Retirement tax questions

Opus 17 · ‎January 3, 2022

@melissaforpeace315 wrote:

@Opus 17 Ah, thank you sooo much for the clarification! I guess my next question is, what would you do if you were me? Should I wait until the end of February to see my tax documents from my university? (unfortunately, I don't trust my school's adminstrators/ HR/ payroll department to simply just believe what they tell me via e-mail if I were to e-mail them requesting clarification on whether my take-home pay is considered "compensation")

What would be the most surefire way to see if my take-home pay from being a TA is considered "compensation"? I should wait for the tax documents available end of February, right? Even if I don't report my 2021 Roth IRA contributions to Turbotax (if they aren't able to understand or categorize my take-home pay as "compensation"), then it's just a matter of time of when the IRS decides to check their computer systems and send me a letter requesting that I send proof of "compensation", correct? And if it is the case where my take-home pay isn't considered to be "compensation" in their definition, then I will owe penalties for one year, and that's it, correct? It won't be something where I will owe penalties every year until I withdraw / distribute the Roth IRA monies that I've "erroneously" contributed in my 2021 tax year, correct?

Thank you so much for your help! I absolutely understand that this forum is used for general informational purposes and is not intended to be "advice" ...... I just wanted to say that I really appreciate you taking the time to answer my questions!

If you are having social security and medicare taxes withheld from your paycheck, that shows that your income meets the most common definition of "earned income" or "compensation". If you aren't having those taxes withheld, then you don't have "earned income" but you might still have "compensation". You don't need to wait for your W-2 since those taxes should show on your pay stubs already.

If you aren't subject to social security and medicare, then your income might still be compensation if it is either,

a. compensation for services you performed for your school (which may be exempt from SS and medicare tax for separate reasons), or

b. represent a non-tuition fellowship or stipend paid to aid your graduate education.

I can't help you with this, it's up to you to determine for yourself. Possibly your graduate program coordinator or the finance office of your graduate program can help you understand exactly why you are being paid, if the payroll office can't.

If the IRS later sends you a letter asking about your compensation, you would reply by sending documents, emails, a copy of your graduate handbook, or any other documents that would show that your income was considered compensation under the regulations. If the IRS office handling your case rules against you, you would still have the option to appeal to their supervisor or the Tax Court.

If you exhaust all appeals or give up, and the contribution is determined to be unallowed, or "excess", then this is what happens.

a. You file an amended return for 2021 reporting the contribution as "excess" and paying a 6% penalty. (In fact, the IRS will probably adjust your account for you and send you a bill for the 6%, so you won't actually have to file the amended return.)

b. Then, you can leave the money in the account indefinitely, and pay a 6% penalty each year that the excess contribution remains in the account (this may offset your investment gains but maybe your investments pay more than 6%). At some future time when you are eligible to make a Roth contribution (when you start a regular job), you can consider the excess to be your legal contribution for that year, after which it will no longer be considered excess and the 6% penalty will go away.

c. Or, you can remove the excess contribution and the gains and close the account. You won't pay tax on the contributions, and you will pay regular income tax plus a 10% penalty on the amount of earnings included in the withdrawal. That will also close out the 6% penalty for excess contributions because that penalty is based on the amount of excess contributions or the total account balance, whichever is less.