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Roth IRA. I have a very specific question about excess

contributions to a Roth IRA...
Roth IRA. I have a very specific question about excess contributions to a Roth IRA. I am a tax preparer. My client made a Roth IRA contribution for 2016 in April of 2017. It then turned out that his income was over the limit for a Roth contribution. However, it will be under the AGI limit for 2017. Can he leave the contribution in his account, apply it to 2017 (since he made it in 2017 anyway)? It is my understanding that in this case, he would not have to pay a 6% penalty since he will not have had an excess if he simply applies the contribution to 2017 instead of 2016. Is this correct?
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Answered in 15 minutes by:
9/30/2017
Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 14,614
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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HI, MY NAME’S LANE - I hold a law degree (J.D.), with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice 1986

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If you’ll please bear with me for a minute I’ll type up my initial response, and then we can go from there if you have further questions on this.

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Just to lay the foundation (may be stating the obvious here) this is an excess contribution. ANd there are four ways to handle an excess contribution.

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The WAYS one can make an excess contribution to an IRA - Roth or otherwise - are the following: (I'll underline the pertinent part)

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• Contribution is more than the annual contribution limit

• Contribution is more than your earned income

• Contribution made to a Traditional IRA at age 70½ or older

• Contribution made on behalf of an individual after date of death

• Required minimum distribution (RMD) is rolled over

• Making an ineligible rollover contribution

Contribution to a Roth IRA and your modified adjusted gross income (MAGI) exceeded the income limit

• Unable to deduct a Traditional IRA contribution; this is truly not an excess contribution because being unable to deduct does not mean that you weren’t able to contribute

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If you do not remove the excess amount by the deadline, you will owe a 6% IRS excise tax penalty.

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Now the four ways to handle

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1. Timely remove excess before the tax filing deadline — The excess or unwanted IRA contribution amount, plus the net gain or loss, will need to be removed by the tax filing deadline (generally April 15), including an automatic six month extension. This means the excess should be distributed generally by October 15.

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If you remove the excess contribution after you file your taxes, you may need to file an amended tax return. If you remove the excess in a timely manner, you will generally owe tax and, if under age 59½, the 10% IRS penalty only on any earnings, not on the excess contribution. But for a Roth, that wouldn't be the case. If you use this one the custodian will report a distribution and show the earnings as the taxable amount on a 1099-R.

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You can then contribute to a 2017 Roth (some custodians may allow and report this without physically making a distribution, but it IS a distribution and new contribution). This is NOT a recharacterization, as some call this.

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2. Recharacterization — A recharacterization involves transferring the annual contributions from the current IRA to the other type of IRA — either Traditional or Roth. It's important to understand that you can’t recharacterize more than your allowable maximum contribution. When recharacterizing an annual contribution, it will be considered to have been contributed for the same taxable year that the contribution was originally made.

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3. Remove excess after the tax filing deadline. You will remove only the amount of the excess; no earnings or loss will be calculated. You will owe the 6% IRS penalty for every year the excess remains in the IRA

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So as you can see, the way you've worded your question, the answer has to be NOT exactly, but by using number 1, and its occurring before october 15, only the earnings in the account will be taxable, and there's no 6% penalty.

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Earnings are calculated as follows:

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Net Income = Excess to be removed x (Adjusted Closing Balance (ACB) – Adjusted Opening Balance (AOB)) / Adjusted Opening Balance

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What you said is essentially the fourth way, a carry-forward, which WILL cause the 6% excise tax:

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Carry forward — You can offset the excess contribution by limiting your annual contribution for the following year to the maximum minus the excess, as long as you qualify to make a contribution. No distribution from your IRA will occur. For example, if your contribution limit is $5,500 and you exceed it by $1,500, you can offset the excess by limiting your contributions to $4,000 the following year. However, if you use the carry forward method, you are subject to the 6% IRS penalty because you did not correct the excess by the deadline.

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Please let me know if you have ANY questions at all, before rating me.

If this has helped, and you DON’T have other questions … I'd appreciate a positive rating (using the stars or faces on your screen, and then clicking “submit")

I hope that you’ll rate me based on my accuracy and thoroughness, rather than any good news/bad news content.

That’s the only way JustAnswer.com will compensate me for the work here.

Thanks,

Lane

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Customer reply replied 9 months ago
All of the examples I have read about a carry forward involve a contribution that was actually made in 2016 for 2016. Because this contribution was made in 2017, at a time in which he is entitled to make a 2017 contribution, why would the 6% penalty occur? At what point would the contribution have exceeded his limit? He made it for 2016 but in 2017, so if he just leaves it in and calls it a 2017 contribution, not sure when the date of taxation begins?
Customer reply replied 9 months ago
Again, no earnings or contributions for 2016 were actually made in 2016.
Customer reply replied 9 months ago
Basically, he will limit his 2017 contibution to zero to carry forward the amount he contributed in 2017. Thus, at no time was there an excess contribution. Please tell me where I am wrong on this.
Customer reply replied 9 months ago
BTW, I would never rate anyone poorly because of bad news. I can accept bad news. I just haven't been convinced yet that I am incorrect since I can't see at what time there would have been contributions/earnings that were in excess of what was allowed, assuming he makes no further contributions in or for 2017.

Individuals are cash basis, calendar year taxpayers

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When he made the contribution, the custodian (based on the form used, web form, etc) MUST apply as a 2016 contribution if he made it before the due date including extensions and the client asked for this to be a 2016 contribution. As calendar year cash basis taxpayers, all transactions are attributed to a specific tax year. For tax purposes, if the client so indicted, this is a 2016 contribution.

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By using the carry forward method (which he must do if he doesn't distribute) there is the 6% tax because the 2016 contribution (doesn't matter when the physical contribution was made) was never removed.

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So sorry to be the messenger. But the tax policy/logic here is that if one is allowed to make a contribution after the end of the physical/calendar year and get the benefit of that for a previous tax year, then it must be treated AS a 2016 contribution.

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To decide, after the fact, that this wasn't a 2016 contribution after all, means that he must use one of the four allowed methods for removing 2016 year excess contribution.

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Not to do so, to simply decide later that this WASN'T a 2016 contribution, after taking advantage of the ability (or perceived ability) to MAKE that deferred contribution, would be keeping the proverbial cake and eating it too.

...

I hope that you’ll rate me based on my accuracy and thoroughness, rather than any good news/bad news content.

That’s the only way JustAnswer.com will compensate me for the work here.

Thanks,

Lane

I hold a law degree (J.D.), with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice 1986.

Ask Your Own Tax Question

Please let me know if you have ANY questions at all, before rating me.

If this has helped, and you DON’T have other questions … I'd appreciate a positive rating (using the stars or faces on your screen, and then clicking “submit")

I hope that you’ll rate me based on my accuracy and thoroughness, rather than any good news/bad news content.

That’s the only way JustAnswer.com will compensate me for the work here.

Thanks,

Lane

I hold a law degree (J.D.), with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice 1986

Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 14,614
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
Verified
Lane and 87 other Tax Specialists are ready to help you
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Customer reply replied 9 months ago
Thanks! Sorry I didn't get back to you sooner.
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