Rollover from Simple IRA to a Regular IRA prior to 2years

Submitted by John Ray on Wed, 2022-08-03 17:22

A taxpayer we will call “Mary” owned both an Traditional IRA and a SIMPLE IRA with different custodians. After a consultation with her financial advisor for the SIMPLE IRA , she consolidated her IRA and SIMPLE IRA in order to simplify administration and maintenance of the IRAs. The custodian rolled over the funds from the SIMPLE IRA to the traditional IRA via a trustee-to-trustee transfer in 2021. The amount rolled over was $6400.

Mary” relied solely on the advice of her financial advisor in performing this rollover. She was not aware that the transfer of funds from her traditional IRA to her SIMPLE IRA was contrary to applicable tax law and could result in penalties. Her custodian executed the transfer despite the fact that, under the tax law does not allow a rollover or transfer from a SIMPLE IRA prior to the two years.

Mary was 53 years old in 2021, She is married and the combined income with her husband was $174,000 Her W2 income was $72,000. Both Mary and her husband each made a $7000 Roth contributions.

The tax preparer reported the rollover as income as well as the 25% penalty. My understanding is that the IRS would consider the rollover as a distribution and a subsequent contribution. Since Mary is covered by a plan at work and the combined income is over the limit, the rollover would be considered a non-deductible contribution. The tax preparer did not report the nondeductible contribution on the return..

If I am correct that the rollover ends up as a non-deductible contribution, then Mary has either over contributed to either the Roth or the traditional IRA since the total that be contributed is $7000.

My Questions are:
1 How does Mary correct the excess contribution?
a. Ask for a distribution(if so would that be taxable in 2022?)
b. Probably best to fix the Traditional IRA but is there a choice?

2. Is there a possibility of getting the IRS to waive or lessen the $1600 penalty ($6400 *25%). If so what is the process since the return has already been filed

3 Are there any other issues?

Thank you



Submitted by Alan - IRA critic on Wed, 2022-08-03 19:27

  • You are basically correct. The SIMPLE Distribution is not eligible for rollover and must be reported as a taxable distribution subject to the 25% penalty. The TIRA contribution in combination with the Roth contribution for 2021 creates an excess contribution, but if Mary filed her 2021 return on time or filed a timely extension, she has until 10/17 to choose which contribution to remove. If their MAGI permits a Roth contribution, the best choice is have the 6400 TIRA contribution returned as an excess contribution with allocated earnings.
  • If there are gains on the 6400 regular TIRA contribution, they will be taxable in the year contributed (2021). It does not matter that the 8606 was not filed since the contribution is being returned. There will be no TIRA deduction or ND contribution reported. If there are no gains, the 2021 return will not have to be amended solely to provide an explanatory explanation for the return of excess contribution.
  • The corrective distribution must be done by 10/17 or excise taxes for 2021 will apply, and also for 2022 if the excess is not withdrawn before year end.

Submitted by John Ray on Wed, 2022-08-03 22:41

Thank you so much for the in depth reply. They did file on time. So they can go ahead and make the corrective distributoon. Correct? ( just making sure I understand. Also do you have any thoughts on getting the penalty waived   

Submitted by Alan - IRA critic on Wed, 2022-08-03 23:33

Submitted by John Ray on Thu, 2022-08-04 01:57

Thank you again.So it looks like the penalty will not apply to the $6,400 using  code section 408(d)(4) as long as she returns the $6,400 by October, 17 2022.  The  penalty would apply to  any earnings  on the $6,400.  So the penalty can just be fixed by amending the return. Correct?

Submitted by Alan - IRA critic on Thu, 2022-08-04 02:54

The major penalty is the 25% SIMPLE IRA distribution penalty on 6400. The penalty for return of the excess IRA contribution is 10% and only applies to the gain on the 6400 while in the TIRA account. Due to market losses this year, it is very likely that the return of the excess IRA contribution will generate a loss. If so, there is no gain subject to the penalty. If an exception to the penalty applies, it would likely eliminate both penalties. Form 5329 would be required to claim any penalty exception, otherwise the penalty can be paid by simply reporting it on        Sch 2, line 8 attached to the 2021 1040X. If the excess IRA contribution has a loss to date, there would be no taxable earnings or additional penalty to the already reported 25% penalty, and a 1040 X would not be necessary.

Submitted by John Ray on Thu, 2022-08-04 14:47

I assumed that the 10% penalty could be eliminated on the contribution with the exception of any gain but I wanted to make sure the 25% penalty could also be eliminated. I thought it could be because they did not get a deduction(It was added back as IRA Income which offsett the W2 reduction) and it will distributed out before 10/17.  Thanks again for your help!!!  

Submitted by Alan - IRA critic on Thu, 2022-08-04 15:26

The SIMPLE IRA distribution must be reported as a taxable distribution, subject to the 25% penalty. The tax return apparently correctly reported this. A rollover should not be reported since it is not allowable. Instead, a regular IRA Contribution was made, which must be removed with allocated earnings (if any) by 10/17. The IRA custodian should be told that the rollover was ineligible and instead created an excess regular contribution because the Roth contributions have used up the contribution space. A 10% penalty and ordinary tax applies to any earnings distributed from the IRS, but not on the return of the 6400 contribution itself.

Submitted by John Ray on Fri, 2022-08-05 14:57

I understand a disitribution must be made of the original contribition plus any earnings and that a 10% penalty would apply to the earnings if any.  I want to make sure  that when they file the amended return, they can also eliminate the 25% penalty that was paid since the regular contribution(ie the rollover) is being reversed.  I assume  you would show the penalty on the amended return as originally filed and then show zero as amended giving them a refund of the penalty minus any penalty on the earnings.

Submitted by Alan - IRA critic on Fri, 2022-08-05 15:20

The SIMPLE IRA distribution cannot be reversed and it cannot be rolled over. As I said, the tax preparer apparently realized that and filed correctly. Ordinary tax and the 25% penalty is due on that 6400 distribution. What can and must be reversed is the resulting excess IRA contribution. Tax and penalty will apply to any gains, but due to the declining market there are probably no gains or very small gains. But there is no solution to the tax and 25% penalty on the SIMPLE IRA distribution other than the usual penalty exceptions chart I posted earlier. In other words, the excess IRA contribution can be reversed, but not the SIMPLE IRA distribution that was reported on the 1099R.

Submitted by John Ray on Fri, 2022-08-05 17:59

Thank you for clarifying!!!

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