2018 excess Roth contribution after 12/31 deadline

[Elsie3]

My husband and I contributed to a Roth IRA in 2018 and 2019. We realized on 1/31/2020 that we shouldn’t have contributed to either. We understand the 2019 can be converted to a regular IRA and then back door converted back to a Roth. However, what do we do to fix the 2018? Everything I read says we should have fixed by 10/15/2019. What should financial institution do for the 2018 funds? What should we do from a tax standpoint? Please help with the most cost effective solution! I understand that we will owe a 6% penalty for 2 years, is that right? Also, are we gonna be hit with 10% early withdrawal? We are under 40years old.  Trying to determine best way to try to keep all in a retirement fund of some sort if possible!  

[DianeC958]

You will need first to amend your 2018 tax return to indicate that you overcontributed to the Roth IRA.  When you do this the program will prepare a form 8606 as part of your return showing the overcontribution.

You will need to carry this information to your 2019 return and also have the form 8606 showing the overcontribution amounts.

Then you need to withdraw the excess contributions and turn the money into Back Door Roth IRA's to have the tax benefits when you retire.

Then in 2020 when you receive the 1099-Rs for the withdrawals the form 8606 helps to show the IRS that the withdrawals are not taxable or to subject to the 10% penalty for early withdrawal.

Link to how to amend prior years' tax returns in TurboTax.

[Elsie3]

Can we carry over into 2019 even if we are not eligible for a ROth in 2019either? Also, what are the penalties? Will we owe the 6%?

We currently have an excess Roth in 2018 and 2019. Is it possible to carry the 2018 Roth into 2019, then recharacterize it to a traditional IRA to avoid the 6% penalty from 2018 passing the 12/31 deadline...and then carry the 2019 Roth into 2020 and then recharacterize it to a traditional IRA too? 

[dmertz]

No recharacterization of the 2018 contribution is permitted after October 15, 2019.  You'll owe a 6% penalty on the 2018 excess with your 2018 amendment and, since the 2018 excess was still in the account, for 2020 you'll owe another 6% penalty on the 2018 excess shown on your 2019 Form 5329.  If you will again be ineligible for a Roth IRA contribution in 2020 you'll have to resolve the 2018 excess by making a regular distribution of the exact amount of the 2018 excess, with no adjustment for earnings or loss; any earnings can remain in the account.  This regular distribution will be nontaxable because it is a distribution of contribution basis.

The excess contribution for 2019 can be resolved by a return of excess contribution before the due date of your 2019 tax return as you mentioned, and must include attributable earnings or loss.

[Elsie3]

Ok thanks. I don’t understand why a recharacterize isn’t available for the 2018 if I am saying the 2018 is for year 2019 and my 2019 taxes aren’t filed yet and I am before the 2019 deadlines to recharacterize. 

[dmertz]

You are not permitted to recharacterize the contribution for 2018 because it is now well after the due date of your 2018 tax return, including extensions.  You can't make an excess contribution for 2018 be an excess contribution for 2019 because it was contributed for 2018, not for 2019.  The only permissible ways to resolve an excess Roth IRA contribution made for 2018 after the due date of your 2018 tax return, including extensions, is to either obtain a regular distribution of the excess or to apply the excess as a subsequent year contribution that you are eligible to make.

Even if you were eligible to apply it as a contribution as a subsequent year's contribution, you are not then permitted to recharacterize that contribution.  You are only permitted to recharacterize contributions made "during the taxable year."  (Contributions made "during the taxable year" includes contributions made for the previous year between January 1 and April 15 of the following year.  Yes, that's a bit awkward because another part of the tax code results in these contributions for the previous year being treated as having been made during the previous year.)  That's the way the law is written:

§ 408A(d)(6)   https://www.law.cornell.edu/uscode/text/26/408A

[Elsie3]

Thank you for your detailed response !!

[Elsie3]

When you said : “Then you need to withdraw the excess contributions and turn the money into Back Door Roth IRA's to have the tax benefits when you retire.” 

1) Were you referring to the 2018 excess or 2019?

My financial advisor is telling me: 

“We will have to 'remove excess contribution' for 2018 - that cannot go into an IRA/Roth but will have to remain outside of a retirement account for 2018 purposes. There does not seem to be away around maintaining a 'contribution' for 2018.

We will do a recharacterization for 2019 - move from the Roths to IRAs. Then we can "convert to Roth" still for 2019.

Going forward we will contribute an IRA (as a non-deductible contribution) and convert to a Roth IRA.”

Additional Questions: 

2)  when they remove the 2018 excess contribution, do we have to also remove any earnings/interest/loss on that excess amount or remove just the excess (5500 for each of us, so 11k)?

3) when the 2018 excess is removed, I have read a blog that if you are past the 12/31 deadline that means you will owe a 6% penalty per year, the 11k also becomes taxable income for 20xx? And there is a 10% penalty for early distribution. Can you confirm? 

4) For 2019, bc we aren’t eligible for a Roth due to income, as noted above our financial advisor is saying we will do  a recharacterization and then conversion to Roth.  I have read different blogs where you must pay income taxes if you convert back to a Roth, so an extra 11k of taxable income for 2019 taxes. Is that right? 

thanks!!

[dmertz]

1)  DianeC958's comment that you quoted doesn't really make sense as written.  The 2018 excess contributions must be withdrawn by making regular distributions from each of the Roth IRAs equal to the amount of each individual's excess contribution for 2018 .  You are correct, there is no way to maintain these as 2018 contributions. That opportunity was was lost by not making a timely correction.  This money just ends up in your pocket.

The portion of the comment about a backdoor Roth only potentially applies to the 2019 contributions.

2)  Because you are subject to the 6% excess contribution penalties on the excess contributions made in 2018, no earnings on the 2018 excess contributions are required to be removed.

3)  Yes, because the excess contributions for 2018 will not have been corrected until 2020, on these excess contributions you owe a 6% penalties calculated on 2018 Forms 5329 and additional 6% penalties on these same excess contributions on your 2019 Forms 5329.  Your 2020 Forms 5329 will show the excess contributions from 2018 being eliminated by the regular distributions

4)  With the recharacterizations, the contributions for 2019 will appear on your 2019 Forms 8606 as nondeductible traditional IRA contributions.  The amounts on line 14 of each of those Forms 8606 will carry forward to line 2 of your 2020 Forms 8606 to be used in calculating the amount of your Roth conversions performed in 2020 and reported on your 2020 tax return.

[Elsie3]

Thank you for the detail!

just to confirm:

3) when the 2018 excess is removed, we will only owe a 6% penalty per year?  This distribution won’t also be taxed as taxable income and also won’t incur a 10% penalty for early distribution?

4) For 2019, bc we aren’t eligible for a Roth, when we do a recharacterization and then conversion to Roth, this 5500 per person won’t count as taxable income for 2019 taxes?  (Sorry, I didn’t understand the part of your response that included all the forms and lines and what that means for it being taxable :( 

[dmertz]

3)  Correct.  The distribution will be a nontaxable distribution of contribution basis.  Assuming that this is a nonqualified distribution, the $0 taxable amount will be calculated on your 2020 Form 8606 Part III.

4)  If you have no other money in traditional IRAs, the only part of the Roth conversion that will be taxable is the earnings that the 2019 contributions incurred while the 2019 contributions were in the Roth and traditional IRAs.  If you do have other money in traditional IRAs, the calculations on Form 8606 will result in only a portion of the basis acquired by making the nondeductible traditional IRA contribution (that results from the recharacterization) being applied to the Roth conversion, with the remainder of the basis in nondeductible traditional IRA contributions remaining with the traditional IRAs to be applied to future distributions until it is all distributed with distribution that brings the traditional IRA balance to zero at year end.

[Elsie3]

At what point is the 6% penalty for the 2018 Roth assessed by the IRS? As a reminder, we aren’t eligible for 2018 or 2019 Roth’s. Our 2018 Roth was past the deadline to convert it and so the only option was to remove the excess. However, we had time for the 2019 Roth, so our financial advisor is working on taking the 2019 Roth and recharacterizing it and then converting it back into a Roth via the back door method.

My financial advisor has already “removed the excess” for 2018, just this week, 2/23/2020. I understand that I won’t get 1099-Rs until 2020 for the 2018 Roth excess removal and the 2019 Roth conversion.

I am not understanding how I will know the exact amount of the 6% penalty and when and how I should pay it to the IRS before the 12/31/2020 deadline so I can prevent a year 3 of penalties for the 2018 Roth. I understand I already owe 6% penalties for the 2018 Roth for year 2018 and 2019.

[dmertz]

The 6% penalty for the excess contribution is calculated on a 2018 Form 5329.  You can cause TurboTax to do this by amending your 2018 tax return using 2018 TurboTax.  You'll pay that separately from the penalty due with your 2019 tax return.

You'll also have the same penalty on your 2019 Form 5329 as part of your 2019 tax return because the excess remained at the end of 2019.