Disallowed IRA contribution

[karl22]

I made a contribution to my traditional IRA in 2021.  It was a stock litigation lawsuit settlement check.  Apparently since I am over 72, I am not allowed to make any IRA contributions; this should have been flagged by my IRA broker. 

All  the instructions that I have found in Turbo Tax are very confusing.  I apparently need to withdraw the contribution before tax filing date, 4/18/2022, no problem.  And pay taxes in my 2021 return on the disallowed contribution or on the 'earnings' only ?

Then wait for a 1099-R form in 2022, related to the withdrawal?  After which I file an amended 2021 tax return?  Or create a fictitious 2021 1099-R (in addition to my real 1099-R for my 2021 MRD), for the 2022 withdrawal?  

[fanfare]

You got it.

Only the earnings, if greater than zero, are taxed in 2021.

[DanaB27]

Please be aware, after 2020 there is no age limit on making regular contributions to traditional IRA (IRS). But you need to have taxable compensation to be able to make contributions.

If you have an excess contribution then to avoid the 6% tax on excess contributions, you must withdraw:

• the excess contributions from your IRA by the due date of your individual income tax return (including extensions); and
• any income earned on the excess contribution.

If you withdrew a 2021 excess contribution plus earnings in 2022 before the due date, then you will get a 2022 1099-R in 2023 with codes P and 1. This 1099-R will have to be included on your 2021 tax return and you have two options: 

• You can wait until you receive the 2022 1099-R in 2023 and amend your 2021 return or
• You can report it now in your 2021 return and ignore the 1099-R when it comes unless there is Box 4 Federal Tax withholding and/or Box 14 State withholding. Then you must enter the 2022 1099-R into the 2022 tax return since the withholding is reported in the year that the tax was withheld. The 2022 code P will not do anything in the 2022 tax return but the withholding will be applied to 2022.

To create a 1099-R in your 2021 return please follow the steps below:

1. Login to your TurboTax Account 
2. Click on the "Search" on the top right and type “1099-R”
3. Click on “Jump to 1099-R”
4. Answer "Yes" to "Did you get a 1099-R in 2021?"
5. Select "I'll type it in myself"
6. Box 1 enter total distribution (contribution plus earning)
7. Box 2 enter the earnings
8. Box 7 enter P and 1
9. Check the "IRA/ SEP/ SIMPLE" box
10. Click "Continue"
11. On the "Which year on Form 1099-R" screen say that this is a 2022 1099-R.
12. Continue until "Did you use your IRA to pay for any of these expenses?" screen and enter the amount under "Another reason" since you are over 59 1/2 

[dmertz]

You are no longer prohibited from from making a traditional IRA contribution because of your age.  The SECURE Act eliminated the age restriction.  That's why your broker did not flag any error.

The only reason that you might not be eligible to contribute to an IRA is if you (or your spouse if filing jointly) do not have compensation to support the contribution.  If that's your situation, yes, you need to obtain a return of contribution by the due date of your 2021 tax return, including extensions.  Be sure to decline any tax withholding on this distribution.  Any attributable earnings will be taxable on your 2021 tax return and to report the earnings before receiving the 2022 Form 1099-R you can enter the form as if you have already received it.  Otherwise, as you said, you can file without entering this Form 1099-R and then amend your 2021 tax return in early 2023 when you receive the form.  (If there are no gains attributable to the amount being returned, there is no need to enter the 2022 Form 1099-R into either 2021 or 2022 TurboTax.  You explanation statement that will be included with your 2021 tax return suffices.)

[karl22]

THANKS! We don't have any 2021 compensation (no wages, only pensions, social security, investment gains and dividends), so I will withdraw the 2021 IRA contribution from my IRA account without tax withholding.   There were no gains attributable to this contribution, held in cash only; so it seems that I don't need to enter any 2022 form 1099-R (aside from the one for my 2021 MRD). 

But I don't understand your comment about 'explanation statement' in my 2021 tax return.  Please clarify.

Also Turbo Tax, in 'step by step' mode asked about the contribution and it seems to change my tax liability (money owed) when I 'played' with the amount.  Is the disallowed contribution taxed in 2021. 

[dmertz]

Your explanation statement is to include the date of the contribution, the date of its return and the gain or loss attributable to the amount being returned (which in this case is zero).  This explanation is needed because the 2021 Form 5498 will show the contribution made for 2021 but the corresponding Form 1099-R for the return of that contribution won't be issued until next year and the IRS when evaluating your 2021 tax return needs to know that you did not simply fail to report an excess contribution.  TurboTax should prompt you to complete the explanation statement.

[karl22]

Thanks again!!  Is there some IRS form that I should use for the 'explanation statement'?

[dmertz]

It appears that TurboTax fails to ask you to provide the required explanation statement when you indicate a traditional IRA contribution and follow that up with indicating that you had some or all of it returned, instead asking for explanation when you enter a Form 1099-R that indicates the return of contribution.  If the return of contribution is made in the year following the year for which the contribution was made, TurboTax developers apparently assumed that you would file reporting the excess contribution and then amend when you receive the Form 1099-R for the return of contribution.  You can either prepare such a statement manually and include it with your mailed tax return or you can try creating a dummy Form 1099-R with zeros in boxes 1 and 2a, code 8 in box 7 and the IRA/SEP/SIMPLE box marked.  This will trigger TurboTax to prompt you to enter and explanation after you click the Continue button on the page that lists your Form 1099-R entries.

[karl22]

THANKS AGAIN!  I think that I am close to understanding what to do.  It is interesting that Turbo Tax 'forms' view has a IRA Contributions Worksheet.  It shows the amount of my 2021 contribution and line for the withdrawal that I will complete by Monday, and a line: Total traditional IRA contribution, which shows '0'.

[karl22]

Sorry to bother you again, but I tried ' you can try creating a dummy Form 1099-R with zeros in boxes 1 and 2a, code 8 in box 7 and the IRA/SEP/SIMPLE box marked.  This will trigger TurboTax to prompt you to enter and explanation after you click the Continue button on the page that lists your Form 1099-R entries.' but TurboTax did not prompt me to do anything.  It just accepted the additional 1099-R.

I think I will just remove the dummy form and correct the situation in later in 2022 or 2023 with an amended return, unless you have another idea.

[karl22 · Accepted solution]

Sorry again!  I continued further with 'step by step' from the dummy 1099-R input and a explanation page popped up.  I wrote that the disallowed 2021 IRA contribution was withdrawn and transferred on 3/16/2022 (which it was).  I got through the reviews without errors.  I'll file this version.

THANKS AGAIN!!