Earning from a Roth access contribution

[Clidinho]

My son contributed the max $6.0k to his Roth in 2020, he now learned that his income is too high for the contribution.  Such contribution has earned ~$3.0k in earnings.  Schwab said he needs to withdraw both the $6.0 and the earnings.  Our question is about the earnings, can he roll that over into a Rollover IRA and avoid paying tax and possible 10% penalty?  Or is he better off, paying the tax+penalty and keeping the cash?  Big thanks to all for your input.

[macuser_22 · Accepted solution]

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@Clidinho wrote:

My son contributed the max $6.0k to his Roth in 2020, he now learned that his income is too high for the contribution.  Such contribution has earned ~$3.0k in earnings.  Schwab said he needs to withdraw both the $6.0 and the earnings.  Our question is about the earnings, can he roll that over into a Rollover IRA and avoid paying tax and possible 10% penalty?  Or is he better off, paying the tax+penalty and keeping the cash?  Big thanks to all for your input.

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Rollover no.  He can either have the contribution returned to him as a "return of contribution plus earnings"  or he can have it recharactorized to a Traditional IRA contribution.  Both the contribution and earnings will be moved to the Traditional IRA as if the Roth contribution never happened and the contribution was to the Traditional IRA instead.  Either one must be done by the IRA custodian.

[wmct]

Hello,

Your information is really useful. I was in similar situation where the money was returned to me in the same year 2020 after I found out that I didn't qualify for Roth IRA. The 1099 R form Fidelity sent me has a distribution code J(early distribution from Roth IRA)  Shouldn't they give me a code P (return of contribution taxable in 2019) instead? 

[macuser_22]

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@wmct wrote:

Hello,

Your information is really useful. I was in similar situation where the money was returned to me in the same year 2020 after I found out that I didn't qualify for Roth IRA. The 1099 R form Fidelity sent me has a distribution code J(early distribution from Roth IRA)  Shouldn't they give me a code P (return of contribution taxable in 2019) instead? 

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That depends of you just asked for a regular distribution of the money or a "return of contribution" plus earnings.   An ordinary distribution will have a code J, a return of contribution will have a code PJ.  A code PJ is taxable in a 2019 tax return and code J in taxable in 2020.   A code PJ eliminates the 6% 2019 excess contribution penalty, a code J means you must fie a 2019 5329 form with the 6% penalty.

Perhaps the financial institution sim-understood and needs to issue a corrected 1099-R.

[wmct]

Hello, 

Thanks for your reply!

I called Fidelity retirement today, after 3 hours of holding. They insisted they had the right code on the form 1099R, which is J. And they stated that this is what they do all the time, sending a form 1099R with a code J and a form 5498. And having both of them side by side should have cleared things up for Tax preparers. They made it very clear that they wouldn’t change code from J to P.  (Basically they said they didn’t misunderstand my situation,  they just put a code J on 1099R for everyone else)

However, TurboTax software said we don’t need to enter form 5498 and there is no way to enter the form 5498.

I went back to TurboTax, realized that TurboTax does address situations like this by having us complete a Substitute Form 1099-R which is located on the same page where 1099-R form would be. 

I hope will solve my problem. Again thank you very much for your reply! 

[macuser_22]

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@wmct wrote:

Hello, 

Thanks for your reply!

I called Fidelity retirement today, after 3 hours of holding. They insisted they had the right code on the form 1099R, which is J. And they stated that this is what they do all the time, sending a form 1099R with a code J and a form 5498. And having both of them side by side should have cleared things up for Tax preparers. They made it very clear that they wouldn’t change code from J to P.  (Basically they said they didn’t misunderstand my situation,  they just put a code J on 1099R for everyone else)

However, TurboTax software said we don’t need to enter form 5498 and there is no way to enter the form 5498.

I went back to TurboTax, realized that TurboTax does address situations like this by having us complete a Substitute Form 1099-R which is located on the same page where 1099-R form would be. 

I hope will solve my problem. Again thank you very much for your reply! 

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If this was a 2020 excess returned in 2020 the  a code PJ would be incorrect.  That is for a 2019 contribution. A 2020 contribution returned in 2020 should have a code 8J.   The earnings (if any) were required to be returned also and go in box 2a.

The substitute 1099-R will ask for an explanation and what you did to have the incorrect 1099-R corrected.    Be sure to include that the financial institution was not cooperative and is ignoring the IRA 1099-R rules.

https://www.irs.gov/instructions/i1099r

[quote]

Roth IRA.

For a distribution from a Roth IRA, report the total distribution in box 1 and leave box 2a blank except in the case of an IRA revocation or account closure and a recharacterization, earlier. Use Code J, Q, or T as appropriate in box 7. Use Code 8 or P, if applicable, in box 7 with Code J. Do not combine Code Q or T with any other codes.

However, for the distribution of excess Roth IRA contributions, report the gross distribution in box 1 and only the earnings in box 2a. Enter Code J and Code 8 or P in box 7.