Correcting 6 years of Excess Roth contributions
I just discovered that a client who routinely files separately has been making Roth contributions every year. I didn’t know about the Roth when I filed them separately (most years for state tax savings). 2023 is on the way to cure.
It appears that he will have to pay the 6%/year on every contribution back to 2018, and withdraw the whole account, paying tax on the income this year – along with a penalty for being under 59-1/2.
Any tips on ways to dull the pain? File a reasonable cause appeal against some or all of the excise taxes? The investment adviser didn’t know they filed separately – and never asked, the tax preparers didn’t know about the Roth. I’m the 2nd or 3rd & I missed the signs.
Permalink Submitted by Alan - IRA critic on Wed, 2024-04-03 23:07
Well, we now know that the new 1040 based statute of limitations for excess contributions is not retroactive to years prior to 2022, which will leave client with these excess contributions and the accumulated excise taxes. 2023 is the only year that client could have the excess returned with earnings (earnings will be taxable in the year the 2023 contribution was made, but no 10% penalty), or the 2023 contribution could be recharacterized as a non deductible TIRA contribution and a back door Roth conversion done for a spouse that does not have any pre tax IRA balances.
To correct the pre 2023 excess contributions, add them up and request a distribution of that amount. This is not a corrective distribution and there is no earnings calculation, so any gains can stay in the Roth IRA. This distribution will be reported on a 1099R like any other Roth distribution, and will be typically tax free because it comes from the regular Roth contribution balance. This distribution would be reported on a 2024 Form 8606. There is no 10% penalty since this distribution is non taxable.
The IRS has no authority or mechanism to waive the excise tax. Each year’s excess will have to be reported on a Form 5329 filed with 1040X and the 6% excise tax paid. Since the 5329 is cumulative start with the oldest excess year and move forward. The tax increases each year because the earlier excess is brought forward and added to the current year excess, so the tax will get pretty bad for 2022 and 2023 even though no new excess will be added for 2023 due to the corrective distribution or recharacterization.
Given the amount of the excise tax for the last couple of years, they may want to consider amending the recent returns to joint returns if there will be a net savings.