What to do about 2014 Excess traditional IRA Contribution?

[jdhlnh2018]

Although my self-employed (I'm retired) income totaled $13,233 in 2014, when my and my wife's 2014 (trad) IRA contributions of $6500 ($13,000 total) were entered in Turbo Tax, only $12,421 was deductible, leaving an excess contribution of $579 for my wife. Form 5329 (with the 6% tax) and 8606 were filed in 2014.

In 2015 filing, on form 5329, her IRA (from beneficiary IRA, not her personal IRA) distributions of $3,433 were subtracted from her 2014 excess contribution of $579, it left a balance of "0" and no 6% tax was charged, and therefore no form 8606 was filed (there being no basis going forward). 

I assume the 2015 form 5329 was incorrect and that we would have to remove or recharacterize the excess contribution from the same IRA into which she contributed (and not her beneficiary IRA).

Do we need to amend 2015 form 5329 filing and pay the annual 6%...each year, all the way to the  current  2020 filing (and assign the $579 to a 2020 contribution)?

[ReneeM7122]

You'll need to file Form 5329 Additional Taxes on Qualified Plans (Including IRAs and Other Tax-Favored Accounts)  for each year starting with 2014.  You don't need to amend your tax returns since paying the penalty won't have an affect on them. According to the IRS instructions:

 5329 part IV that would have the 2014 excess and the 6% penalty on that excess.   Keep in mind that since you are filing Form 5329 for prior years, you must use each prior year's version of the form. If you don't have any other changes and haven't previously filed a federal income tax return for the prior year, file the prior year's version of Form 5329 by itself (discussed earlier). 

After you complete the form for 2014, file a 2015 Form 5329 with both the 2014 excess and 2015 excess so the 6% penalty will be for both.    Continue this procedure for each year 2014-2019.  When you're done, 2019 will show the total of 2019 excess and all prior years.

Where to retrieve IRS prior year forms

VIsit this IRS link and select the forms that you require from 2014 to 2019.

[dmertz · Accepted solution]

I see a number problems here.  First, it seems that your net profit from self-employment would have needed to have been $13,366 to be able to make $12,421 of deductible traditional IRA contributions.  I'll assume that your net profit was actually $13,366 and just address an excess contribution of $579 for 2014.

As you mentioned, the $579 excess is deemed to be in your wife's traditional IRA.   Also as you indicated, your 2015 tax return improperly treated the distribution from the inherited IRA as reducing the excess in her own IRA.  Assuming that this excess was never removed and was never able to be absorbed as a subsequent year's contribution, the excess remained for 2015 through 2020 and a 6%, $35 penalty should have been paid with Form 5329 for each of those years.  However, because it was reported on her 2015 Form 5329 that the excess was resolved and the IRS never challenged that, the 3-year statute of limitations for the IRS to challenge that reporting has expired and you may not have to do anything about the excess.

Ignoring the statute of limitations, correcting the excess in 2021 would require that your wife receive a regular distribution of $579 in 2021.  This distribution would not be taxable because you never received a deduction for the distribution.   Explaining to the IRA custodian that the $579 distribution is a distribution of an excess contribution after the due date of your 2014 tax return might allow the custodian to leave blank box 2a of the Form 1099-R reporting this distribution or they might just report it they way they would normally report a regular distribution, with $579 in both boxes 1 and 2a, but in either case to get TurboTax to treat the distribution as a nontaxable distribution of excess after the due date of the 2014 tax return you would need to put a zero in box 2a of TurboTax's 1099-R form.  Doing so causes TurboTax to prompt for an explanation statement regarding such a distribution.  An amended 2015 Form 5329 and Forms 5329 filed for years 2016 through 2020 would need to be filed and penalties totaling $210 paid.

[jdhlnh2018]

dmertz: Once again, you've been very helpful and have explained the situation very well. Thanks for taking the time to reply! One question remains: Should the distributions from inherited IRAs be included in line 7 of 2020 Form 8606 (and in line 11 of Form 5329 - year 2015-"Traditional IRA distributions included in income")? Turbo Tax includes these distributions in these locations from the 1099 info. As for the 2020 Form 8606, It doesn't seem right that the inherited IRA distributions should impact one's traditional IRA basis, nor should there be a non-taxable portion of the inherited IRA distribution based on a conversion of a portion of one's traditional IRA into a Roth IRA. I hope I've made this question clear.

[dmertz]

Should the distributions from inherited IRAs be included in line 7 of 2020 Form 8606 (and in line 11 of Form 5329 - year 2015-"Traditional IRA distributions included in income")?

No.  This seems to suggest that you did not tell TurboTax that code 4 Form 1099-R indeed reports a distribution from an inherited IRA.

(Note the 2020 TurboTax currently has a bug where it is including distributions from an inherited IRA on the beneficiary's own Form 8606, but that bug does not appear to be present in 2015 TurboTax, at least not in the final version of 2015 TurboTax.)