My son who is in college has a good size bank account. He had an income of only $3,000. He switched money($5500) from a savings account to a ROTH IRA. 6% penalty

[KEN405]

Or $2500 would be incurred every year money was in account. Some answars said the $2500 would just be income. TT said to switch to regular IRA. What is best. Don't people gift into a Roth IRA for kids who have no income?

[Carl]

Your son's ROTH IRA contributions can not exceed $5,500 or or his taxable earned income for the tax year, whichever is "LESS".  So assuming he had $3000 of income and every penny of it was earned, and every penny was taxable, he contributed $2500 more to the ROTH than he earned. So there's a penalty for that.

[TaxGuyBill]

He needs to remove his "excess contributions".  Make sure he specifically tells the IRS custodian that, and not do a regular withdrawal.

No, people can not gift into a Roth IRA for kids who have no income.

[KEN405]

Thanks Bill what happens next I filled out the form for transfer excess contribution. I won't get a 1099 will I? Since it was done in 2018 How do I record in TT?

[TaxGuyBill]

I think I know the answer, but I'll flag the expert, so I won't need to look it up.   🙂

@dmertz

[Carl]

"Don't people gift into a Roth IRA for kids who have no income?"
No. They don't because they can't. Those folks are usually self-employed with a home based business and hire their kids in their home based business and pay them a wage. Then they can deposit the lesser of $5,500 or their total earnings in a ROTH IRA. If total earnings is less than $5500, then the amount deposited is what's left after the child pays their SS and Medicare taxes, unless the parent who hired them "does the thing" so they don't have to pay those taxes.

In a nutshell, your son's ROTH IRA deposits in a tax year, can not exceed his taxable earnings in that same tax year. At best, the most your son could possibly deposit in his ROTH IRA with no penalties (with $3000 of earned income reported on a W-2 and that's his only income for the entire year) would be $2770.5 after paying the 1.45% medicare tax and 6.2% social security tax.

[dmertz · Accepted solution]

Switching to a traditional IRA doesn't help.  The combined contributions to traditional and Roth IRA accounts is still limited by his $3,000 of compensation.

The excess contribution for 2017 must be removed entirely by a "return of contribution."  It's a return-of-contribution form the he must provide to the custodian; I'm not sure if that is what you meant by a "transfer excess contribution" form.

In 2017 TurboTax, enter the original $5,500 Roth IRA contribution.  In the follow-up when TurboTax indicates that $2,500 is an excess contribution, indicate that the $2,500 will be withdrawn by April 17, 2018.  TurboTax should then prompt you to provide an explanation of the return of contribution.  The amount distributed for a return of contribution must be adjusted by the custodian for any gain or loss while the excess was in the account; the custodian should calculate and apply the adjustment for you.  Any gains distributed will be taxable and subject to early-distribution penalty.

If the original Roth IRA contribution was made in 2017, the return of contribution will be reported on a code JP 2018 Form 1099-R issued next year.  The code JP 2018 Form 1099-R must be reported on his 2017 tax return because code P means taxable in the year prior to the year of the Form 1099-R.  However, since it will be another year of so before this Form 1099-R will be available, to complete his tax return and not have to amend later you'll need to enter this Form 1099-R as if you he has already received it:

• Box 1 = gross amount distributed, adjusted for gain or loss on the $2,500 contribution being returned
• Box 2a = any gains included in this distribution
• Box 7 = codes J and P

Any gains will be subject to tax and a 10% early-distribution penalty.

If the original contribution for 2017 was instead in 2018 (this month), the codes on the 2018 Form 1099-R will be J and 8 and will instead be reportable on his 2018 tax return.