I made a nondeductible IRA contribution. Can I cancel my contribution to the IRA account?

[Coselman]

I did not realize I did not qualify for a full IRA deduction (5,500) because of my AGI. Can I either cancel the nondeduction amount or move it to my Roth Account?

[Hal_Al · Accepted solution]

You can cancel it. Contact the IRA financial institution (custodian) to do that. Then just don't enter it into TurboTax.

You can convert it to a Roth, but that can be complicated* if you currently have traditional IRA(s). The conversion will be treated as a 2017 tax event not for 2016.

* This year's (2016) contribution cannot be converted in isolation from any existing traditional (including rollover) IRA(s). It's best explained by example. Let's say you have a $95,000 balance in all your existing traditional IRAs and that balance consist of $45,000 in deductible contributions, $10,000 in previous non-deductible contributions and $40,000 in earnings (interest, dividends & capital gains). This year you make a $5000 non-deductible contribution and convert $5000 to a Roth. Only 15% of the $5000 conversion ($750) will be tax free. Your basis, in all your IRAs, is $15,000 (the previous $10,000 of non-deductible contributions plus this year's $5000 contribution). TurboTax will divide that $15,000 basis by the $100,000 balance ($95K+5K) to arrive at the 15% tax free ratio. This is the way the IRS requires it to be done. The calculations will be shown on form 8606.

See: http://www.bankrate.com/finance/retirement/drawback-one-type-roth-conversion.aspx

http://thefinancebuff.com/how-to-report-backdoor-roth-in-turbotax.html

[DS]

Moving on, I did cancel the unauthorized IRA and moved dollars back to conventional saving but the provider of the IRA, in this case a bank, submitted a 1099 R to the IRS and to me with a box 7 code of 7. Doing my 2019 taxes on turbo tax , it is seeing the cancellation as un-taxed with draw from a an IRA and applying appropriate tax. The IRA was not used in 2018 to reduce the tax burden so it is money that has already been taxed. How do I communicate this information to the IRS,

[Hal_Al]

If you received an erroneous 1099

You have several choices:

1. Ideally, you get a corrected 1099-R from the payer
2. Don't report it on your return. Attach a copy of the 1099 and a statement explaining the circumstances. You can't e-file. From the IRS instructions: Form 1099 incorrect? If this form is incorrect or has been issued in error, contact the payer. If you cannot get this form corrected, attach an explanation to your tax return and report your income correctly.
3. After entering the 1099-R, tell TurboTax you rolled it over. 
4. Do nothing and hope you can explain it away when & if the IRS contacts you