Excess Contributions Roth IRA Married Filing Separately

[kate3116]

My husband and I started filing married filing separately for student loan benefits in 2017. (As I sit here today, I now know we cannot directly contribute to a Roth IRA if we make over $10,000 and how to get money into a Roth via a Traditional IRA.)

We hired a CPA to do our taxes in 2017.  We gave him our tax documents showing contributions to a Roth IRA and income in excess of $10,000.  He said nothing about the income limit.  

We contributed to the Roth IRA in 2018 and used Turbo tax to do our taxes.  The software did not prompt us or cue us to the fact that we made excess contributions. 

We contributed to the Roth IRA in 2019.  I will be recharacterizing those contributions and putting them into a Traditional IRA.

After speaking to one CPA (not so great) and two Turbotax professionals (who were great), I believe these are the steps I need to take. 

1. File amended returns for both my husband and myself for 2017 and pay the 6% penalty on the contributions and earnings. 

2. File amended returns for both my husband and myself for 2018 and pay the 6% penalty for 2018 contributions and earnings and for 2017 contributions and earnings.

3. Withdraw the excess contributions and earnings ASAP and put them into a traditional IRA. 

First question: If I remove the excess contributions before the filing date for 2019 taxes, do I have to pay the 6% penalty on our 2019 taxes for 2017 and 2018?

Second question: Removing the funds will be a taxable event for 2020 and I will incur a 10% penalty on the withdrawal, correct?

Third question: Am I missing anything?

Thank you so much in advance. 

[MinhT1]

1. If you withdraw your Roth contributions of 2017 and 2018 and their earnings before April 2020, you are still liable for the excise tax of 6% in 2019.

2. Removing the funds in 2020 will make you liable for the penalty of 10% and income tax on the earnings only, not on the amounts you contributed.

3. Make sure that you are eligible for a Traditional IRA in 2019 taking into account your filing status and your MAGI. For this, please read this IRS document.

[kate3116]

Do I need to withdraw the earnings on the excess contributions?

Or can I keep them in the account since I will have paid the penalty?

Thank you!

[MinhT1]

You have to withdraw the excess contribution and its earnings. If you do not, you will have to pay an excise tax of 6% for every the excess or the earnings remain in your Roth IRA.

[dmertz]

No earnings are to be distributed with regard to the excess contributions for 2017 and 2018.  Paying the 6% penalties and removing earnings are mutually exclusive.  To resolve the excess Roth IRA contributions for 2017 and 2018, obtain a regular distribution of only the amounts of the excess contributions for those years.

Since you will be recharacterizing the Roth IRA contributions made for 2019, the transfer of the excess from the Roth IRA to the traditional IRA will include the attributable earnings, calculated by your Roth IRA custodian, making those earnings become earnings in the traditional IRA.

[fanfare]

when you request the withdrawal, the custodian will calculate the gain or loss and adjust your net amount.

[niel2k]

@MinhT1 , @kate3116 , @dmertz 

I have exact same question and unfortunately the answers do not resolve the situation for me.

Say, I contributed 5500 in 2018 to Roth IRA and now I am finding out that all of that was excess. lets say that 5500 yielded 200$ in 2018 and it also yielded 400$ in 2019.

The 2018 taxes were already filed while I am working on 2019 taxes.

I talked to Vanguard today and they said my excess withdrawal will remove only the 5500 and will generate the forms (1099 R) only in year 2021. 

So, my question is: 

1. Is it right that Vanguard will remove only 5500?

2. Do I need to amend 2018 tax return? 

       a. Do I need to pay taxes on the 200$ it earned in 2018? If so, if Vanguard doesn't provide that to me, who will?

      b. If I don't have to pay taxes on the 200$, when what do I need to modify the 2018 returns for?

3. Finally, I make this excess removal now, I will pay the now 12% penalty (6% each year). But does that need to happen in my 2019 return or 2020 return. Remember Vanguard will give me the forms only in 2021 January.

[kate3116]

To answer your questions (based on my experience and how I fixed my issue:

1. Yes. You only need to remove the excess contributions.  I was concerned about this too but think about it:  you pay a 6% penalty on the excess.  Some people think that’s worth it becaus they will make more than 6%.  So no need to remove the earnings, just the excess contributions.

2.  Yes.  You need to amend the 2018 tax to

include the 6% penalty.  Make sure you have a copy of your 2018 return.  You fill in all the information on the 1040x (which should mostly be the same until you hit the part where you need to add the penalty.  6% of 5500 is $330.  You will include an explanation on the amended return.  Keep it simple:  Amending return to include 6% penalty on excess Roth contributions.   I was able to do the amended returns without the help of software/tax prep by downloading the 1040x form and form 5329 and the accompanying instructions, and following them line by line.

Send the amended return (1040x and accompanying forms) to the IRS with a check for the penalty owed and send it certified mail return receipt requested.  

Note: if you are in a community property state and file MFS, you will split the $5500 excess contributions and subsequent $330 between you and your spouse evenly.  Submit a community property worksheet to show the allocation.  Form 8958.  You will need to file amended returns for both spouses and send in two checks, each for half the amount ($165).  So for each return, you claim excess contribution of $2750 and 6% of that is $165.  Again,  this note is only if you file Married file separately in a COMMUNITY PROPERTY STATE.  I don’t know what the rules are for MFS in non community property states regarding allocation of amounts. Rules requiring penalty payment would be the same.

I did this for 2017 and 2018 and sent the amended returns in early February 2020.  The checks have been deposited by the IRS, but I have received no other indication/confirmation that I did it 100% correctly. 

2a.  Again, no taxes on earnings, just 6% penalty on excess contributions.

2b.  You amend the return to pay the 6% penalty on the contributions.

3. You will pay the 6% penalty again on your 2019 return since the excess contributions were in the account in 2019.  Same amount if no additional excess contributions: $330. Whatever Vanguard sends you in 2021 will go on your return for 2020.  TurboTax has this capability just make sure you use the correct level software.  (See discussion regarding community property in answer 2 if applicable).

These answers are based on a lot of internet research, reading IRS publications, speaking to three TurboTax professionals, the helpful answers here from other community members, a free consultation with a CPA, and the removal of excess contributions from my own account (and not gains/earnings).  

I found this to be a helpful article too: 

https://www08.wellsfargomedia.com/assets/pdf/personal/goals-retirement/taxes-and-retirement-planning...

In order to make contributions to a roth in the future, google “back door roth”.  I’d include a description here but it would be off topic and perhaps you already know.

Good luck. And I promise, it’s not as complicated as it may first seem.

[dmertz]

niel2k, to summarize what kate3116 said, because you will be receiving the corrective distribution in 2020, long after the due date of your 2018 tax return, and are required to pay 6% excess contribution penalties for 2018 and 2019, the corrective distribution is simply a distribution of your $5,500 excess only.  No earnings need to be distributed.

The amendment to your 2018 tax return is to add 2018 Form 5329 to calculate and pay the 6%, $330 excess contribution penalty on the $5,500.  You'll have the same penalty on your 2019 tax return because the excess was not removed before the end of 2019.  The regular distribution of $5,500 that Vanguard indicated will eliminate the excess when you file 2020 Form 5329 with your 2020 tax return next year.

[niel2k]

Thanks @dmertz. Can you also provide me a link to an article that gives me step by step instructions to re characterization followed by conversion. 
specifically I can’t seem to find answer to this:

because I simply didn’t know that I would be above the limit, I contributed in Jan 2019 the 6000$ for 2019 year. And now I know I am above limit. So I am going to recharacterize that to a brand new traditional IRA as after tax money. The intent then is to backdoor Roth IRA it through conversion. Now, the 6000 has become about 6900 as of today (it was about 6700 on dec 31 2019). My intuition says that I would have to pay tax on the 700$ with my 2019 returns and pay 200 on 2020 return. But because vanguard will not send me any forms till 2021 I won’t know. 

I am sure I am not the first one running into this. So any help or existing link would help me a ton. 

[dmertz]

I don't understand what you are looking for.  The recharacterization and a subsequent Roth conversion are separate transactions and apply to different tax years.  The recharacterization is indicated in 2019 TurboTax by simply answering Yes in the Roth IRA contribution section when TurboTax asks, "Switch from a Roth To a Traditional IRA?"  There is no need to enter the 2020 Form 1099-R that you will receive next year reporting the recharacterization; even if you do, TurboTax will essentially ignore it.

If the resulting traditional IRA contribution is nondeductible, your 2019 tax return will include 2019 Form 8606 to report that contribution.  There is no tax on your 2019 tax return that results from the recharacterization.  The recharacterization will eliminate the excess contribution penalty that you had when the contribution was being treated as a Roth IRA contribution.

The Roth conversion will be reported on your 2020 tax return, with the taxable amount determined on 2020 Form 8606.  If you have no traditional IRAs other than the one that will receive the recharacterization of $6,000 (with a transfer of $6,900 assuming its current value), you'll convert $6,900 in 2020 with a nontaxable amount of $6,000 and a taxable amount of $900.

[niel2k]

Aha! @dmertz I think I understand. 
Using my words so you can confirm. Is what I am saying ahead of any sense?
For after tax traditional Ira earnings are not taxable until we withdraw / convert from it. 2 examples:

1. Scenario 1: if I contribute to post Tax traditional IRA for say 2019, 2020, 2021 6000 each. And I convert all of that money in 2022 to a Roth IRA. At that time the money is say 19000 I.e. 18000 in contribution and 1000 in earnings over these years. Then the 1000 is taxable all at once for year 2022 (year of conversion) that I will file taxes before April 15th of 2023. Is this right?

2. Scenario 2: exactly same scenario but in 2022 instead of conversion I happen to be over 69 and take distribution of say all of those 19000, even then that 1000 is taxable all at once for year 2022 to be filed before April 15th of 2023. Is this right?

i am hoping to understand this. 
final question: for 2020 is there a 6000 limit on money I can put in a his traditional post TAX IRA?

[dmertz]

Both 1 and 2 are correct, assuming that the contributions were nondeductible and the individual has no other money in traditional IRAs.  The amount of taxable income is the same whether converted to Roth or simply cashed out.

Yes, the contribution limit for 2020 is $6,000 (plus an additional $1,000 for those age 50 or over in 2020), or available earnings, whichever is less.

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-li...