Correcting a poorly executed withdrawal of 2016 excess Roth IRA contributions + earnings

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qqg
Posts: 6
Joined: Sun Apr 10, 2016 3:19 pm

Correcting a poorly executed withdrawal of 2016 excess Roth IRA contributions + earnings

Post by qqg » Fri Apr 06, 2018 5:24 pm

Hi, everyone! I need some help correcting errors that I made trying to correct excess contributions to my Roth IRA.

In 2016, I contributed the full $5500, but had a better financial year than I'd expected, wasn't eligible to make that contribution, and withdrew the entire $5500 before the end of 2016.

The problem is: I did it wrong, and didn't know to specifically ask Vanguard to withdraw the 2016 excess contribution and earnings. In 2017, before the tax deadline, I withdrew what I calculated to be the earnings from that contribution during the time that it was in the Roth IRA.

For my 2016 return, I filed a replacement 1099-R after (in good faith, but nonetheless incorrectly) misinterpreting guidance online. I split the withdrawal into the contribution (which I coded as 8) and the earnings (which I coded as J) on this replacement 1099-R. (The original 2016 1099-R that I received from Vanguard had only the $5500, coded as J.)

I've now received a 2017 1099-R from Vanguard, which reports only the withdrawal I made to account for the earnings. It's coded as J.

I wasn't eligible to contribute to a Roth IRA in 2017 and likely won't be in 2018 either. I haven't made contributions for either of those years. I did, however, have a non-zero balance in the account before 2016, as I was eligible to contribute for several years up to and including 2015.

I seem to have a slightly different case than the one on this thread: viewtopic.php?t=219990

That said, I'm at a loss for what to do to fix this situation after doing quite a bit of reading and research. Any help would be very appreciated. Thank you!

Alan S.
Posts: 7613
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Correcting a poorly executed withdrawal of 2016 excess Roth IRA contributions + earnings

Post by Alan S. » Fri Apr 06, 2018 10:35 pm

Of course, you probably realize that all those explanations of what you need to do did not clearly indicate that the custodian must do it for you and then code the 1099R to reflect a return of excess contributions in Box 7. Otherwise, even if you withdrew the correct amount the 1099R is not going to be coded as a return of an excess contribution.

As to where you are now, Form 5329 is used to report your excess Roth contribution for 2016 on which you owe a 6% excise tax of $330. Since you must file a 1040X for 2016 with Form 8606 to report the Roth distribution, file the 5329 with that 1040X as well. The 1099R for 2016 requires you to treat the 5500 distribution as a typical early distribution, but NOT a return of your excess amount because you did not have the custodian calculate the earnings and return them at the same time. There is no tax due for the distribution because it came from your regular Roth contribution balance. Unfortunately, if you had waited until Jan, 2017 to withdraw the 5500 without earnings it would have counted to reduce your excess amount to 0.

For your 2017 return (amended return if you already filed) you must file another 8606 to report the small distribution. If you have made regular contributions anytime in the past, this amount will also come from your remaining regular contribution balance and WILL reduce your outstanding excess by the amount of that distribution. You also need to file another 5329 and pay another amount, but your excess of 5500 was reduced by whatever your 2017 distribution 1099R showed, so you would owe a little less than $330 for the 2017 excise tax.

To clarify, while the amount you withdrew was the amount you thought was earnings on the contribution, under the Roth IRA ordering rules it was probably not earnings unless you never made a contribution other than the 2016 contribution. This withdrawal would come from any regular contribution balance you had left and would be tax free as reported on Form 8606. You need to know your balance of regular and conversion contributions from Day 1 from your own accounting to properly file the 8606. The custodian does not know this. You might google the "Roth IRA ordering rules" for a more detailed explanation of what you actually withdrew in 2016 and 2017.

While Form 5329 will apply your excess to later years if you are eligible for a Roth and did not contribute, you were NOT eligible. Therefore, you need to simply withdraw the remaining excess amount on which your 2017 excise tax was based. This will again be reported on a J coded 1099R for 2018, so you will need to complete an 8606 for 2018 to report this distribution. Not clear whether you will owe tax or not, as that depends on those ordering rules and how much in regular contributions you have left. You will also have to file a final 5329 for 2018 just to show that your excess amount has been eliminated by your 2018 distribution. No excise tax for 2018.

In the end you will have withdrawn the excess amount twice because the first 5500 did not count as an excess removal so the excess contribution was not eliminated until the 2017 and 2018 distributions were taken out.

You can tell from this explanation that a complex mess was created. Perhaps you should have asked Vanguard what you needed to do or if you did, you did not get any help. This is now complex enough that you might have further questions, so feel free to ask.

qqg
Posts: 6
Joined: Sun Apr 10, 2016 3:19 pm

Re: Correcting a poorly executed withdrawal of 2016 excess Roth IRA contributions + earnings

Post by qqg » Mon Apr 16, 2018 2:23 pm

Alan,
Thank you so much for your detailed response, and pardon my slow response—I was out of town.
Therefore, you need to simply withdraw the remaining excess amount on which your 2017 excise tax was based. This will again be reported on a J coded 1099R for 2018, so you will need to complete an 8606 for 2018 to report this distribution. Not clear whether you will owe tax or not, as that depends on those ordering rules and how much in regular contributions you have left. You will also have to file a final 5329 for 2018 just to show that your excess amount has been eliminated by your 2018 distribution. No excise tax for 2018.
Am I correct as reading this piece to mean that I should contact Vanguard to withdraw the excess 2016 contribution, in the amount of $5500 minus the amount that I withdrew in early 2017 to attempt to account for the 5500's earnings?

Thank you again! I really appreciate your time, energy, and knowledge.

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