Made excess contribution for new Roth IRA in Jan 2020. Withdrew via excess contribution form in Jan 2021. When and how do I pay taxes on any earnings + the penalty?

[uk05]

Hello @macuser_22 -

Including you in this thread since you were able to successfully answer a similar question in another thread:

https://ttlc.intuit.com/community/retirement/discussion/excess-roth-ira-contribution-made-in-2017-an....

Mine situation is similar, but with an additional contribution year.

Details:

I'm 38 years old. I opened a Roth IRA during the 2020 tax year (Jan 28, 2020). It’s the only IRA account I have.

The same day, I immediately contributed $6k for 2019, then another $6k for 2020.

During the 2020 year the contributions doubled (gains from stocks).

What I didn't realize until recently was that my AGI for 2019 and 2020 only allow me to contribute a portion of the $6k for each of the aforementioned years.

Rather than worry about withdrawing the correct excess amount for 2019 & 2020, and possibly future years, I decided to: 

Liquidate all of my stocks, then

Fill out an Excess Contribution Withdrawal Form through my brokerage firm (completed Jan 2021), which was completed before the 2020 tax deadline. This withdrew all of my funds in my Roth IRA (contributions + earnings from them).

After speaking with both the brokerage firm & TurboTax over the phone, both said I would pay the taxes on earnings + 10% penalty during the 2021 tax year since that's when the excess contribution withdrawal occurred and my 1099-R for it would be generated / sent in Jan 2022. Based on this guidance, I filed my taxes for 2020 without including said earnings + penalty, since I will be include them in my 2021 return. 

A few days after filing, however, I was sent a letter (PDF) from my brokerage firm confirming my request to remove an excess contribution before your tax filing deadline (including extensions), along with contributions + earnings calculations, and this statement:

“The amount of earnings returned to you, if any, will be reported as taxable income for the year in which the excess contribution was made.”

So it sounds like this should be filed in 2020. This raises a few questions.

Questions:

1. Should the taxable earnings from both contributions be added to my AGI for the 2020 or 2021 tax year?

2. Is the 10% penalty paid in 2020 or 2021 tax year?

3. Since the 2019 contribution was technically added in the 2020 tax year (Jan 28, 2020) and I withdrew the excess contributions + earned income for it before the 2020 tax deadline, am I able to avoid the 6% excess contribution penalty for it? 

[macuser_22 · Accepted solution]

Since the money was removed in 2021 you will not receive 1099-R's until Jan 2022.   You should receive two 1099-R's one for the 2021 contribution that will have  non penalty since it was removed before the 2020 due date of Apr 15, 2021.   However, since it was a 2020 contribution the earnings are taxable in 2020 and must go on your 2020 tax return.   The 1099-R should have a code "PJ" on box 7.

The 2019 contribution made in 2020 returned in 2021 will be a normal distribution that will have a code J in box 7.    That distribution is reported on your 2021 tax return.   Since it was NOT removed before the due date of then2019 tax return, you will need to amend 2019 and in the IRA contribution section add the Roth contribution and indicate that it was an excess contribution not removed by the 2019 due date which will produce a 2019 5329 form with a 6% penalty for the excess.

[uk05]

Thanks for the guidance, macuser_22.

Since I've already filed my 2020 tax return, should I file an amendment for it this year before the deadline (i.e. once it's been accepted / rejected by the IRS & the option is available in TurboTax), or wait until Jan 2022 when I get the associated 1099-R that breaks everything down?

If the latter (Jan 2022), I would be filing three returns, correct?

2019 - 1040X (amend)

2020 - 1040X (amend)

2021 - 1040

Would that include both federal & state?

And does it matter that during the 2019 & 2020 year I lived / worked in Illinois, but in Jan 2021 when I withdrew the funds via the excess contribution I now live / work in Indiana?

[macuser_22]

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@uk05 wrote:

Thanks for the guidance, macuser_22.

Since I've already filed my 2020 tax return, should I file an amendment for it this year before the deadline (i.e. once it's been accepted / rejected by the IRS & the option is available in TurboTax), or wait until Jan 2022 when I get the associated 1099-R that breaks everything down?

If the latter (Jan 2022), I would be filing three returns, correct?

2019 - 1040X (amend)

2020 - 1040X (amend)

2021 - 1040

Would that include both federal & state?

And does it matter that during the 2019 & 2020 year I lived / worked in Illinois, but in Jan 2021 when I withdrew the funds via the excess contribution I now live / work in Indiana?

---

I neglected to  add to my previous answer that the 2019 6% penalty repeats each year until the excess is removed.   Because the excess 2019 was not removed until 2021 then the 2019 excess will generate a separate 2020 6% penalty.     You need to also enter the excess in the 2020 Roth contribution  interview and say it was NOT removed in 2020 on you 2020 tax return or amended 2020 tax return.  (I overlooked that you said the 2019 excess was removed in Jan 2021 - a carry-over excess from 2019 goes on a calendar year basis so had to be removed before Dec 31, 2020 to avoid a 2020 6% penalty).

The 2019 can be amended anytime since the only only change to the 2019 is to pay the 5329 penalty and the sooner it is paid, the sooner the interest will stop.    The 2019 excess distribution only goes on the 2021 tax return and will not be taxable.

[uk05]

Thank you, @macuser_22.

This is incredibly helpful, but a much more complex situation than I'm used to dealing with when filing my taxes. I'm going to take some to digest and fully understand it, and may follow-up if I have questions.

[uk05]

@macuser_22 

I’ve had some time to review your feedback and have some follow up questions. Any insight would be appreciated.

1. On the excess contribution form I completed, I actually claimed that the full $6k from 2019 & $6k from 2020 as excess due to misinterpreting how I calculated my MAGI (I was leaving 401k contributions in).  I presume this will show up on my 1099-R because that’s the info I gave to the brokerage account.  Should I have this info updated with them so that the 1099-R info actually reflects what my allowed vs excess contribution amounts were for 2019 & 2020?  Or, will the TurboTax software know to adjust what I owe based on my MAGI coupled with the questions they ask and how I answer?

2. For 2019 contribution:  outside of the 6% penalty, will the earnings from the allowed + excess contributions will be added to my AGI for 2021 and taxed then because that's when the excess form was completed / withdraw occurred?

3. For 2020:  Since the excess contribution form was initiated before the 2020 tax deadline in Jan 2021, I’ll add the excess contribution earnings to my AGI on my 2020 amended return (since I already filed).  What about the earnings from the allowed contribution that weren’t considered excess?  Will those earnings be added to my AGI in the 2021 tax year since that’s when the withdraw happened?

4. Will the 10% penalty be paid on my 2021 tax return since that’s the year when the funds were withdrawn?

5. Does it matter that both the allowed + excess contributions along with their earnings were both withdrawn via the same excess contribution form? 

[uk05]

Hi @macuser_22. After reviewing your posts and my tax situation further, I have some follow-up questions. I've included the 2019 & 2020 breakdowns below to help you answer them.

Questions:

1. I cited all $6k for 2019 & $6k for 2020 as excess contributions on the excess return form, but some was actually allowable based on the numbers above. I presume this will make it to the 1099-R.

a. Should I update this with my brokerage account? Or, will the TurboTax software know to adjust what I owe based on my MAGI coupled with the questions they ask and how I answer?

b. Does it matter that the withdrawal of allowable contributions + associated earnings were made on the excess contribution form? Would this cause an issue with turbo tax or the IRS? Would another form need to be filled out?

2. For 2019 earnings from allowable + excess contributions: will that be added to my AGI for the 2021 tax year b/c that's when the distribution occurred and the 2019 tax deadline to withdraw excess earnings expired?

3. For 2020 earnings from allowable contributions:  will that be added to my AGI for the 2021 tax year since that’s when the normal distribution occurred (even though it was initiated by the excess contribution form)?

4. For 2019 & 2020 early withdrawal:  when will the 10% penalty be paid and why?

[macuser_22]

#1.  If in the 2019 software yiu enter the entire contribution the  TurboTax will calculate the excess and penalty on the 5329.    Only the excess is subject to penalty.   Because you owe the penalty the earnings do not need to be removed from the IRA - they stay in it.    Only a "return of contributions" before the due date require earning to be removed.  The 6% penalty allows the earning to stay in  the IRA.

For 2020 if you removed the excess plus earnings (hopefully you removed a bit more) because the taxable earnings will add to your MAGI possibly making a new excess.    When you are in the MAGI "phase out" range any increase in MAGI creates a new excess (round-robin) so some extra should be removed to allow for that to prevent a 2nd distribution.

[uk05]

Thanks, @macuser_22 .

When I filled out the excess contribution form, I requested everything be withdrawn & moved to my individual brokerage account. That includes allowed + excess contributions & the associated earnings. I did this to prevent getting into this situation again.

Based on this info, can you also provide guidance on questions 2-4?

Thank you.

[macuser_22]

Any taxable distribution in 2021 will be taxable in 2021.    If you are under age 59 1/2 then any distribution that is more than the amount of your contribution will have a 10% early distribution penalty on your 2021 tax return.   Your own contribution is not taxable.