I created a Roth IRA account which has earned money since July 2020. Unfort, I did not realize I am above the required income limitations. How do I handle that on taxes?

[macuser_22 · Accepted solution]

Several options.

1) Do you think you will be under the income limit in 2021 for the excess amount.  If so you can just apply the excess as a 2021 contribution.

2) A safer method is to have the account trustee return the excess and the earnings attributed to the excess as a "return of contribution" before the April 15 due date (be sure it is a return of contribution and not just a normal distribution so the resulting 1099-R will be coded correctly).   The trustee will issue a 2021 1099-R that you will receive in January 2022.  Only the earnings returned will be taxable.

3) You can have the trustee recharacterize the excess plus earnings to a Traditional IRA as a non-deductible contribution (or possible deductible if your MAGI is within the deduction limits).  In this case there is no tax at all as the earnings simply move to the Traditional IRA. Again this must be done by the April 15 due date.

[sjb25]

Thank you for your help mac_user22.  I think Option3 probably works best for now   A follow on question if I can do that here ..... So will the original Roth I set up in June 2020 with a contribution of $7000 for 2019 (because the deadline was extended in 2020 due to covid) and a contribution of $7000 for 2020, still count as my 5 year clock to start ticking for the Roth, even thou I technically didn't meet requirements to open one so I can get no earnings yet?  I will be under the income constraints in 2022 so can start using it as planned at that time, but was hoping the clock would already be halfway done for my 5 years before I can access it. Is it technically still a Roth account, or will the IRS classify it as just a normal savings account because I was over the income limitations when I created it?  THANKS

[macuser_22]

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@sjb25 wrote:

Thank you for your help mac_user22.  I think Option3 probably works best for now   A follow on question if I can do that here ..... So will the original Roth I set up in June 2020 with a contribution of $7000 for 2019 (because the deadline was extended in 2020 due to covid) and a contribution of $7000 for 2020, still count as my 5 year clock to start ticking for the Roth, even thou I technically didn't meet requirements to open one so I can get no earnings yet?  I will be under the income constraints in 2022 so can start using it as planned at that time, but was hoping the clock would already be halfway done for my 5 years before I can access it. Is it technically still a Roth account, or will the IRS classify it as just a normal savings account because I was over the income limitations when I created it?  THANKS

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If you recharacterize to a Traditional IRA, there is no 5 year clock.   Recharacterization of a contribution means that the contribution to the Roth is treated a never happening and it was to the Traditional IRA in the first place.  

The proper way to report the recharacterization and earnings which is to enter the 2019 IRA contribution in the IRA contribution interview section and then say yes to "Did you switch from a Roth to a Traditional IRA - recharacterize".

The amount The amount of the original Roth contribution must be entered - not any earnings or losses.

Then TurboTax will ask for an explanation statement where it should be stated that the original $xxx.xx plus $xxx.xx earnings (or loss) were recharactorized.

There is no tax or penalty on the before-tax earnings since the earning were simply switched into the recharactorized account.