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I'd like a clear answer on the process of correcting an excess IRA contribution.

My Roth IRA has an excess contribution from 2 years back. This means for 2017 I will be paying a 6% penalty. My understanding is that the only way to correct his is with a distribution (my income limit prevents me from making any more Roth IRA contributions).

  1. When is the deadline for the distribution so I do not incur another 6% penalty in FY2018?

  2. What amount should the distribution from the Roth IRA be equal to? In other words, should the distribution include the gains accrued by the amount over the last 2 years, or the exact overage amount?

  3. What, if any, additional penalties will need to be paid after receiving the distribution. The Roth IRA account is > 5 years old and I am not old enough to take a distribution on the interest without a 10% penalty.

  4. The distribution will generate a 1099-R. What will the codes be on the form and how does one correctly enter the distribution to a) pay the correct penalty, b) indicate that the Roth IRA account is now correct.

Sorry if this question seems like a duplicate, but I have yet to find an explicit answer explaining the entire scope for the process to take a distribution after paying the 6% penalty.

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Adding my own answer with info from Vanguard*. Clearly this is not a well understood topic since both answer so far are wrong.

  1. After the tax filing season in the year the contribution was made hast past (Oct 15th), the deadline for correction is December 31st. Waiting to December 31st, means you still owe 6% penalty for previous year. For example, since this was a 2015 contribution, the last date to "undo" the contribution was Oct 15th 2016. Since this was not done there is a 6% penalty for 2015 and a 6% penalty for every year tax ending Dec 31st after that. At this point 2017 is past, so penalty is due up through 2017.

  2. I requested the distribution of the exact amount for the year in which I made the contribution. A 1099-R is going to be issued for the current year (2018). There is no impact to my 2017 tax filing other than the penalty.

  3. The distribution does not include the earnings since it is past the original Oct 15, 2016 deadline. To me this is the one positive. The earnings will remain tax free, this probably offsets most or all of the 6% penalty. I'll have to do the math to be sure.

  4. In 2018 I'll have to account for the distribution. Since this is a Roth IRA, I'm expecting this not to be penalized, but I could be wrong (I will update if I get more details on this part).

* DISCLAIMER: These details come from my conversionation w/ Vanguard. I can't guarantee this is accurate info.

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Per the IRS, there are two ways to correct excess IRA contributions (per Publication 590-A):

Withdrawal of excess contributions For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made.

If you timely filed your 2017 tax return without withdrawing a contribution that you made in 2017, you can still have the contribution returned to you within 6 months of the due date of your 2017 tax return, excluding extensions. If you do, file an amended return with "Filed pursuant to section 301.9100-2" written at the top. Report any related earnings on the amended return and include an explanation of the withdrawal. Make any other necessary changes on the amended return.

Applying excess contributions If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in 1 year to a later year if the contributions for that later year are less than the maximum allowed for that year.

Vanguard offers similar advice, in simpler language on this page:

If you discover it after you've filed your tax return

You can either:

  1. Remove the excess within 6 months and file an amended return by October 15.
  2. Reduce next year's contributions by the amount of the excess. For example, if your limit is $5,500 and you exceed it by $1,500 in the current year, you can offset the excess by limiting your contributions to $4,000 the following year.

Be aware that when you "carry forward" an excess to a future year, you'll have to pay a 6% penalty until the excess is absorbed or corrected.

Note: If you contributed to a Roth and traditional IRA in the same tax year and your total contribution went over the allowable IRA amount, IRS regulations require you to remove the excess from the Roth IRA first.

You may want to talk with a tax advisor about the best way to handle any excess contributions.

In your case, since you're past the October 15th deadline, your best option is to apply the excess to the next tax year. Keep in mind you'll still be liable for the 6% excess contribution penalty on the excess amount.

  • Thanks for the response, however I've read this info and it's still ambiguous to me. The first section is talking about removing before the deadline, which I am past. Second, I can't apply excess contributions to the next year because my contribution limit is 0. What is the 3rd option? – cmcginty Mar 11 '18 at 21:13
  • Maybe my reading of 590-A was incorrect before. It's not clear if the the first paragraph is talking about the year when the contribution was made, or any year after? If withdrawing is my only option, then does that mean taking the withdrawal, plus earnings and then amending my 2015 tax return? Still confused. – cmcginty Mar 11 '18 at 21:30
  • @cmcginty, my interpretation of the second paragraph (titled "applying excess contributions") is that you can apply the excess to a later year. But I agree with Vanguard, check with a tax advisor/accountant to make sure that you're doing it right. – JW8 Mar 12 '18 at 1:06
  • According to 590A "If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in 1 year to a later year if the contributions for that later year are LESS THAN THE MAXIMUM ALLOWED FOR THAT YEAR." As I said a few times, my maximum allowed is now 0. – cmcginty Mar 12 '18 at 4:37
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If you overcontributed in 2016, and didn't correct it before the deadline in 2017 (normally Oct. 15, but 16 that year because 15 was Sunday), you owe the (corrected!) 6% excise tax for tax year 2016, in addition to tax on earnings. This will require an amended return on 1040X, which is something of a nuisance because 1040X must be filed on paper not electronically. (Edit: I thought I remembered sometime seeing an allocation by year, but on checking apparently not, except sort of for closed years, which doesn't apply here.)

For tax year 2017, since you indicate you can't use it as a contribution, you have until Oct. 15 2018 to correct it, as described in JW8's answer. I'd say it's better to do it by April 15-this-year-17, which you have time to do, because then you will definitely get a 1099-R and I believe an updated 5498 from the custodian, and yes there are specific codes assigned for this case. Make sure you tell the custodian this is a corrective withdrawal so they will compute it (with the attributable earnings) and report it as such. If necessary talk to a human rather than using their website or a preprinted form intended for regular distributions.

You will owe tax at ordinary rates on the earnings, (corrected) AND the early distribution penalty. (My memory played me false on this one. The one time I was in this situation, long ago, I could 'use up' the excess contribution the second year and thus didn't need to take a distribution.)

Yes, pub 590A on the web or downloadable is the first port of call for this question, but it is rather brief for Roth, with less detail than the equivalent case for traditional. Pub 590B for distributions similarly covers traditional fully but barely mentions Roth. The instructions for 1099-R box 2a for Roth are more complete, specifying that only earnings go in 2a as taxable, and box 7 uses code J and 8 or P. The 'guide to codes' just after boxes 12-17 explains 8 and P as excess contributions/deferrals/earnings taxable in 2017 or 2016 respectively, and J as (any) early distribution, so yes the additional 10% for early distribution applies to the earnings. Sorry I got that wrong the first time.

And in case it wasn't obvious, to make things even worse, since you will now pay tax that is considered to have been due in April 2017, your payment is late and you nominally owe the penalty for late payment, and interest. You can probably get that penalty waived (offically called abated) assuming you have otherwise been compliant, but AFAIK they never actually waive interest -- although if the amount is small enough they may not bother collecting. (I have had them 'forget' interest of a dollar or two.) See https://www.irs.gov/businesses/small-businesses-self-employed/penalty-relief-due-to-first-time-penalty-abatement-or-other-administrative-waiver if necessary.

  • 10%, do you mean 6%? As for "tax on ordinary rates", can you confirm that means refiling in the year I made the excess contributions. I'm looking at 590A and see, "The earnings are considered earned and received in the year the excess contribution was made." – cmcginty Mar 12 '18 at 4:41
  • @cmcginty: yes 6%, sorry; and yes on checking it all goes back in the year of contribution = 2016 and you will need specifically to file an amended return for 2016 using 1040X, to add the 'missing' income (thus tax on it) and the form 5329 tax. See edit. – dave_thompson_085 Mar 17 '18 at 2:56

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