Roth IRA Excess Contributions

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HoboKent
Posts: 27
Joined: Sat Jun 11, 2016 8:47 am

Roth IRA Excess Contributions

Post by HoboKent » Thu Feb 09, 2017 5:30 pm

Hello,

I think I did something really bad. I recently came to the conclusion that my spouse and I are both ineligible, based on income, to contribute to Roth IRAs. I believe this goes back as far as 2012, total of about $40,000 in excess contributions. I've already contacted Vanguard and had them recharacterize the 2016 and 2017 contributions to traditional IRAs. Now I'm trying to figure out what to do about all the previous years.

I asked Vanguard to calculate the interest that can be attributed to these over contributions. I was told by the retirement specialists that since it's beyond the deadline to recharacterize those years, the IRS won't require me to remove the interest and wont penalize me on it. Thoughts on that? It sounds a little too good to be true to me. I've averaged more than 10% annual return on these accounts so the interest is pretty significant.

Regarding the over-contributions...I assume when/if I'm contacted by the IRS they will make us file 5329s for each year which as of today would look something like this:

5329 2012 - ($0 carry over + $10,000 current) * 6% = $600 penalty
5329 2013 - ($10,000 carry over + $10,000 current) * 6% = $1,200 ($1,800 cumulative)
5329 2014 - ($20,000 carry over + $10,000 current) * 6% = $1,800 ($3,600 cumulative)
5329 2015 - ($30,000 carry over + $10,000 current) * 6% = $2,400 ($6,000 cumulative)
5329 2016 - ($40,000 carry over + $0 current) * 6% = $2,400 ($8,400 cumulative)

Will this continue forever and can the IRS go back to the beginning no matter how long this goes until I take distributions or are they limited to a three year window? Meaning if I do nothing and they contact me in five years would my risk be $2,400 x 3 ($7,200 cumulative) or would they penalize me all the way back to 2012?

I'm really beside myself looking at what a mess this is. I know it doesn't matter but none of this was malicious or intentional. I filed my taxes timely every year and never omitted anything. The IRS has all the info on my earnings and contributions. Originally, we qualified to contribute to Roth accounts and then gradually our incomes increased. If the IRS had contacted us after a year or even two this wouldn't be so bad :oops:

Alan S.
Posts: 6911
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Location: Prescott, AZ

Re: Roth IRA Excess Contributions

Post by Alan S. » Thu Feb 09, 2017 7:59 pm

HoboKent wrote:Hello,

I think I did something really bad. I recently came to the conclusion that my spouse and I are both ineligible, based on income, to contribute to Roth IRAs. I believe this goes back as far as 2012, total of about $40,000 in excess contributions. I've already contacted Vanguard and had them recharacterize the 2016 and 2017 contributions to traditional IRAs. Now I'm trying to figure out what to do about all the previous years.

I asked Vanguard to calculate the interest that can be attributed to these over contributions. I was told by the retirement specialists that since it's beyond the deadline to recharacterize those years, the IRS won't require me to remove the interest and wont penalize me on it. Thoughts on that? It sounds a little too good to be true to me. I've averaged more than 10% annual return on these accounts so the interest is pretty significant.

That is correct. Having to pay the 6% excise tax for excess contributions is mutually exclusive with the return of earnings. You DO get to keep the earnings on these excess contributions in your Roth.

Regarding the over-contributions...I assume when/if I'm contacted by the IRS they will make us file 5329s for each year which as of today would look something like this:

5329 2012 - ($0 carry over + $10,000 current) * 6% = $600 penalty
5329 2013 - ($10,000 carry over + $10,000 current) * 6% = $1,200 ($1,800 cumulative)
5329 2014 - ($20,000 carry over + $10,000 current) * 6% = $1,800 ($3,600 cumulative)
5329 2015 - ($30,000 carry over + $10,000 current) * 6% = $2,400 ($6,000 cumulative)
5329 2016 - ($40,000 carry over + $0 current) * 6% = $2,400 ($8,400 cumulative)

Correct. So retaining the earnings is just a small consolation.


Will this continue forever and can the IRS go back to the beginning no matter how long this goes until I take distributions or are they limited to a three year window? Meaning if I do nothing and they contact me in five years would my risk be $2,400 x 3 ($7,200 cumulative) or would they penalize me all the way back to 2012?

There is NO statute of limitations on excess contributions. While you rarely hear of a decade's worth of excise taxes plus the late interest the IRS can charge on the payment of those excise taxes, the only way to start a 3 year statute of limitations is to file a 5329 for the respective year reporting either 0 excess contributions or an excess amount, and you would of course have to pay on the reported amount. And reporting 0 appears to be a red flag, as it is unlikely anyone would file a 0 unless they were concerned that they had an excess contribution in the first place. So if they contacted you anytime in the future, your exposure would be 8400 through 2016 plus 2400 for each year thereafter plus late interest.

I'm really beside myself looking at what a mess this is. I know it doesn't matter but none of this was malicious or intentional. I filed my taxes timely every year and never omitted anything. The IRS has all the info on my earnings and contributions. Originally, we qualified to contribute to Roth accounts and then gradually our incomes increased. If the IRS had contacted us after a year or even two this wouldn't be so bad :oops:


Exactly. The IRS administration of IRA rules of all kinds is abysmal. Their systems are antiquated and these kinds of errors can go years without hearing anything from the IRS. Tax programs do far more to identify infractions than the IRS, so the bulk of errors are self discovered or discovered by tax programs or preparers. Someday I expect to hear of a tax court case filed by a taxpayer regarding late detection. By the way, how do you file your return since that process apparently failed to disclose the excess contributions.

So, do you want to know what you need to do now, and how to report it?

HoboKent
Posts: 27
Joined: Sat Jun 11, 2016 8:47 am

Re: Roth IRA Excess Contributions

Post by HoboKent » Thu Feb 09, 2017 10:48 pm

So the IRS is going to charge me interest on top of the penalty that I self-report? Wow, that's draconian.

At least the earnings are safe. Vanguard calculated about $2300 in earnings on just the 2016/17 contributions that we recharacterized. I'd hate to see what that would end up being going back to 2012. Nice to know that money is not only penalty free but tax free forever.

As for tax preparation, my wife usually handles it while I manage our investments. I knew we were close to the income limit but thought it included deductions like mortgage interest, property taxes, etc which would have made us eligible. I took a hard look at the rules recently and realized the mistake.

And yes, I'd like to hear the next step and what I should do at this point. I've been speaking with an accountant but she appears to be wrong on both parts. She told me I had to withdraw the interest which would be penalized 10% and then reported as income. And that the IRS could only go back three years. :confused I was skeptical so I've been doing my own research.

Thanks.

Alan S.
Posts: 6911
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Roth IRA Excess Contributions

Post by Alan S. » Thu Feb 09, 2017 11:19 pm

HoboKent wrote:So the IRS is going to charge me interest on top of the penalty that I self-report? Wow, that's draconian.

They may or may not, but they are certainly entitled to since you would be paying your excise taxes several years late.

At least the earnings are safe. Vanguard calculated about $2300 in earnings on just the 2016/17 contributions that we recharacterized. I'd hate to see what that would end up being going back to 2012. Nice to know that money is not only penalty free but tax free forever.

Actually, if the earnings are high enough for a recent contribution, you could actually come out ahead by paying the excise tax that year so that you would not have to withdraw the earnings and pay tax or penalty or recharacterize like you did that sends those earnings to a TIRA where they will eventually be taxed when withdrawn. Depends on your marginal tax rate.

As for tax preparation, my wife usually handles it while I manage our investments. I knew we were close to the income limit but thought it included deductions like mortgage interest, property taxes, etc which would have made us eligible. I took a hard look at the rules recently and realized the mistake.

If she was using a good tax program, it should have alerted her to an excess contribution. Evidently it either did not or she missed it.

And yes, I'd like to hear the next step and what I should do at this point. I've been speaking with an accountant but she appears to be wrong on both parts. She told me I had to withdraw the interest which would be penalized 10% and then reported as income. And that the IRS could only go back three years. :confused I was skeptical so I've been doing my own research.

[color=#FF4040]Yes, it is surprising that many tax preparers do not understand this stuff, including CPAs.
To correct the excess contributions, you need to file a 5329 for each year calculating the 6% excise tax (you have already done this correctly). Start with 2012 through 2015 and carry that excess forward, until you are done. You could try to file them alone, but the IRS technically wants a 1040X for each 5329 even though it serves no purpose. Staple them together and send to your IRS filing office with a cover note and check for the total excise taxes 2012-2015.

For filing your 2016 return, include an explanatory statement regarding the contribution you recharacterized to TIRA. Assuming that TIRA contribution is non deductible you will need to file an 8606 (for each spouse) to report the non deductible contribution. The 2016 5329 should be attached to the 2016 return and 6% excise tax for the 2016 total paid with that return.

You need to withdraw the total excess amounts, but you do not incur another excise tax until 2017, so you can postpone this distribution until December to give those contributions several months more to generate tax free gains. When you order the distribution of the total excess amounts do not mention anything about a corrective distribution. Just ask for a regular distribution. You will get a 1099R for that next January. For your 2017 return you will report the distributions on Form 8606 Part III. Since they come from your regular contribution balance (which you need to know) the distribution will be tax and penalty free. Finally, file a 2017 5329 which will show the distribution that removes the excess contribution amount. No penalty for 2017. The actual tax cost is therefore limited to the excise taxes paid. Hope the IRS does not bill any interest.

[/color]Thanks.

HoboKent
Posts: 27
Joined: Sat Jun 11, 2016 8:47 am

Re: Roth IRA Excess Contributions

Post by HoboKent » Fri Feb 10, 2017 10:49 am

Ok, that all makes sense and is about what I was expecting at this point except for one thing...when I spoke with Vanguard they told me I needed to tell them this was a distribution for excess contributions, not a regular distribution. They said there was a different code for regular vs excess.

That would seem reasonable because Vanguard would report it coded as a withdrawal for excess and then it could flag at the IRS if I didn't file a 5329 to match. Otherwise, if there's no code for excess vs normal distribution, I could withdraw the excess and file an 8606 but no 5329. In that case, if the IRS came after me five years from now, the carry forward would be stopped on the 2017 5329 where I zero out line 24 and they would probably charge me interest but no additional penalties beyond 2016, correct?

I'm asking mostly to make sure I don't screw up the withdrawal request so it's allocated properly and not considered a "normal distribution" if there is in fact a difference. If there isn't it would seem even harder for the IRS to catch these types of mistakes.

Also, I appreciate the time and feedback. I feel like I'm finally getting to the bottom of this after several weeks of uncertainty. Even if it's not the outcome I was hoping for.

Alan S.
Posts: 6911
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Roth IRA Excess Contributions

Post by Alan S. » Fri Feb 10, 2017 2:05 pm

HoboKent wrote:Ok, that all makes sense and is about what I was expecting at this point except for one thing...when I spoke with Vanguard they told me I needed to tell them this was a distribution for excess contributions, not a regular distribution. They said there was a different code for regular vs excess.

That is true if you are removing an excess distribution BEFORE the extended due date, but it does not apply to removal after the extended due date. The extended due date is 10/15 following the year IN WHICH the excess contribution is made providing you either filed your return or extension on time. Otherwise the normal due date applies. Therefore, your extended due date for 2012-2015 excess contributions have passed, you owe the 6% excise tax for those years, any earnings for those years STAY in the Roth IRA, and you only withdraw the excess contribution amount. Yes, the coding is different for the two types. For removal after the extended due date, the 1099R coding is the same as any other Roth distribution and it is also taxed in the same manner, reported on Form 8606.

That would seem reasonable because Vanguard would report it coded as a withdrawal for excess and then it could flag at the IRS if I didn't file a 5329 to match. Otherwise, if there's no code for excess vs normal distribution, I could withdraw the excess and file an 8606 but no 5329. In that case, if the IRS came after me five years from now, the carry forward would be stopped on the 2017 5329 where I zero out line 24 and they would probably charge me interest but no additional penalties beyond 2016, correct?

It is up to you to file the 5329. Note that an excess contribution after the due date is automatically cured by either contributing less than you are eligible to in a later year (5329 applies the excess to the difference) or if you take a distribution from the Roth for any reason you want. Many people end accumulation of excise taxes by accident from these two occurrences. Take a look at the 5329 Part IV, and you can see how this is done. To answer your question, if you failed to file the 5329 and the IRS charged you continued excise taxes, since there is no statute of limitations for excess contributions, I assume there is no statute of limitations for filing a 5329. So even if the IRS contacted you 8 years after an excess contribution, if you had taken a distribution after 5 years, you would be able to file a 5329 for that year which would end the excise taxes. (But be careful of filing an incorrect 5329 because that will start the 3 year SOL). You would only be charged interest for excise taxes that you actually owe and are paid late, so you could stop accumulating new excise taxes as you did in 2016, but if you do not pay the taxes that already exist, interest could be charged. Perhaps they will not, if you self report and correct the excesses. You may not know for sure until at least a year passes from the date you pay the back excise taxes.

I'm asking mostly to make sure I don't screw up the withdrawal request so it's allocated properly and not considered a "normal distribution" if there is in fact a difference. If there isn't it would seem even harder for the IRS to catch these types of mistakes.

I think there was just a simple miscommunication between you and VG about the corrective distribution after the due date. Call back and talk to a different rep and clarify that you are removing excess contributions that are all PAST the extended due date for those returns. The rep should confirm that this is ordered like any other distribution, simply a dollar amount to distribute to you that will result in an early J coded 1099R that you will report on Form 8606 and 5329. Caveat: VG apparently does have many improperly trained CSRs who give incorrect advice at times. So try to get to an IRA Dept specialist. (Tax code Sec 408(d)(3)(5) covers corrective distributions after the due date).

Also, I appreciate the time and feedback. I feel like I'm finally getting to the bottom of this after several weeks of uncertainty. Even if it's not the outcome I was hoping for.

HoboKent
Posts: 27
Joined: Sat Jun 11, 2016 8:47 am

Re: Roth IRA Excess Contributions

Post by HoboKent » Sun Mar 19, 2017 9:12 pm

So I was ready to make a partial withdrawal of the excess contributions from my and wife's Roth accounts. I was thinking of taking $5000 now and leaving the remaining $37000 in the accounts until December since there's no additional penalty. I called Vanguard to ask if I could do this online as a normal sale and distribution or I needed them to do anything special given the circumstances.

After waiting on hold for 30 minutes to speak with a IRA specialist I was told I needed to coordinate with them, fill out a form and I would receive a 1099-R with code P. That really alarmed me because it seemed wrong. I started the conversation explaining I had already recharacterized my 2016 and 2017 contributions. I was calling to address my excess from years prior to that. I was at lunch and didn't have time to continue the conversation (wasn't expecting the 30 minute wait) so I hung up and resolved to call back.

I tried again a few days later in the evening, another extended wait before I reached a second gentleman who this time agreed that code P was not correct for my situation and that I would get a code 1 (I was expecting a code J). He also stated that I should coordinate the distribution with Vanguard. According to him they fill out an internal form to denote the removal as an excess contribution.

At this point I'm quite anxious about the whole mess. A few questions...

1. Should I be worried about the code 1 versus code J? They both mention early distribution without an exception but code J states Roth IRA.
2. Is there any downside to not notifying Vanguard ahead of time? Do I need the involvement of someone at Vanguard I'm confident understands my situation and what I'm trying to accomplish? If I just go online and take a distribution at my convenience could that screw this up somehow?

Alan S.
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Joined: Mon May 16, 2011 6:07 pm
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Re: Roth IRA Excess Contributions

Post by Alan S. » Sun Mar 19, 2017 10:48 pm

They need a lot of training over there.

I always suggest when you are correcting an excess contribution AFTER the due date as you are, to NOT mention anything about excess contributions to the IRA custodian. Most of them only understand corrective distributions BEFORE the due date.

You do not have to coordinate anything with VG, and as you can see if you try a can of worms results. Just take a typical distribution when you want to. Code J will apply because this is a Roth early distribution, not a TIRA distribution. If you just take a regular distribution I am sure the 1099R will be coded J and it will not have an 8 or P with it because you are not pulling a recent excess contribution with earnings.

There is no reason to notify Vanguard at all, as I assume you can request a distribution on line from your Roth IRA anytime you wish. It is also a good idea to delay the distribution till early December to allow more time to generate earnings in the Roth which will stay in the Roth. This should be very simple with no risk as long as you get the distribution out in time.

This cleanup project will be concluded when you file the final 5329 which will show that the total distributions this year have eliminated the excess and reduced it to 0.

HoboKent
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Re: Roth IRA Excess Contributions

Post by HoboKent » Mon Mar 20, 2017 9:11 am

I would agree with the lack of training. It's a little bit disconcerting. Anyway, thank you very much for the guidance. At this point, I'll likely wait until December and do the distributions in one shot.

Alan S.
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Re: Roth IRA Excess Contributions

Post by Alan S. » Mon Mar 20, 2017 1:40 pm

I suggest no later than early December to avoid the risk that the distribution is not done before year end. That would trigger another year of excise taxes.

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Epsilon Delta
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Re: Roth IRA Excess Contributions

Post by Epsilon Delta » Mon Mar 20, 2017 3:32 pm

I think they're supposed to be trained to say "Vanguard doesn't give tax advice, consult your tax advisor." The ones I have spoken to have been very well trained.

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