SEP IRA incorrect contribution
Client made a $30,000 SEP IRA contribution in 2022. Client was not allowed to make any contribution and did not consult with me. I told the client to explain to Vanguard what happened and in 2023 the client removed the full amount and closed the account, (the 30K) was the only amount in the account plus $500 of earnings. The client received a 1099R showing $30,500 of distributions with a Code 7. I told the client to go back to Vanguard and explain that the original deposit was in error and Vanguard will not change the Code 7 designation. Is there anything I can do in preparing the tax return to correct this problem
Permalink Submitted by Alan - IRA critic on Mon, 2024-05-20 18:10
This may be one of those cases where the combination of two flawed transactions is not easily correctible, in this situation leading to double taxation.
While unlikely to work here, the best solution would be to generate a SEP deduction to offset the distribution taxes. If client made the 2022 contribution early enough in the year that it could be assigned to 2021 and 2021 contributions fell short of the 2021 SEP deductible amount, the contribution could be applied to 2021 and generate an additional 2021 deduction. Similarly, if the client had enough net earnings from SE in 2023, all or part of the 2022 excess could be carried over to 2023 and deducted on that return. Other than applying to 2021, the 10% excise tax on Form 5330 would be due for 2022 and the 2022 return would need to be amended to remove the SEP deduction. I realize that neither of these solutions are likely to apply here.
Otherwise, there does not appear to be a template to offset the taxation of this 1099R. Note that a non deductible SEP contribution cannot be reported as TIRA basis on Form 8606, even though the 1099R distribution might not be fully taxable if client happens to have IRA basis that could be applied to this distribution on Form 8606.
Even if client met the timing requirements for removal of the SEP excess prior to due date, no IRA custodian would reissue the 1099R as a corrective distribution unless there was evidence that the client requested the removal properly and the custodian mishandled.
Permalink Submitted by Marc Schain on Mon, 2024-05-20 18:21
The client should not have made a SEP IRA contribution as they had no earned earning from a business in 2022 or 2023.
Permalink Submitted by Alan - IRA critic on Mon, 2024-05-20 19:25
That eliminates carrying over the excess to 2023, but what about the 2021 option?