Mistakenly removed Excess Contributions from Roth IRA

[fehrdl]

Last year (2022) I unexpectedly exceeded the Roth IRA contribution limit and had to do a Removal of Excess Contribution and associated gains. This was discovered in February 2022 and at that point I had already made some 2023 Roth IRA contributions. Fearing that I would also exceed the contribution limit in 2023 I did not make any more Roth IRA contributions.  In October 2023 I made an estimate of my MAGI and determined that I was going to exceed the limit again. I then had my bank process the excess removal for my 2023 Roth IRA contributions and associated gains. I wanted to get this done before year end so that it would show up on my 2023 1099-R and be "cleaner".

Turns out I mistakenly used the 2022 MAGI limits as I didn't realize they had increased for 2023. My MAGI for 2023 did not exceed the Roth IRA contribution limit. So, now what do I do?

Because I processed the withdrawal as a removal of contribution and the 1099-R Distribution Code is "8J," I believe I'm only taxed on the gains and will also have to pay the 10% penalty (on the gains). Since I didn't "need" to remove the contribution, I cannot avoid the 10% penalty and claim it was for a "Corrective distribution made before the due date of the return."

For the purposes of illustration, let's say I contributed $1000. My bank processed the excess removal and calculated $200 in gains. My 1099-R shows a $1200 distribution with only a $200 taxable amount. I will need to pay tax and the penalty only on the $200 portion.

On a side note, if I really wanted to, I could actually contribute up to $5500 for 2023 still. The 2023 Roth contribution limit for under 50 is $6500, however I have already contributed $1000 (it still counts even though it has been removed).

Please confirm my understanding or correct me where I've gone wrong. Thank you in advance for your advice!

[fanfare]

"confirm my understanding"

Is your Roth IRA holding contributions made prior to 2022?

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" (it still counts even though it has been removed)."

No, if you removed it by "excess plus earnings", it doesn't count.

@fehrdl 

[fehrdl]

Yes, I've been contributing to my Roth IRA for many years now.

Got it, so I can actually contribute up to the full $6,500 for 2023 (if done before April 15 2024).

[fanfare]

"amount reported as income" for a Roth IRA distribution is calculated on Form 8606 and appears on line 25c.

Since you have contributions, the allocable earning of $200 is a tax free return of contributions.

@fehrdl 

[fehrdl]

I don't think that is correct. At least Publication 590-A reads very differently. I'm very confident that the removed earnings are considered income. My 1099-R indicates that they are. I'm just unsure if the additional 10% penalty can be avoided since it wasn't a true "Excess Contribution."

Form 8606 isn't appearing in my "Forms in My Return" list. When I opened it directly, nothing is populated. I believe this is because my 1099-R classified the withdrawal as '8 - Excess contributions plus earnings/excess deferrals (and/or earnings)' which is an exception to Form 8606. All I see is the 1099-R Summary and Form 5329 which calculates the additional 10% early withdrawal penalty.

Publication 590-A 

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How to treat withdrawn interest or other income.

 You must include in your gross income the interest or other income that was earned on the excess contribution. Report it on your return for the year in which the excess contribution was made. Your withdrawal of interest or other income may be subject to an additional 10% tax on early distributions discussed in Pub. 590-B.

Beginning on or after December 29, 2022, the 10% additional tax will not apply to your withdrawal of interest or other income, if withdrawn on or before the due date (including extensions) of the income tax return. See Pub. 590-B for more information.

[fanfare]

does your 1099-R  box 2a "taxable amount not determined" have a blank or a checkmark ?

If you examine Form 8606 Part III and enter your amounts, you will see the result.

When the amount allocable to income 5329 Line 1 is zero, the penalty is zero.

@fehrdl 

[fanfare]

OK I see that you are correct and I was wrong.

Distributions that are a return of excess contributions can't be used on Form 8606 Line 19.

@fehrdl 

[fehrdl]

I have a value in box 2a of my 1099-R and 2b is NOT checked. This is the $200 I was referring to in my example.