Roth IRA

[Timbo7]

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[macuser_22]

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@Timbo7 wrote:

Not thoroughly knowing the rules for the Roth IRA, we contributed $5,500 to our minor's Roth IRA in 2016.  He did not have earned income until 2019.  So, my understanding is that we now need to back-file a 5329 for each of those years (2016, 2017, 2018) to show the excess contribution carried year-over-year with the 6% penalty each time.  Is this right?  We also need to amend his 2019 return (his first ever return) with a 5329.  Luckily his income in 2019 and 2020 will wipe out the overage, so we have not removed it. 

If the above is correct, can we file all 5329s together and write one check?  Do we need to include an additional penalty and interest payment now?

The penalty applies to him, not you. If he did not file tax returns for those year then he need to file now with the 5329 form.  If he did  file tax returns then  he needs to amend those years  and include the 5329 and penalty. 

If he is qualified to make a 2020 Roth contribution the the excess can be applies as a 2020 contribution, otherwise it mist be removed before Dec 31, 2020 to avoid another penalty.

[fanfare]

I he earns over five thousand five hundred for three years that will "work off" the excess but he can't contribute more during that time.  a 5329 is required each year to show the excess coming down. It may be worth paying the 6% penalty, especially if the IRA has grown.

If the IRA has not grown, you really have to ask yourself "Why?" given the surge in the stock market since election day..

[dmertz]

When filing these forms, pay just the penalties calculated on the Forms 5329.  The IRS will bill for any interest or other penalties.

[fanfare]

If you have the custodian negate that contribution for 2019,

before the tax due date, you can apply the 2019 amount available to "work off" 2016 immediately.

[dmertz]

I don't see it mentioned that there was any contribution made for 2019 that can be returned.  From the details provided, it appears that the compensation for 2019 was insufficient to be apply the entire excess as a 2019 contribution, leaving some amount of excess to be resolved in 2020.

[Timbo7]

Yes, the excess contribution will be resolved by his 2020 earned income, so one more 5329 next year.

[fanfare]

okey dokey once again I guess I misread the original post.

[TwoTaxed]

Part One

When my daughter was 16 in 2020 she contributed $1,250 to her Roth.  She was a dependent on our tax return, and she did not file her own return that year. Turned out, $1250 was not earned income.  Whoops. So, we withdrew the $1250 from her Roth account to make things right.

First question set:

1. Does she need to file 2020 Fed AND State returns on her own, report her $1250 income and pay the 6% fine?

2. Does she also have to pay the 6% penalty on that $1250 on her 2021 return as well? If so, how to pay?

Part Two

In 2021, she contributed $6k to her Roth.  It turned out she only had $2600 AGI income, and so should have only contributed $2600 to her 2021 Roth IRA.  To fix this we removed the extra $3400 plus earnings from her 2021 Roth.

Second Question Set:

1.  How does she pay her 10% fine on $3400 generated earnings for 2021? 

2. Do these fines on the excess Roth contributions only affect federal returns?

Thank you

[dmertz]

@TwoTaxed 

First questions:

1. The answer depends on when and how the distribution from the Roth IRA was made.  When was this distribution made?  What is the code in box 7 of the Form 1099-R reporting the distribution from the Roth IRA?  If the corrective distribution was after April 15, 2021, it could only be done by a regular distribution and 2020 Form 5329 Part IV would need to be filed stand-alone and the 6% penalty paid with that.
2. No.

Second questions:

1. The corrective distribution should have been done by a return of contribution.  Assuming that this was done in 2022, this will be reported on a 2022 Form 1099-R with codes J and P in box 7, the sum of $3,400 and the earnings in box 1 and just the earnings in box 2a.  You can enter this now in 2021 TurboTax as if you've already received this form and TurboTax will include the earnings on Form 1040 line 4b and on Form 5329 line 1.  (If the corrective distribution for the $1,250 excess contribution for 2020 was made after April 15, 2021, Form 5329 will also show this distribution on line 20 to eliminate the excess carried into 2021 which should be present on line 18.)
2. As far as I know, no state assesses an excess contribution penalty, but as least one state (California, 2.5%) assesses an early-distribution penalty which would be due on the earnings distributed.

[Chris_99]

Thank you so much for your expert answer! We REALLY appreciate it. The content is dense, I'm still digesting the answers.

We are filing a 2020 return for her now because of this excess contribution issue.

For year 2020, the contribution of $1,250 was made on 12/11/2020. It was pulled out on March 4, 2022 from Vanguard. Vanguard said they will only return $1,250. The earnings stay in her Roth IRA. We haven't received the 1099-R yet. You are right, TurboTax generated a Form 5329. Part IV, line 25 shows $75 Additional tax.

By the way - this $1,250 was an injury settlement payment from Chipotle's legal department. As far as we can tell, this $1,250 should NOT taxable income, right? 

We are in California but we don't see anything in the California return about the 2.5% penalty. Her tax due shows $0 in TurboTax.

For year 2021 your answer is packed - we have to soak that one tonight and might come back to you tomorrow to get more help.

Thanks again for sharing your awesome knowledge. 

[dmertz]

Since the distribution was made on March 4, 2022, it was properly done after April 15, 2021 as a regular distribution with no distribution of attributable earnings.  In this case it is a nontaxable distribution of contribution basis so there is no income tax or early-distribution penalty on this.  Your daughter's 2022 tax return will include the distribution on line 20 of Form 5329 to eliminate the excess-contribution penalty for 2022 and beyond.  Since the distribution is not taxable, there will also be no 2.5% California early-distribution penalty on this distribution.

There is a 6%, $75 excess-contribution penalty due with the completion of Part IV of a 2020 Form 5329 which can be mailed stand-alone if not already done.   As you have indicated, another 6%, $75 excess-contribution penalty is due with Part IV the Form 5329 included with your daughter's 2021 tax return (or sent stand-alone if she is not otherwise required to file a 2021 tax return) because the excess carried into 2021 was not corrected before the end of 2021.

Injury settlements are generally tax exempt, so it would not have been included in taxable income on her  2020 tax return. 

[fanfare]

@dmertz 

 According to Pub  590B a return of excess from a Roth IRA also involves Form 8606 (basis in Roth).

If I do it your way  code J  and box 2a with other tax software 

I get a taxable distribution on Form 8606 line 21

which I can eliminate by entering my earlier contribution to my Roth IRA line 22.

This clears out Form 5329.

[dmertz]

fanfare, I think we are saying the same thing.  It's true that the code-J distribution will also be reported on 2022 Form 8606 Part III, but it won't be taxable because it is a distribution of contribution basis.  It also appears on 2022 Form 5329 line 20 to be subtracted from the carried-forward excess that will be present on line 18.

[Chris_99]

I really appreciate your great answers. Your posts are so knowledgeable, sometimes can't quite understand the technical terms - let me try to restate in my words what I think you're saying just to confirm.

2020 Questions

1. For the 2020 excess contribution, my daughter needs to file a 2020 Federal 1040 return with the $75 penalty on form 5329 - does that sound right?

2. Vanguard said they only returned the original $1,250 to my daughter and kept the earnings her Roth account. Is that the correct procedure?

3. How should I report her interest generated by the $1,250 for tax year 2020?  

4. Should I mock the 1099-R now in the 2020 return we're about to file? We don't want to have to file an amended 2020 return once I receive the official 1099-R later this year.

2021 Questions

5. Our daughter's 2021 return has not been done yet because we're still figuring out 2020. I understand from your post that we have to pay 6% on that $1,250 for 2021 as well even though we withdrew the excess contributions before the April 2022 deadline. Could you please confirm if this is correct?

6. What should we include on my daughter's 2021 return so we can avoid a future amending?

Here is the background. In 2021 our daughter made $2,800 as a summer intern and received a 1099-NEC form.  When plugging the numbers into her 2021 return,  we learned that $2,602 was "earned income".  

For this same tax year 2021, we contributed $6,000 into a Vanguard Roth for her on 7/19/21. Realizing we over--contributed by mistake, we pulled out the excess $3,398 on 3/4/22.  Vanguard said $3,398 plus earnings will be returned to her bank account.  

7. How should we classify the earnings from the $3,398 excess contribution? Should those go in to tax year 2021 or 2022?

8. How to enter the numbers in the 2021 return - do these answers look right? We're asking because Form 5329-T, line 18 says $4,648 but shouldn't it be $1,250?

Q: "Enter your total Roth contributions for 2021",  A: $6,000

Q: "Switch from a Roth to a Traditional IRA", A: No

Q: "Would you like us to track you Roth IRA basis", A: Yes

Q: Withdraw from Your Roth IRA Before 2021, A: No

Q: Enter Prior Year Roth IRA Contributions (confirm you net regular contributions prior to 2021 that remain in your Roth IRA, A: $7,250 ($1,250 + $6,000)

Q: Any Roth IRA conversions, A: No

Q: Enter Excess Contributions (Your Excess Roth IRA Contributions for Prior Years ), A: $4,648 ($1250+$3398)

Q: How much Excess to 2021 (indicate how much of your remaining excess contribution of $1,250 you want to credit toward your 2021 Roth IRA contributions, A: 0

Q: Enter the value of your Roth IRAs on 12/31/2021, A: $8,235

Q: Contributions Withdrawn Before the Due Date 4/18/22, A: $4,648 ($1250+3398)

In the summary of "Your 2021 Deductions & Credits" page, it shows "$1352".  Should it be $2,062?  (1250+6000-1250-3398)

Thank you and sorry for the long post! This has been vexing us for weeks.