itworks wrote:Thanks Alan for the very clear explanation. I noticed your advice above is to pay $24 and report it in Form 5329 with 2012 return, and then pay $0 and report it in Form 5329 with 2013 return. Why not simply paying $24 in 2013 and reporting it in 2013 return, if I only need to pay the "penalty for year 2012" in "year 2013"?
And, do you mind explaining why I should not ask for corrective distribution? My guess is that I've already paid the 6% penalty hence there is nothing further to correct. Is that right?
Since your excess contribution is for 2012, the excise tax is due for 2012, not 2013. The 2012 5329 will indicate that you have an excess contribution that has not been corrected by the due date. The 2013 5329 basically shows that you entered 2013 with an excess of $400, but you withdrew the $400 by the end of 2013, and therefore 400 less 400 equals 0 remaining excess. Because the excess has been withdrawn, there is NO excise tax due for 2013. Many people do not know for years that they made an excess contribution, but the IRS is very slow to notify taxpayers. If you discover 3 years later that you made an excess contribution in 2009, you will owe a 6% excise tax for 2009 plus late interest, another 6% for 2010 plus late interest, another 6% for 2011 plus late interest, and will need to file a 5329 for each year. In your case, if you do not pay the $24 by 4/15, the IRS will start adding on late interest to the date you do pay it.
With respect to forms, many IRA custodians do not have forms to clearly address a corrective distribution done AFTER the due date. Even Vanguard's form could be misleading in trying to simplify the options for handling excess contributions. While earlier, we said you should wait until after 10/15 to withdraw the $400, you can do it in January if you want to make sure you don't forget. Usually, if someone has an excess contribution on which they are paying the 6% tax, they are better off to wait until the end of the year to withdraw it and let it generate earnings that will stay in the Roth IRA. But let's say in your case, $400 is small and you just want to make sure it is withdrawn in January so you don't forget to do it later. In that case, neither of Vanguard's options apply because the deadline has NOT passed and you are choosing to pay the 6% excise tax for individual reasons. Their form is fine if you choose to wait until after 10/15, but if you wanted to take care of it next month, I would just ask for a $400 distribution. If you choose to pay the 6% excise and are just removing the contribution amount itself, it is better not to even mention an excess contribution since that can trigger more questions and confusion from the custodian.
1) If you choose to go this route to avoid calculation chaos, and you want to leave the contribution in till after 10/15, use Vanguard's form and indicate the deadline has passed.
2) If you want to get the $400 out in January so you don't forget, don't use Vanguard's form since it does not address your situation. Just ask for a distribution of $400. Your 2013 5329 and 8606 will be done exactly the same way whether you take out the $400 in January, mid year, or December.
While you are doing this to avoid earnings calculation headaches, some people do the same thing when their excess contribution (or the IRA holding the contribution) has big gains. Assume a 5,000 contribution that gains 30%. If you remove the contribution in the usual fashion, you will have ordinary tax on 1,500 of income and a penalty of $150. Assuming 20% combined fed and state rates, you would pay $450 and 6,500 is distributed from your Roth.
Compare that to paying the 6% excise tax. You pay 6% of 5,000 or $300 and only 5,000 comes out of your Roth. You save $150 and the 1,500 of earnings gets to stay in your Roth to generate future tax free earnings.