Can my spouse and I contribute to our traditional or ROTH IRAs when all our earned income is foreign and exempt to taxes?

[ezsg]

We have contributed in our ROTH IRAs already and Turbotax is telling us all these are in excess. Apparently, we can move these contributions to our Traditional IRAs (called recharacterization). We are not sure if this is a valid procedure and we can contribute at all to our Traditional IRAs.

[Critter-3]

If you have no taxable earned income on the return because you excluded it all then you cannot make ANY IRA contributions of any kind.  

[DanaB27]

No, as Citter-3 mentioned, you need taxable compensation to be able to contribute to an IRA. Using the Foreign Earned Income Exclusion excludes your income therefore you don't have taxable compensation. Please see What Isn’t Compensation? for details.

You will have to withdraw the excess contribution plus earnings by the due date to avoid the 6% excess contribution penalty. Please contact your financial institution and request to withdraw the excess contributions plus earnings.

You will get a 1099-R 2022 in 2023 with codes P and J for the withdrawal of excess contribution and earnings. This 1099-R will have to be included on your 2021 tax return and you have two options: 

• You can wait until you receive the 1099-R  2022 in 2023 and amend your 2021 return or
• You can report it now in your 2021 return and ignore the 1099-R when it comes unless there is Box 4 Federal Tax withholding and/or Box 14 State withholding. Then you must enter the 2022 1099-R into the 2022 tax return since the withholding is reported in the year that the tax was withheld. The 2022 code P will not do anything in 2022 tax return but the withholding will be applied to 2022.

To create a 1099-R in your 2021 return please follow the steps below:

1. Login to your TurboTax Account 
2. Click on the "Search" on the top right and type “1099-R”
3. Click on “Jump to 1099-R”
4. Answer "Yes" to "Did you get a 1099-R in 2021?"
5. Select "I'll type it in myself"
6. Box 1 enter total distribution (contribution plus earning)
7. Box 2a enter the earnings
8. Box 7 enter J and P
9. Check the "IRA/ SEP/ SIMPLE" box
10. Click "Continue"
11. On the "Which year on Form 1099-R" screen say that this is a 2022 1099-R.

Please be aware, code P will say in the drop-down menu "Return of contribution taxable in 2020" you can ignore that since the follow-up question will tell TurboTax that it will be taxable in 2021.

[dmertz]

Income that you treat as nontaxable foreign earned income is not income that will support any kind of IRA contribution, traditional or Roth.  Without supporting compensation, you can't fix the excess by recharacterizing, you can only fix it by obtaining an explicit return of contribution.