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JanAnnDan
Level 2

Excess Roth Contribution from 2 Years Ago - Complicated Issue

I am working on a 2020 tax return where an excess Roth IRA contribution was made in 2018 and distributed to the taxpayer in 2020, and there was a loss on the investment.  A 1099-R with code J (early distribution from Roth IRA, no known exception) was issued, but does not include a second code to explain that the distribution was due to an excess contribution.  The second codes available are 8 (excess contributions plus earnings taxable in 2020) or P (same thing but taxable in 2019), but there is no code for two years back.  I understand that if there were earnings on the distribution, they would be taxable in 2018 in the year of contribution, but the investment lost money, so there are no earnings.  The amount of the excess contribution was reported on form 5329 for 2019, and carries over to 2020.  Since the 1099-R reports a distribution that is less than the excess amount (due to the loss), Turbotax is calculating the 6% penalty on the remaining amount (equal to the loss).  Example $1,000 excess contributed, $200 loss on investment, $800 distributed, form 5329 shows $200 remaining from the excess contribution.  Instructions for form 5329 details instructions if the balance of the entire Roth was distributed, but that is not the case.  How do I report that the excess contribution WAS fully distributed, and no penalty is due? 

2 Best answer

Accepted Solutions
dmertz
Level 15

Excess Roth Contribution from 2 Years Ago - Complicated Issue

In your example, the mistake was requesting a distribution that was adjusted for investment loss.  After the due date of the 2018 tax return, a 2018 excess contribution can only be eliminated by making a regular distribution (code J) of the entire amount of the excess or by applying that excess as an eligible contribution for a subsequent year.

 

In your example, only $800 of the $1,000 was distributed and TurboTax is correctly reporting that $200 of the 2018 excess still remains in the Roth IRAs (unless the balance in all Roth IRAs was zero at the end of 2020 which you would indicate to TurboTax by saying that no Roth IRAs were "open" at the end of 2020).  Since 2020 has passed, that $200 will need to be distributed as a regular distribution in 2021 to eliminate the remaining excess on the 2021 Form 5329.

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dmertz
Level 15

Excess Roth Contribution from 2 Years Ago - Complicated Issue

That section (albeit the part about withdrawal by the filing due date) refers to a loss:  "If there was a loss, the net income you must withdraw may be a negative amount."  Does that apply to withdrawals after the filing deadline?


No, only to a return of contribution before the due date of the tax return.  Because the tax code permits an excess to simply be applied as a subsequent year's contribution, if eligible, no adjustment for earnings is done after the due date of the tax return and imposition of the 6% excess-contribution penalty.  Applying the excess as a subsequent year's contribution is equivalent to taking a distribution of the exact amount of the excess and using that money to make a new contribution.

 

but is it the IRS' intent to tax earnings but ignore the implication of a loss?


Yes, if the distribution is made before the due date of the tax return, otherwise both gain and loss are ignored.

 

Imagine a case where a Roth IRA started with a $1,000 balance, a contribution was made for $6,500 (an excess of $1,000, which is later withdrawn).  If that $7,500 account dropped in value to $5,000, must you still withdraw the $1,000 excess rather than prorate the account balance?


If done after the due date of the tax return, yes.

 

Distribution of the excess before the due date of the tax return and distribution of the excess after the due date of the tax return are covered by separate subsections of section 408 of the tax code.

 

That instruction section also said, "In most cases, the net income you must withdraw will be determined by your IRA trustee or custodian." The IRA custodian made the calculation and distributed less than the excess contribution, so they must think (right or wrong) that the contribution return must be prorated to reflect the loss.


That instruction applies to a return of excess contribution before the due date of the tax return.

 

The IRA custodian should not have done any earnings calculation on the distribution of the 2018 excess since the distribution was made after the due date of the 2018 tax return, including extensions.  The fact that they mistakenly did this calculation suggests that the IRA custodian is inexperienced, perhaps a smaller bank. Unfortunately, it's common for smaller banks to mishandle various transactions involving IRAs, partially because the statutes and regulations involving IRAs are so convoluted.  (That's why I decided years ago to educate myself on these matters.)

 

Unless you intend to pursue compensation from the IRA custodian for the $20 excess contribution penalty that you have for 2020 (that you would not have had had the IRA custodian not inappropriately adjusted the $1,000), there is no need to involve the custodian in determining how much to have distributed from the IRA to correct the remaining $200 excess.  Simply request a regular distribution of $200 without mentioning that it has anything to do with an excess contribution.  Because it's so common for the smaller IRA custodians to mess this up, it's common for that those who understand the nature of this to suggest that no mention be made of an excess contribution when obtaining the regular distribution necessary to correct an excess contribution after the due date of the tax return.

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6 Replies
dmertz
Level 15

Excess Roth Contribution from 2 Years Ago - Complicated Issue

In your example, the mistake was requesting a distribution that was adjusted for investment loss.  After the due date of the 2018 tax return, a 2018 excess contribution can only be eliminated by making a regular distribution (code J) of the entire amount of the excess or by applying that excess as an eligible contribution for a subsequent year.

 

In your example, only $800 of the $1,000 was distributed and TurboTax is correctly reporting that $200 of the 2018 excess still remains in the Roth IRAs (unless the balance in all Roth IRAs was zero at the end of 2020 which you would indicate to TurboTax by saying that no Roth IRAs were "open" at the end of 2020).  Since 2020 has passed, that $200 will need to be distributed as a regular distribution in 2021 to eliminate the remaining excess on the 2021 Form 5329.

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JanAnnDan
Level 2

Excess Roth Contribution from 2 Years Ago - Complicated Issue

Thank you - that makes sense as there are codes for excess contribution distributions for 2019 and 2020 but not for earlier tax years.  The request to the IRA custodian was to distribute the excess contribution, but unfortunately, the custodian made the calculation and distributed the $800 amount, as opposed to our requesting a specific amount.   Thanks for the response, and we will be requesting the balance tomorrow.  Can you point me to where I can find this info and which instruction resource?  This is the first issue where I have been unable to locate an answer, so I would like to know what I overlooked.  I found info about how to handle if it was a final distribution from the Roth, which is different than our case.  Thanks again.   

dmertz
Level 15

Excess Roth Contribution from 2 Years Ago - Complicated Issue

It's not really straightforward to find this.  It derives from section 408(d)(5) of the tax code which was originally written for traditional IRAs.  This means that you must look in IRS Pub 590-A in the section that describes a distribution after the due date of the tax return of excess contributions made to traditional IRAs.  Also look at Part IV of Form 5329, in particular ho a regular distribution reported on line 20 reduces the excess.

JanAnnDan
Level 2

Excess Roth Contribution from 2 Years Ago - Complicated Issue

Thanks again for your response, and I have another follow up if you don't mind another discussion.  I'd already reviewed the minimal instructions for Roth IRA excess contributions, but this time went to the section you mentioned on traditional IRA's.  That section (albeit the part about withdrawal by the filing due date) refers to a loss:  "If there was a loss, the net income you must withdraw may be a negative amount."  Does that apply to withdrawals after the filing deadline?  Neither the traditional IRA or Roth IRA section with contributions withdrawn after any filing deadlines address how to handle a loss.  However, if there are earnings, the instructions indicate to amend the return and report in the original contribution year.  Your guidance about distributing the full amount does resolve the problem on the 5329 penalty situation, but is it the IRS' intent to tax earnings but ignore the implication of a loss?  Could be.  Imagine a case where a Roth IRA started with a $1,000 balance, a contribution was made for $6,500 (an excess of $1,000, which is later withdrawn).  If that $7,500 account dropped in value to $5,000, must you still withdraw the $1,000 excess rather than prorate the account balance?   That instruction section also said, "In most cases, the net income you must withdraw will be determined by your IRA trustee or custodian." The IRA custodian made the calculation and distributed less than the excess contribution, so they must think (right or wrong) that the contribution return must be prorated to reflect the loss.  I'm trying to be on solid ground before trying to contact the custodian about how to handle this, since they will likely defend their calculation.  Many thanks again!  No one else responded because this is tricky situation!

 

 

dmertz
Level 15

Excess Roth Contribution from 2 Years Ago - Complicated Issue

That section (albeit the part about withdrawal by the filing due date) refers to a loss:  "If there was a loss, the net income you must withdraw may be a negative amount."  Does that apply to withdrawals after the filing deadline?


No, only to a return of contribution before the due date of the tax return.  Because the tax code permits an excess to simply be applied as a subsequent year's contribution, if eligible, no adjustment for earnings is done after the due date of the tax return and imposition of the 6% excess-contribution penalty.  Applying the excess as a subsequent year's contribution is equivalent to taking a distribution of the exact amount of the excess and using that money to make a new contribution.

 

but is it the IRS' intent to tax earnings but ignore the implication of a loss?


Yes, if the distribution is made before the due date of the tax return, otherwise both gain and loss are ignored.

 

Imagine a case where a Roth IRA started with a $1,000 balance, a contribution was made for $6,500 (an excess of $1,000, which is later withdrawn).  If that $7,500 account dropped in value to $5,000, must you still withdraw the $1,000 excess rather than prorate the account balance?


If done after the due date of the tax return, yes.

 

Distribution of the excess before the due date of the tax return and distribution of the excess after the due date of the tax return are covered by separate subsections of section 408 of the tax code.

 

That instruction section also said, "In most cases, the net income you must withdraw will be determined by your IRA trustee or custodian." The IRA custodian made the calculation and distributed less than the excess contribution, so they must think (right or wrong) that the contribution return must be prorated to reflect the loss.


That instruction applies to a return of excess contribution before the due date of the tax return.

 

The IRA custodian should not have done any earnings calculation on the distribution of the 2018 excess since the distribution was made after the due date of the 2018 tax return, including extensions.  The fact that they mistakenly did this calculation suggests that the IRA custodian is inexperienced, perhaps a smaller bank. Unfortunately, it's common for smaller banks to mishandle various transactions involving IRAs, partially because the statutes and regulations involving IRAs are so convoluted.  (That's why I decided years ago to educate myself on these matters.)

 

Unless you intend to pursue compensation from the IRA custodian for the $20 excess contribution penalty that you have for 2020 (that you would not have had had the IRA custodian not inappropriately adjusted the $1,000), there is no need to involve the custodian in determining how much to have distributed from the IRA to correct the remaining $200 excess.  Simply request a regular distribution of $200 without mentioning that it has anything to do with an excess contribution.  Because it's so common for the smaller IRA custodians to mess this up, it's common for that those who understand the nature of this to suggest that no mention be made of an excess contribution when obtaining the regular distribution necessary to correct an excess contribution after the due date of the tax return.

View solution in original post

JanAnnDan
Level 2

Excess Roth Contribution from 2 Years Ago - Complicated Issue

Thank you SO much for taking the time to go through this very detailed exercise, especially since the IRS instructions failed to fully address the situation.  The custodian was VOYA, so not a small bank.  They failed on this issue, and also issued a second 1099-R for a recharacterization using the wrong year code so we're waiting on that correction as well.   I really appreciate your expertise!

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