"Since the earnings increase my AGI, they could create a cycle of additional excess contributions."
I don't think that's supposed to happen. You can try it and see, just don't finalize the return. You can go back and make changes if you need to. I'm also not sure the "removal of excess" procedure is supposed to be used if you want to remove more than the amount of excess contribution. The recharacterization can be done on any amount of the contribution.
In this option, aside from ordinary income tax on earnings, is there a 10% early withdrawal penalty on the earnings?
No. You would report this by creating a substitute 1099-R for the corrective withdrawal. Put the total amount of the withdrawal in box 1, the taxable earnings in box 2a, and use codes "P" and "J" in box 7.
"By recharacterizing the excess (plus earnings) to a Traditional IRA, then converting it back to a Roth IRA, I avoid reporting the earnings in 2024"
This is more or less correct. If you recharacterize the $1000 as a traditional IRA contribution, the custodian should move both the contribution and the earnings. You need to include the recharacterization on your 2024 return, you will get a form 8606 for the non-deductible basis in the traditional IRA, which you must use when preparing your 2025 return that has the conversion on it.
"Financially, Option 2 results in lower taxes than Option 1 since it avoids immediate taxation and penalties on earnings."
Not exactly. You will pay taxes on the earnings either in 2024 or 2025, and the tax rates will be the same, unless Congress does something radical. There is no penalty for early withdrawal in either situation. The benefit to option 2 is that the $1000 remains invested in tax-deferred retirement savings, rather than being removed and left in a bank savings account, a stock account, or getting spent. However, the backdoor Roth only works if you have no other tax-deductible funds in any IRA. (For the backdoor Roth, all traditional IRA balances are considered as one IRA, so if you have a tax-deductible traditional IRA with a balance already, even if it is with a different broker, the backdoor Roth won't work. Use option 1 or 3 if you have any tax-deductible traditional IRAs; option 2 is the best strategy as long as you have no other tax-deductible traditional IRA.
Option 3 would be to leave the excess in the Roth IRA, pay the 6% penalty, and apply the excess to next year's limit by contributing less than your maximum next year.
