10 years of excess Roth contributions

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Topic Author
red5
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Joined: Sun Apr 01, 2012 4:42 pm

10 years of excess Roth contributions

Post by red5 » Sat May 16, 2020 5:04 am

Hey folks, I hope I can get help from this forum once again. Also, this is for a friend, not me (really). I've done a ton of internet research here and elsewhere and think have nailed down what my friend needs to do. Basically I'm hoping my thinking is correct. He is also waiting to meet with a tax accountant but in the meantime would like an idea of what is needed to resolve his problem.

My friend had always done taxes by hand but for tax year 2019 decided to use Turbo Tax. I also happened to suggest trying for the Retirement Savings Credit. Inputting Roth IRA contribution information actually caused his taxes owed to increase by $180. Upon investigation we found that the income limit for MFS (married filing separately) is a mere $10,000, which he makes more than. [He files MFS because his spouse has some sort of student loan issue].

He also says he has been filing MFS ever since 2008. His investment manager (a local individual) found he has contributed about $20,000 from 2008 to 2019.

So we basically came up with 3 options to pursue. The last that I'll discuss is undoubtedly the correct route to take.

1) Take all this money out so the 6% penalty on excess contributions stops and then hope the IRS never catches his mistake. This does not seem ethical and could potentially get him into more trouble down the road (interest).

2) Hire a tax attorney and try to fight this penalty or to at least reduce it (offer in compromise). My friend thinks he has been wronged because his investment manager has always said his contribution limit has been the maximum amount ($3k, $5k, etc). But he knows this mistake is ultimately on him and not his investment manager (who does not do his taxes). This also seems unlikely to succeed.

----------------------------------------
3) Okay so this is the part I'm hoping I understand correctly and probably the correct course of action.

a) Take out all the excess contributions from 2008 to 2018 (approximately $17,000) and leave those earnings in. The earnings are allowed to stay in while the excess contributions have been incurring a 6% penalty for each year they were in. If he invested about $1,545 per year for 11 years then I estimated that penalty would be about $7,150 (from 2008 to 2019). Would the penalty have already happened for 2020? Or would there be no penalty for 2020 if he withdraws the excess contributions? [For what it's worth, this approximately $17,000 would be put into a taxable account].

My understanding is there would be no further penalties or income taxes involved with this since his earnings would stay in the Roth and his contributions were already taxed at the initial time.

b) Have his investment manager withdraw his 2019 and 2020 Roth Contributions and have no penalty for these contributions (approx $3,000 in contributions between 2019 and 2020). This can still happen because it is not yet 6 months after the tax deadline for each of those tax years. The investment gains associated with these contributions would have to be calculated and also withdrawn and would be subject to a 10% early withdraw penalty and income taxes (but not the excess contribution). Essentially he can get a "do over" for 2019 and 2020 contributions.

c) My understanding is the tax return he just filed (for 2019 tax year) would not have to be amended since he did not even report his Roth contribution to begin with (he filed a couple weeks ago but was playing with the numbers yesterday to see if he could have taken the Retirement Savings Credit).

He would report the $20,000 in distributions and also the gains associated with 2019 and 2020 contributions on next years tax return (for tax year 2020) and at that point would pay the 10% penalty and income taxes on those gains.

He would have to fill out a form 5329 for each and every single year, from 2008 to 2019, and calculate his 6% penalty, which I quickly estimated would be roughly around $7,150. [my line of thinking is...The penalty would arise from the excess contributions that were made from 2008 to 2018 for the years that they were in the account, which was 2008 to 2019 (not sure if the penalty would apply for 2020 since this is the year he will take them out). The contributions from 2019 to 2020 can still be withdrawn penalty free since the 6 months after tax deadline for each year has not passed. But the gains for the 2019 and 2020 contributions would been to be withdrawn and taxed next year with a 10% penalthy. Also, the gains from the 2008 to 2018 contributions are allowed to stay in the Roth, free from penalty and tax]

If I'm correct with filling out 11 or 12 form 5329s, would those be sent in to the IRS immediately with payment ? Next tax year with tax return?

To anyone who made it through this and especially to anyone who cares to comment you have my (my friends) immense gratitude. Please let me know if you need more info.

Topic Author
red5
Posts: 794
Joined: Sun Apr 01, 2012 4:42 pm

Re: 10 years of excess Roth contributions

Post by red5 » Sat May 16, 2020 5:24 am

OP here. So in a nut shell...

Contributions from 2008 to 2018 immediately withdrawn and subject to 6% penalty each year; 2008 to 2019 (or is it 2020).

Earnings from 2008 to 2018 contributions stay in Roth and are a-okay

Contributions from 2019 to 2020 immediately withdrawn but not subject to 6% penalty.

Earnings associated with 2019 and 2020 contributions immediately withdrawn and subject to 10% early withdrawal penalty and income taxes for tax year 2020.

retiredjg
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Re: 10 years of excess Roth contributions

Post by retiredjg » Sat May 16, 2020 7:15 am

I think you are generally headed in the right direction. Not sure about all the details, but I'm pretty sure one detail is incorrect.

If your friend withdraws (gets a return of) his 2019 Roth IRA contribution, the earnings are taxable for the year 2019 not 2020. This will require an amendment to the 2019 taxes.

I'm not sure if/how the $20k distribution is reported on taxes - it should be coded on the 1099 as a return of excess contributions so should not add to taxable income. Be sure he does not just take this money out himself - his custodian must do this so that it will be coded correctly on the 1099. See Alan's comments below.

I believe form 5329 is one of the forms that can be signed and sent to the IRS alone (not with a tax return). That is what I'd do unless the instructions say otherwise.


Is it possible your friend might want to have the 2019 (and maybe the 2020) contribution recharacterized to tIRA instead of withdrawn? Because of his income, it would be a non-deductible contribution (assuming he has a retirement plan at work). If he has no other IRAs, he could do a Roth conversion on that money and it would end up back in Roth IRA. All of this would be captured on a 2019 and 2020 Form 8606.

This adds another layer of complexity and might not be worth it to your friend just now. But that option seems available.
Last edited by retiredjg on Sun May 17, 2020 12:09 pm, edited 1 time in total.

Topic Author
red5
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Joined: Sun Apr 01, 2012 4:42 pm

Re: 10 years of excess Roth contributions

Post by red5 » Sat May 16, 2020 10:28 am

Thank you so much for taking the time to respond.

So you believe that even though the gains would be withdrawn in 2020 they would still have to be reported on the 2019 tax return...because the contributions were from 2019? What if he decided just to withdraw the 2019 contribution along with the 2008 to 2018 contributions and pay a 6% penalty, I suppose then he could just leave the gains in the Roth and not even deal with an amendment?

And I'll pass along the tidbit of recharacterizing to the tIRA. It is something we came up with but I think he was leaning towards not doing this in order to keep it as simple as possible.

Again, much thanks.

retiredjg
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Re: 10 years of excess Roth contributions

Post by retiredjg » Sat May 16, 2020 11:11 am

red5 wrote:
Sat May 16, 2020 10:28 am
So you believe that even though the gains would be withdrawn in 2020 they would still have to be reported on the 2019 tax return...because the contributions were from 2019?
Yes. I was surprised when we were first told this, but it sort of makes sense now.
What if he decided just to withdraw the 2019 contribution along with the 2008 to 2018 contributions and pay a 6% penalty, I suppose then he could just leave the gains in the Roth and not even deal with an amendment?
I'm not sure if this is allowed or not. It is not officially "excess" until October 15, but I suppose it could be withdrawn after that and reported with the 2021 Form 5329, paying the 6% on that contribution then.

And I'll pass along the tidbit of recharacterizing to the tIRA. It is something we came up with but I think he was leaning towards not doing this in order to keep it as simple as possible.
That seems smart to me. Too many moving pieces on 1 tax return can mess things up. Or at least make it harder to unwind if the IRS has an inquiry later on.

retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: 10 years of excess Roth contributions

Post by retiredjg » Sat May 16, 2020 11:13 am

The people who can probably help you best on this are Alan S. and Spirit Rider.

Let me rephrase that....there are very likely others as well. Those just happen to be the names that come to mind. :oops:

trueblueky
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Joined: Tue May 27, 2014 3:50 pm

Re: 10 years of excess Roth contributions

Post by trueblueky » Sat May 16, 2020 11:23 am

I would probably try 2). The cost of the attorney is far less than the penalty, so it's worth trying, in my opinion.

Topic Author
red5
Posts: 794
Joined: Sun Apr 01, 2012 4:42 pm

Re: 10 years of excess Roth contributions

Post by red5 » Sun May 17, 2020 5:29 am

Thank you. This is a great start. I'll keep looking for new replies but in the meantime I think this gives him a good foundation of what to expect. I'll admit that I was a bit overwhelmed in trying to help at first.

lakpr
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Re: 10 years of excess Roth contributions

Post by lakpr » Sun May 17, 2020 5:47 am

It might be financially a better choice to amend all prior tax returns as Married Filing Jointly?

HomeStretch
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Re: 10 years of excess Roth contributions

Post by HomeStretch » Sun May 17, 2020 9:48 am

Has your friend vetted that the tax accountant is familiar with dealing with excess Roth contributions?

Alan S.
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Location: Prescott, AZ

Re: 10 years of excess Roth contributions

Post by Alan S. » Sun May 17, 2020 11:38 am

The IRS has no authority to waive the 6% excise tax, and therefore am not aware of any PLRs to that effect.

As for an OIC, these are mostly for those who lack the liquidity to pay their taxes.

For the year the excess amount is fully distributed, there is no excise tax due. But a 5329 must still be filed to document the elimination of the excess amount. The distribution request to the custodian need not mention excess contributions. The distribution will be coded like any other distribution and must be reported on Form 8606. Since it would come from regular contributions there is no tax or penalty. Therefore, in the year the excess is fully eliminated there is no excise tax or income tax on the distribution.

However, the late payment of the cumulative excise tax can generate a sizeable interest charge in addition to the actual excise tax.

retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: 10 years of excess Roth contributions

Post by retiredjg » Sun May 17, 2020 12:11 pm

Alan S. wrote:
Sun May 17, 2020 11:38 am
The distribution request to the custodian need not mention excess contributions. The distribution will be coded like any other distribution and must be reported on Form 8606.
Alan, thanks for correcting my misunderstanding.

Topic Author
red5
Posts: 794
Joined: Sun Apr 01, 2012 4:42 pm

Re: 10 years of excess Roth contributions

Post by red5 » Tue May 19, 2020 4:45 am

Thank you so much everyone. I'll pass along all this info. At first it was a bit overwhelming but it has seemed to clear up quite a bit. Again, thank you.

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