Excess Roth IRA contributions removed as normal distribution (not corrective distributions)

[a_v]

I contributed $1500 directly to Roth IRA in 2022 (towards Year 2022) and then realized my income wont let me directly contribute to Roth IRA. So I removed it as a normal distribution and thought everything is fine. The other day I read that I should have removed it as corrective distribution, so I called my brokerage and they are saying that since it was done more than 6 months before, they can't change it. The amount I contributed was removed as is - no-earnings/no-loss. But I am worried that it will be reported in 1099-R as normal distribution, and that I also contributed $1500.

Now I am planning to contribute $6000 to traditional IRA that I am eligible to do for the year 2022, but will I be in a problem if I do so. Will the $1500 that I contributed be added to $6000 and then IRS will treat $1500 as excess?

I am not sure if the $1500 normal distribution from Roth IRA will nullify $1500 contribution to Roth IRA.

Any advice?

[Anonymous_]

@dmertz 

[dmertz · Accepted solution]

A regular distribution in 2022 does not correct an excess contribution made for 2022.

If you contribute $6,000 to a traditional IRA, you will have made a total of $7,500 in total contributions, but when you make contributions to both a traditional IRA and a Roth IRA, the excess is deemed to be in the Roth IRA even if you were otherwise eligible to contribute to a Roth IRA, so you won't have an excess contribution to the traditional IRA.  Since the $1,500 contributed to the Roth IRA is already an excess contribution, the contribution of $6,000 to the traditional IRA doesn't change anything with respect to excess contributions.

If in the past you have contributed more than $1,500 to the Roth IRA, your $1,500 distribution came from that contribution basis, making the distribution nontaxable.  If after the $1,500 distribution you have no money in Roth IRAs, that distribution will have satisfied the requirement to remove the excess.

If there was no investment gain or loss in the entire Roth IRA account while the $1,500 was in the account, you could make the argument that the $1,500 distribution was the properly gain/loss adjusted amount distributed, but this would require explanation to the IRS.  I don't know how the IRS would respond to this position.  Even if there was investment gain or loss, you could possibly make the argument that this distribution constituted some amount of return of contribution adjusted for gain or the entire excess adjusted for loss plus some amount of regular distribution, but again, I don't know if the IRS would accept this position.

[a_v]

Thanks @dmertz. I called my brokerage firm to check my option on how we can correct this mistake, and here is what I learnt from them

1) I had no contribution to my Roth IRA in 2022 except for the $1500 contribution that I made - say on 03/01/2022

2) Then I took a regular distribution of $1500 on 03/15.

3) So now, there is no way for the brokerage account to correct it - either re-characterization to traditional or a corrective distribution. Because the money doesn't exist.

So, the safest option it seems is to -  Contribute $4500 to Traditional in 2022. This way I am still under the max contribution of $6000. ($4500 + $1500)  

So now, I contribute less in 2022 (I am okay with it), but I don't get penalized for the Roth contribution as an excess contribution. The distribution from Roth will not have any penalty, because we are talking about after-tax money throughout this thread. 

@dmertz Do you see any issues with the above option?

[dmertz]

Do you have any money in Roth IRAs now?  If not, there should be no problem with your proposed solution.

[a_v]

Currently Roth IRA has money, all of it was from conversion from traditional IRA with no excess contribution in any of the past years, and was invested in years prior to 2022. In 2022 I contributed $4500 to traditional and converted it to Roth IRA now in December. 

[dmertz]

" So now, there is no way for the brokerage account to correct it - either re-characterization to traditional or a corrective distribution. Because the money doesn't exist."

That's false.  You still have money in a Roth IRA, so you still have a $1,500 excess Roth IRA contribution for 2022 that is subject to penalty unless you take the position that the regular distribution you made qualifies as a return of contribution as I described in the last paragraph of my original reply.  Absent doing that, avoiding the excess-contribution penalty still requires correction, either by recharacterization or by a proper return of contribution.

Are your converted funds in the same Roth IRA account as the one to which you made the deposit of the excess contribution?

In what year did you do your first Roth conversion?  Was it a taxable conversion?

[a_v]

"Are your converted funds in the same Roth IRA account as the one to which you made the deposit of the excess contribution?"

 - Yes.

"In what year did you do your first Roth conversion?  Was it a taxable conversion?"

 - First conversion in 2021. All the money in Roth IRA is from conversion and is after tax, I never ever contributed to Roth IRA directly before this mistake that I did in 2022.

"So now, there is no way for the brokerage account to correct it - either re-characterization to traditional or a corrective distribution. Because the money doesn't exist." --> This is what the brokerage retirement services personnel explained to me. I did tell him that I have $4500 balance in IRA that was converted from traditional, so technically I do have balance and they should be able to re-characterize the 2022 $1500 direct contribution. But as per them, converted money is accounted separately and cannot be treated as direct contribution and hence cannot be used to withdraw (corrective) or re-characterize the $1500 direct contribution. 

But based on the response here, I think I'll have to call the brokerage firm again and talk with another representative.

[dmertz]

"But as per them, converted money is accounted separately"

Nothing in the tax code provides for such separate accounting.  You, not the custodian, are the one responsible for maintaining the accounting of your contribution and conversion basis, particularly because you could have many Roth IRAs and could transfer funds between them.  Money in an IRA account is fungible, it's not treated as having come from any particular source.

I calculating the attributable gain or loss on the $1,500 excess contribution,  when determining the adjusted opening balance the $4,500 deposited into the Roth IRA as a conversion gets added to the balance that the Roth IRA had immediately following the excess $1,500 contribution.  When determining the adjusted closing balance the $1,500 distributed as a regular distribution gets added to the balance in the account immediately prior to the recharacterization or return of contribution.  https://www.law.cornell.edu/cfr/text/26/1.408-11

If you do get them to perform a recharacterization or return of the the $1,500 excess contribution, your earlier $1,500 distribution would still be an early distribution that is too late to roll over.  However, because all of the other funding of your Roth IRA(s) came from nontaxable conversions, this distribution would be from your nontaxable conversion basis and would therefore not be subject to the 10% early-distribution penalty that would otherwise apply.

[fanfare]

You can work off your excess in 2023 by ensuring that your Roth and/or Traditional IRA contribution next year is less than the max allowable,
particularly by the amount of your excess. Then your penalty situation will be resolved, using Form 5329.
if you are eligible next year to contribute 6000, or (some amount) you can apply that amount to resolving your excess and you don't have to take anything out. see Form 5329.

You still pay the 6% penalty for 2022 ( or possibly less, see Form 5329 line 25.)

@a_v