Assistance Needed: Incorrect 10% Penalty on Traditional IRA Return of Contribution in TurboTax

[Alex3]

I contributed $6,500 to a Traditional IRA in September 2024 with after-tax funds and withdrew the exact same amount in December 2024. This qualifies as a 'return of contribution,' but TurboTax is treating it as an early distribution and applying a 10% penalty. The system does not provide an option to categorize it correctly or remove the penalty. Can you guide me on how to override this or make the correct adjustments?

[dmertz]

"I contributed $6,500 to a Traditional IRA in September 2024 with after-tax funds and withdrew the exact same amount in December 2024. This qualifies as a 'return of contribution,'"

Not necessarily.  If you took a regular distribution reported with code 1 in box 7 of the Form 1099-R, the distribution is not a return of contribution and is subject to the 10% early-distribution penalty.  An actual return of contribution is a special type of distribution that must be explicitly requested and would be reported with code 8 in box 7.

[Alex3]

I contributed $6,500 to a Traditional IRA in September 2024 with after-tax funds and withdrew the exact same amount in December 2024. This should be reported as a ‘return of contribution’, which is non-taxable and not subject to the 10% early withdrawal penalty since no earnings were involved.

However, TurboTax is treating it as a taxable early distribution and applying the 10% penalty. I can’t find an option in the software to correct this. Can you guide me step-by-step on how to properly categorize this transaction in TurboTax so that my taxes are completed correctly?

[dmertz]

You received a regular distribution.  This distribution does not constitute a return of contribution because it was not made as an explicit return of contribution.  For the distribution to have been treated as a return of contribution, the distribution is required to have been treated as an explicit return of contribution.

In 2024 TurboTax you must report the traditional IRA contribution and the regular distribution.  If the contribution is treated as nondeductible, the distribution adds to your basis in nondeductible traditional IRA contributions on Form 8606 Part I.  The taxable amount of the distribution is also calculated on Part I and only the taxable amount is subject to the 10% early-distribution penalty.  If the contribution is not treated as nondeductible, the entire distribution will be taxable unless you already had some basis in nondeductible traditional IRA contributions from previous years.

However, because the distribution was made in December 2024, you are still within the 60-day window where you can roll the distribution back into the traditional IRA and then obtain a proper return of contribution (provided that it would not be a violation of the one-rollover-per-12-months limitation on rollovers because of a previous rollover that you did in or after December 2023).  The original distribution would be reported as a rollover and you would receive a code P 2025 Form 1099-R that you would need to report on your 2024 tax return.