Exceeded income limit for Roth IRA-next steps

[aac351]

After already contributing $6,000 to my Roth for 2020 last year, I subsequently sold some stock which pushed my income over the limit for contributing to a Roth. It seems like my options are:

a. Remove the excess contributions, which would incur an early withdrawal penalty

b. Recharacterize it as a traditional IRA

It seems to me that there are no downsides to recharacterizing compared with removing, so is that the optimal step to take?

[DanaB27 · Accepted solution]

Option b):

Yes, recharacterizing the Roth contribution to a traditional IRA contribution would be a good option. Also, if you choose to make the contribution nondeductible then you can convert it to a Roth IRA and only pay taxes on the earning (this is called backdoor Roth contribution). Please see How do I enter a backdoor Roth IRA conversion? for more information.

Please make a request with your bank to recharacterize your Roth contribution to a traditional IRA.

Please follow these steps to enter the recharacterization:

1. Login to your TurboTax Account 
2. Click on the Search box on the top and type “IRA contributions”
3. Click on “Jump to IRA contributions"
4. Select “Roth IRA”
5. Answer “No” to “Is This a Repayment of a Retirement Distribution
6. Enter the Roth contribution amount 
7. Answer “Yes” to the recharacterized question on the “Did You Change Your Mind?” screen and enter the contribution amount (no earnings or losses)
8. TurboTax will ask for an explanation statement where it should be stated that the original $xxx.xx plus $xxx.xx earnings (or loss) were recharacterized.
9. On the screen "Choose Not to Deduct IRA Contributions" answer "Yes" (if you want to convert this to a Roth IRA later on)

You will get a 1099-R 2021 for the recharacterization with code R-Recharacterized IRA contribution made for 2020 and this belongs on the 2020 return. But a 1099-R with code R will do nothing to your return. The box 1 on the 1099-R will report the total recharacterized amount (contribution plus earnings) but it does not separately report the earnings and box 2a must be zero.

Option a) 

If you want to withdraw the excess contribution and earnings then you will have to let your bank know that you want to withdraw the excess contribution plus earnings. Only the earnings will be taxable.

You will get a 1099-R 2021 in 2022 with codes P and J. This 1099-R will have to be included on your 2020 tax return and you have two options: 

• You can wait until you receive the 1099-R  2021 in 2022 and amend your 2020 return or
• You can report it now in your 2020 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 2021 1099-R into the 2021 tax return since the withholding is reported in the year that the tax was withheld. The 2021 code P will not do anything in 2021 tax return but the withholding will be applied to 2021.

To create a 1099-R in your 2020 return please follow the steps below:

1. Login to your TurboTax Account 
2. Click on the Search box on the top and type “1099-R”
3. Click on “Jump to 1099-R”
4. Select "I'll type it in myself"
5. Box 1 enter total distribution (contribution plus earning)
6. Box 2 enter the earnings
7. Box 7 enter P and J 
8. On the "Which year on Form 1099-R" screen say that this is a 2021 1099-R.

[dcollins451]

I exceed my income limit for my Roth IRA contributing $6,000 when in 2021 I was not permitted to contribute anything for 2021. Would the solution be to removed the $6,000 from the account since I took a loss from my additional investment? I feel like there should be more to do.

[DanaB27]

Yes, if you did not have enough taxable compensation (like wages, self-employment income) to make any IRA contribution then you will have to request the withdrawal of excess contribution to avoid the 6% penalty. Since you had a loss instead of earnings the distribution amount will be less but you will enter into TurboTax that you withdrew the full $6,000 contribution amount on the penalty screen during the IRA contribution interview.

1. Login to your TurboTax Account 
2. Click on "Search" on the top right and type “IRA contributions”
3. Click on “Jump to IRA contributions"

You will get a 1099-R 2022 in 2023 with codes P and J for the withdrawal of excess contribution minus loss. 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 1099-R  2022 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 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 minus loss)
7. Box 2a $0
8. Box 7 enter J and P
9. Click "Continue"
10. On the "Which year on Form 1099-R" screen say that this is a 2022 1099-R.
11. Click "Continue" after all 1099-R are entered and answer all the questions.

Please see What happens if I made an excess Roth IRA contribution for additional information.

@dcollins451 

[dcollins451]

What if my losses exceeded $6,000? 

[DanaB27]

You can only count the losses associated with the $6,000 contribution therefore the loss cannot be more than the contribution. 

@dcollins451