 excess contribution of 4500 with earnings. The earnings portion you receive will be taxable and subject to penalty (If under 59.5) on your 2021 return. If you do this, your 2021 5329 will instead have these figures: Line 18 6000; 19 0; 20 and 21 10,500; 22-25 0
Your spouse’s 5329 forms will be the same as yours except 3700 will replace 4500 and 222 would replace 270
If you decide to pay the second year of excise taxes and not request the return of your 2021 contribution with earnings, you will still have to withdraw 4500 by year end in a regular distribution like the one you took in error last year to eliminate the excess by the end of 2022. While that eliminates tax and penalty on any earnings, you would owe the 270 excise tax. Therefore, the choice is between the 270 or tax and penalty on the earnings, and to make that decision you would have to know what the earnings amount is and then trust the custodian’s software to calculate it correctly. If these Roth accounts were not heavily invested in stocks or stock based funds, the earnings will be low and you would be better off requesting the removal of your 2021 excess than paying the 270 excise tax.
Both of you also have to file Form 8606 for 2021 to report the distributions you took. 8606 deals with the income tax, Form 5329 is just for the excise tax. But there should be no income tax due. Your 8606 would show 10,500 on line 19 and 21, and the total amount of regular contributions you have made since day 1 goes on line 22; that figure should be more than 10,500 and therefore line 23 should be 0 and you are done, No income tax due.
If any of this does not make sense, let me know. I don’t know how you intend to file – tax preparer, your own tax program or paper, but you need to get the correct numbers filed in some manner.
Permalink Submitted by joe taxpayer on Tue, 2022-04-19 22:57
Thanks, this is tremendously helpful. I think I understand what you have said.I typically self-prepare with H&R Block software. I am not sure the version I have supports preparation of amended returns, but it appears that preparing the 1040X and 5329 for 2020 manually would be fairly straightforward.
Permalink Submitted by Thomas Horan on Thu, 2022-05-12 20:12
My Son made a $7,000 excess contribution to his Roth account in 2021. He recognized the error in April 2022 when he started his 2021 tax return using Turbo Tax. He then had the administrator (Vanguard) withdraw the excess $7,000 contribution and the related earnings. He also extended his 2021 tax return until October 15, 2022. Vanguard will issue their form 1099R in January 2023. Since the return is on an extention, he wants to correctly report the transaction when he files his 2021 tax return. From what I gather from the above discussion he should correctly file forms 8606 and 5329 with his 2021 form 1040. Then nothing should be required to be filed with his 2023 tax return or will he have to also file a form 5329 with his 2023 tax return? We are hopping that Vanguard properly completes their form 1099R to be received in January 2023 Thank You,Tom Horan
Permalink Submitted by Alan - IRA critic on Thu, 2022-05-12 20:55
This situation differs from that of the original poster, since your son correctly had the 2021 excess removed before the extended due date. If he received more than 7000, there were earnings generated, and the amount of earnings will be taxable on his 2021 extended return on line 4b of Form 1040. Form 8606 is not required to report distributions of excess contributions prior to the due date, and if the 10% penalty on any earnings is due, it can be reported directly on line 8 of Sch 2 instead of filing Form 5329. But he should also include an explanatory statement with the return indicating the date and amount of the 2021 Roth contribution, that it was an excess contribution and that it was returned with allocated earnings in 2022. If there were losses and he got back less than 7000, then there will be no tax or penalty, but the explanatory statement should still be included. The tax reporting will be completed with the 2021 return, and the 1099R issued next January will be coded to show any earnings are taxable in 2021. Nothing further needs to be done on the 2022 return. I think you meant to refer to the 2022 return where you mentioned the 2023 return.
Ttax is likely one of the programs where he will have to create a dummy 1099R for the return of contributions +/- earnings for the program to place the correct amounts on the 1040 lines. Since the dummy 1099R will be a 2021 form, the codes in Box 7 will be J8 assuming he is under 59.5. Box 2a will contain the earnings, if any. Box 1 will show the total amount returned.
Permalink Submitted by David Mertz on Thu, 2022-05-12 23:33
In 2021 TurboTax one can enter this as a code JP *2022* Form 1099-R (TurboTax asks the year of the form when code P is present) and TurboTax will generally treat this the same as it would a code J8 2021 Form 1099-R. A code J8 2021 Form 1099-R cannot be used in place of a code JP 2022 Form 1099-R if taxes were withheld from the return of contribution (tax withholding on a return of contribution should generally be declined) because TurboTax would credit the tax withholding to the wrong tax year.