Form 5329 – where to put absorption $ of prior year excess contributions related SEP IRA

Submitted by PQ on Fri, 2025-02-14 18:10

My situation that I am trying to navigate myself .

  • 2017 returned filed with extension on 10/15/28 when we found out that I can only contribute $2,085, but my contribution early on for 2017 was $17,000 (estimated based on last year’s income). Only $2,085 was claimed as deduction on 2017 return. No 5329!!  I was advised to withdraw the over contribution of $14,915; it was done with $14,490 (loss some money) on January 18, 2019 after the deadline 10/15/2018.
  • 2018, net profit from Schedule C was $49,698. Allowable contributions could have been $9,940 (ABSORPTION?). NO contributions and 2018 1040 was filed again with extension on 10/15/2019. No 5329
  • 2019, net profit from Schedule C was $78,884.  Allowable contributions could have been $15,315 to absorb $4,975 remaining from 2018? NO new contributions, but I did withdraw $14,490 as mentioned above.  No 5329! I received 1099-R from broker, as Taxable Income with Tax $ not determined. 2019 1040 didn’t include this distribution as the CPA didn’t think it was required.
  • June 2022, IRS sent a Notice of Deficiency, claiming that I owed tax on this distribution as ordinary income. I have appealed and it has been with the tax court for the last almost 3 years.
  • The trial is next month, with new IRS tax attorney, as it was transferred to S court and location.   A new IRS tax attorney was assigned and we start all over again. The entire assessment is $3,736, but if I calculated 6% penalty, the total I would have paid for last 3 years would have been $1,194 (6% @ 2017 $14,915,  6% @2018 $4,975, and $0 2019 as it was fully absorbed and withdrawn).What are my chances? and specifically, where can I put the absorption $$ on form 5329 for 2018 and 2019 if applicable?


Submitted by Alan - IRA critic on Fri, 2025-02-14 21:48

For excess SEP IRA contributions, Form 5330 is used instead of 5329 and the excise tax is 10% instead of 6%, but the application is otherwise the same. An excess SEP contribution can be absorbed in a later year and the excise tax will not apply in the absorption year. Or the excess can be eliminated by taking a distribution in any year after the excess year. Form 5330 is much longer than 5329, but you only need to address Sec 4972 in the 5330.

In 2018, Form 5330 should have indicated that 9,940 of the prior excess was absorbed, reducing the remaining excess to 4,975. Therefore, you only needed to withdraw 4,975 in 2019 to eliminate the remaining excess. You withdrew much more than you needed to. In addition, because 9940 was absorbed you should have deducted that as a SEP contribution on your 2018 return, but the statute of limitations for that deduction has expired.

While the 5330 should have eliminated the excise tax in 2019, the odd sequence of events and delay in addressing has been costly. You never got the deduction for the absorption, and the 2019 distribution is taxable, resulting in double taxation. That’s probably costlier than the excise taxes for 2017 and 2018. The CPA made a large error in not reporting that 1099R as taxable. That resulted in the IRS Notice, but the IRS appears to only be looking at the taxable income, not the excise tax situation. That’s somewhat typical of the IRS.

I don’t know if the new tax attorney can appeal the tax due for that distribution on the grounds that you forfeited the deduction for the absorption in 2018 because the SOL ran out. It may be worth a try but also might trigger the IRS to ask about why a 5330 was never filed. Truly a mess.

 

Submitted by PQ on Sat, 2025-02-15 01:23

Thank You, Alan.

Form 5330 should have also be filed with 2017 return, right?

I am curious then why line 12 in form 5329 mentioned about SEP IRA, is this only for employees, but not for self-employed?  and where would one put the absorption on this form?

I am dreading to face this and maybe just agree with their assessment and move on :-(.  I plan to write to her explaining the situation, but afraid to bring up form 5330; sadly, the previous attorney and this one don’t seem to even know these common issues.

 

Submitted by Alan - IRA critic on Sat, 2025-02-15 13:03

The 5330 for 2017 might have been filed with the 2017 return, but in most cases excess SEP contributions are not discovered until later on, in which case the 2017 5330 would be filed with a 1040X. If discovered before the 1040 was filed, the excess would normally be removed by the due date, which would eliminate the need to file a 5330 at all.

The IRS 5329 instructions are confusing because the IRS does not clarify that a SEP IRA is actually a traditional IRA, but with special employer contribution limits, and the 5329 addresses only personal excess contributions, while the 5330 addresses SEP excess contributions. A personal IRA contribution can be made to a SEP IRA, but it must be clearly identified as such on the Form 5498 issued by the custodian.

In the 5329 instructions, line 9 only includes personal excess contributions from prior years (not excess SEP contributions). Line 10 identifies amounts absorbed, and lines 11 and 12 indicate the amount of the excess that is reduced by a distribution, with line 12 being the portion that is not taxable because a deduction was never taken. Reference to SEP contribution in the line 12 instructions is only made to recognize that a SEP contribution is a traditional IRA contribution and the higher total contributions limits for SEP IRAs should be added to the personal statutory limits to avoid a SEP contribution from limiting the amount for which a personal excess removal could reduce the personal excess.

It’s very likely that most CPAs and everyone at the IRS does not understand this complexity. In short, Form 5329 does not apply to you unless you also have a personal excess TIRA or Roth IRA contribution balance.

Your dilemma is that the IRS appears to be focusing only on the taxable distribution, not on SEP excess excise taxes. The 2022 Notice you got from them was just in time to meet the 3 years SOL for assessing most ordinary taxes due. There is no SOL for Form 5329 or 5330, so it’s possible that they could still assess excise taxes into the future because you never filed a 5330 that would have started a 6 year SOL.

With respect to the 1099R for 14,490 showing the taxable amount in 2a which the IRS is after, Box 2a could have been blank if you had requested the distribution be made per Sec 408(d)(5) which is for excess contributions withdrawn after the due date. In your case, this amount was never deducted, so you should not owe taxes twice. Few taxpayers or custodians are even aware of this option to obtain a 1099R without a taxable amount, but if you had the IRS would probably never have sent the Notice.  You might appeal the situation to eliminate the assessment (and late interest that goes with it), but then the IRS could look into the lack of a 5330……….tough situation.

 

Submitted by PQ on Sat, 2025-02-15 13:45

Wow!!  Thanks so much for your explanations..  I am so glad that I have found this forum.

I plan to explain to the new IRS attorney (she seemed reasonable although not knowing too much about this subject, it seemed) that it was an honest mistake and see how it goes; she did suggest that she couldn’t find any IRS materials about tax charged twice due to not claimed deduction (sigh!!!)

“According to 2017 Publication 560, the retirement income is subject to tax in 2019 and we have no legal basis for waiving such tax for you regardless of whether you received tax deduction benefit for the contribution in 2017 or not. This is because you did not withdraw the over contribution during the tax-free window.  However, you can carryover and deduct the over contribution to future years. See page 7 of 2017 Publication 560 (copy attached)”

Your input gives me confidence that I shouldn’t be charged taxes twice (that has always been my position, hence the appeal to the court).  I figured if I give her as if 5330 was filed, the assessment owed still more than $1000 less than what I was assessed as ordinary income tax, right?  I tried to see if I could get some money back and I think I might have a chance.  We are retired, we have plenty of time, ha ha!!

Thanks again for your help.  It is clearly that having a good CPA or not can really break you.

Submitted by Alan - IRA critic on Sat, 2025-02-15 14:10

You might indicate that the 1099R would not have had a taxable amount in Box 2a had you known to request the distribution per Sec 408(d)(5).

P 12 of the 2024 1099R instructions indicates how such a distribution is to be reported, and there has been no change to this over the last decade. That said, the “taxable amount not determined” box would have been checked which means that the distribution is not necessarily tax free but could be. Determining the correct taxable amount should certainly reflect that you did not claim a SEP deduction for the excess contribution.

Submitted by PQ on Sun, 2025-02-16 13:34

Would you recommend going ahead to fill out the form 5330 as if it was still applicable, and that would have been involve for 3 years, right? 2017, 2018, 2019.

Thank You!

Submitted by Alan - IRA critic on Sun, 2025-02-16 14:28

Yes, a 5330 should have been filed for those years instead of 5329. But if the case is in tax court now, I wouldn’t do anything until that case is concluded because the findings are not predictable.

Submitted by PQ on Mon, 2025-02-17 17:57

I was thinking going ahead to prepare 5330 and the penalty owed would be lower than the ordinary income tax they try to assess and be done with it as the new IRS tax attorney seemed to give me that information “However, you can carryover and deduct the over contribution to future years. See page 7 of 2017 Publication 560 (copy attached)”.   I tried to see if I can settle with her outside of the trial and move on :-(, but no guarantee that she will agree either, so perhaps, just go to trial and wait for the outcome.

I wished that I had this information as soon as the notice was given instead of 3 years has almost passed by.  My argument has always been, I didn’t benefit from that excess, so the distribution shouldn’t be taxed as ordinary income.

Thank You

 

Submitted by PQ on Tue, 2025-02-18 20:16

A quick update..

Well, it looks like I will present my case in court.  Just received a Pretrial Memorandum from IRS attorney cited that

“A taxpayer is not required to include pension distributions in income if the
taxpayer makes a qualified rollover. I.R.C. § 402(c)(1); Treas. Reg. § 1.408-4(b).
The rollover contribution consists of the transfer of any portion of the proceeds
received to another eligible retirement plan or an IRA within 60 days of the
distribution. I.R.C. §§ 402(c)(3), 408(d)(3).

Petitioners did not roll over the distribution, therefore, they were required to
include the amount of the distribution in their gross income on their 2019 tax return.”

Submitted by Alan - IRA critic on Tue, 2025-02-18 21:37

To summarize, you made excess SEP contributions in 2017, but in 2018 you were able to absorb $9940 of that excess, reducing the excess to $4975, on which the 10% excise tax was due.

Then in 2019, you were able to absorb the rest of the 4975 excess and deduct it, so the distribution was unnecessary as absorption already eliminated the excess. No excise tax due for 2019 or later years, but you owe the tax on the distribution. That distribution would have been eligible for rollover per the cite above, but you did not do so, probably because you thought that the distribution included excess contributions.

Therefore, the IRS attorney is correct. The problem is that you were eligible to deduct the absorbed excess in 2018 and 2019, but due to the statute of limitations, if you did not deduct these within 3 years, the SOL has run out.

It still sounds like the IRS is not focusing on the excise taxes or excess contributions. They just want to collect taxes on that 2019 distribution.

 

 

Submitted by PQ on Fri, 2025-02-21 16:23

Alan, you probably are tired of seeing my notes here :-(.

A quick update, the IRS attorney appeared to entertain the following:

“I can check with my manager to see if we can allow you to carryover to 2019 and take the SEP deduction in 2019 since you didn’t claim any SEP deductions in 2018 and 2019 per your tax returns. However, if we take this approach, you may have to pay that 10% ($1,449) excise tax that should have been paid in 2017 as part of the settlement.” (**I am okay with this as I should have paid the 10% excise tax in 2017 anyway, and perhaps with the allowable deductions in 2019, my tax owed will be less to offset with the tax on the distribution).

However, later on, she wanted to recall the above message, and then post this:

In addition to the 10% excise tax for 2017, you were supposed to pay federal income tax on the excess contribution for tax year 2017 per Section 402(h)(2). Upon reviewing your tax returns, I noted that you did not pay any tax on the excess contribution in 2017. As such, I don’t believe it is eligible for carryover to future years.

I.R.C. 402((h)(2)

Limitations on employer contributions. Contributions made by an employer to a
simplified employee pension with respect to an employee for any year shall be treated as
distributed or made available to such employee and as contributions made by the
employee to the extent such contributions exceed the lesser of—
(A)25 percent of the compensation (within the meaning of section 414(s)) from such
employer includible in the employee’s gross income for the year (determined without
regard to the employer contributions to the simplified employee pension), or
(B) the limitation in effect under section 415(c)(1)(A), reduced in the case of any highly
compensated employee (within the meaning of section 414(q)) by the amount taken
into account with respect to such employee under section 408(k)(3)(D).

PLEASE HELP to explain this.  Also, regarding excise tax, as a self-employed individual, do I need to file both 5330 as employer and 5329 as employee (I read some comments on this site referred as such).

Thank You!

 

Submitted by Alan - IRA critic on Fri, 2025-02-21 21:09

I can’t explain 402(h)(2) in this regard, as it appears to conflict with the 5330 instructions and to somehow convert an excess SEP contribution to an excess personal contribution. It also conflicts with Pub 560 explaining excess SEP contributions.

The confusion is aggravated by the treatment of a self employed owner as both an owner and an employee, or “owner-employee”.  I have seen a couple instances (eg Fidelity excess SEP removal form) where they refer to both a 5330 10% penalty for employer and 5% for employee (5329), but the circumstances where both would be due are not explained.

If you somehow can get out with a 6% excise tax using a 5329 instead of a 5330, you should probably go for it, as long as the excess can be absorbed, which would reduce either excise tax in 2018 and the rest of it in 2019.

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