Excessive Roth Contribution

[phildonnia]

I contributed $6000 to my Roth for 2019.  I have a MAGI of 193,200, which puts me over the threshold for eligibility for Roth contributions.  

By my calculations, I need to return $120, plus the earnings, and report the earnings as income.

But if the earnings are income, doesn't that affect my MAGI again?  And wouldn't that further affect my Roth eligibility? How is this untangled?  I don't see in the IRS instructions where it says not to include retirement distributions in MAGI.

[SusanY1]

Since you will be withdrawing the excess plus earnings in 2020, the earnings will become income to you for 2020. 

Your financial institution will provide you with Form 1099-R  next year that will code the return of the excess as a 2019 event and the earnings as income for 2020. 

[phildonnia]

Ah, I didn't know that was how it worked.  I assumed that it was all considered part of the previous year.

That makes perfect sense, thanks for your help!

[dmertz]

"But if the earnings are income, doesn't that affect my MAGI again?"

Yes, that's an unfortunate consequence of being in the Roth IRA contribution phase-out range.  You need to do an iterative calculation to determine the actual amount that needs to be distributed.  In your case, the amount of the excess is rather small, so it won't take too many iterations to come up with the actual amount that needs to be returned.

Alternatively, you could leave the excess in for 2019, pay the 6%, $7 penalty, then resolve the excess after October 15, 2020 but before the end of 2020 by making a regular distribution of exactly $120 or by applying the $120 as part of your 2020 Roth IRA contribution if you are eligible to do so.  That allows you to leave the earnings in and not have to deal with any iterative calculation.

[dmertz · Accepted solution]

SusanY1 incorrectly indicated that the earnings are taxable in 2020.  The 2020 Form 1099-R will have codes J and P indicating that the earnings are taxable on your 2019 tax return.

[phildonnia]

I am seriously considering just paying the penalty and dealing with it in 2020.  It's like, $7.

I see there is some debate over whether the distribution is for the prior year or not, so I'll research the matter further.  Thanks for your take on it.

[dmertz]

From IRS Pub 590-A:

The earnings are considered earned and received in the year the excess contribution was made.

https://www.irs.gov/publications/p590a#en_US_2019_publink1000231025

[phildonnia]

Seems like the earnings are applied in the prior year, as I originally thought.  Not sure how this is supposed to practically work: I don't even know what the earnings will be until my broker calculates it, so how can I iterate the calculation?

So here's my solution: My actual earnings on $120 is going to be somewhere around $5.  That's not going to move the needle much on eligibility, (which moves in ten-dollar increments anyway).  So I'll just take out $150, and that should cover whatever recursive mess results.

But seriously, how is this supposed to be done?

[dmertz · Accepted solution]

With accurate records you can do the same attributable earnings calculation yourself.  Assuming no intervening contributions or distributions, you just need to know the account balance immediately after making the contribution and the balance immediately prior to the distribution to be able to calculate the percentage gain.  With only about a $5 increase in modified AGI you'll only need to take out a few dollars more than the $120 of excess originally calculated.  Say, if you obtain a return of contribution of $125 and the attributable earning end up being $5.20, that will round down to $5, increasing your MAGI to $193,205, resulting in an excess contribution of $123 which the return of $125 covers.  A $125 return of contribution would even accommodate close to $9 of attributable earnings at a rate of around 4%.

A more detailed description of the attributable-earnings calculation is in the tax code:

https://www.law.cornell.edu/cfr/text/26/1.408-11

[phildonnia]

Thanks.  I was able to guess the earnings using my statement balances.  I "iterated" the calculation a second and third time, and the eligibility amount stabilized.  So I guess that's how it's done.

[mnjogger]

Please clarify the sentence "The earnings are considered earned and received in the year the excess contribution was made."  What gives me pause for thought is that this statement makes no reference to the tax year for which the Roth IRA contribution was made.  My example:  In Feb 2020 I submitted what turned out to be an excess contribution to my TY 2019 Roth IRA.  I withdrew the excessive amount and earnings in March 2020.  Are the earnings to be included in my 2019 tax return or my 2020 tax return?  If I take Pub 590-A literally, earnings should be included in my 2020 tax return despite it being a TY 2019 Roth IRA contribution.  Is that correct?

[phildonnia]

Yes, that is confusing. 

Don't take my word for it, but I would interpret that as the contribution having been made in 2019, and so the earnings also credited to 2019.  Even though both the contribution and the correction occurred in 2020. 

Weird, but that would be consistent with the general principle that contributions made for the prior year are considered for all purposes to be made in that year.

[dmertz]

The quoted text from the IRS results from the wording in the statute that was written before the change in the law that permits IRA contributions for a particular tax year to be made by the due date of the tax return for that tax year.  The wording in the statute was never updated to resolve the ambiguity and the IRS has never issued any guidance to clear up this ambiguity.  That leaves it largely up to the IRA custodian to interpret the statute.