What is the best option: conversion of excess contribution to traditional IRA; distribution, or leave for now?

Question

I made a contribution to traditional IRA in '09. For various reasons, I did not receive some POD CD's of 2008 until now (2012). Now because of higher AGI for that year, figured on amended form, I have an excess amount in that IRA. How should I handle it and what tax forms are due for which year? 2009 or 2010 or even this year 2012? or every year on that amount & it's earnings?

Answer 1

First of all, make sure that the money that you got from the POD (pay on death?) account is actually taxable income to you. If you get a gift, you do not have to pay income tax on the money. If you get a bequest, which is typically what payments from a POD account usually are, that is not taxable income to you. Now, there may be gift tax due in the one case and estate tax in the other, but that tax is paid by the donor of the gift or the estate of the deceased, not by the beneficiary. Also, normally, the bank or investment company holding a POD account will pay the amounts to the beneficiary upon receipt of a copy of the death certificate of the deceased owner, bypassing the settlement of the estate and anything to the contrary that the last will and testament of the deceased might say about where those assets should go. It is the duty of the executor of the estate to send the death certificate and to include the amounts in POD accounts on the estate tax return and pay the estate tax, if any. So you might want to investigate as to why the funds were distributed to you so many years later instead of soon after the death of your benefactor. Maybe the executor was dilatory in sending the death certificate, maybe the bank lost the death certificate, or the matter slipped through the cracks and the account never got closed etc. But if the bank claims that the POD amount is taxable income to you, then you need to talk to your own tax accountant and/or lawyer to get the matter resolved. One possibility is that because of a screw-up, the money that should have been transferred to you in 2009 (or 2008 when the death occurred) actually got transferred in 2012. Even if this is the case, the value of the account as of the date of death is not taxable income to you; what is taxable income is the increase in value between the date of death and date of payment. So please do check to make sure that you are not declaring a bequest as taxable income. I will add that all the above does not quite apply if the POD account was an IRA or 401k or other tax-deferred account in which case different rules apply, but you have not called the POD account an IRA and so I am assuming that it is not an IRA.

Whatever amount of the payment from the POD account actually is taxable income to you, if you are required by the IRS (or your accountant tells you) to declare it as 2009 taxable income even though you received the money only in 2012, then I would recommend that you

• File an amended return (Form 1040X) showing the additional income for 2009
• If the revised AGI makes you ineligible wholly or in part to have made a deductible Traditional IRA whereas you had made an IRA contribution for 2009 and deducted that on your original 2009 return, then do not take a deduction (in whole or in part, as appropriate) for a Traditional IRA contribution on the amended return. This will increase your 2009 AGI even further and make you liable for more income tax. But do not withdraw the excess contribution from your IRA. Instead, file a Form 8606 for 2009 claiming that you made a nondeductible contribution to your Traditional IRA that year. Again, depending on the numbers, your 2009 IRA contribution might be deductible in part and nondeductible in part, or might be wholly nondeductible. In any case, you now have a basis in your Traditional IRA. When you begin withdrawing funds from your Traditional IRA (or rolling over your Traditional IRA into a Roth IRA) you will not have to pay income tax on the basis in your Traditional IRA; it will be distributed to you (or rolled over into the Roth IRA) tax-free. Of course, earnings on the basis amount will be taxable when distributed or rolled over into a Roth IRA, but the basis itself will not be taxed.

(Note: I have not read the Form 8606 instructions for a couple of years, and maybe what I have said above is all wrong because it is not possible to file a new or revised Form 8606 with an amended tax return. If so, someone else is sure to point out this error very soon).

Answer 2

As littleadv mentioned, it's not an excess contribution, per se, but a retroactive inability to treat it as deductible. You need to file amended returns for each year that had a non-deductible IRA deposit and include form 8606 for those years. If its only the one year, it will just be the one set of forms. Keep the 8606 handy, as it's used to track IRA basis right until you convert to Roth or withdraw.