How to calculate the penalty for excess contribution to Roth IRA

[tomekj]

I need some help with calculating the penalty for excess contributions to the Roth IRA. I've used TurboTax to amend tax returns where the excess contributions were made but IRS requested an addtional payment, on top of what I paid based on amendments filed in TurboTax. I would like to double check these calculations and understand if and where there was a mistake.

Here is my situation:
1. In 2021, 2022 and 2023 I exceeded the income limit for contributing to Roth IRA. Nevertheless, I made full contributions in each of these years: $6,000 in 2021, $6,000 in 2022 and $6500 in 2023.

2. After filing 2023 return I realized that I was not eligible to contribute to Roth IRA in 2021 - 2023. After 4/15/2024 but before the extended filing deadline, 10/15/2024, I removed all these contributions and filed amended returns for 2021, 2022 and 2023.

3. The penalty for 2021 is 6% of $6,000 + interests = $360 + interests

4. The penalty for 2022 is 6% of  $12,000 + interests = $720 + interests

What is the expected penalty for 2023? Since the Roth IRA contribution for 2023 has been removed before 10/15/2024 then I expect that it  would not be subject to the penalty. However, I probably still owe 2023 penalty for 2021 and 2022 contributions which would be again $720 + interests. Is this correct?

I would appreciate any help with this.

[Opus 17 · Accepted solution]

At the time of removal of the excess contributions in 2024, you were not allowed to use the special "removal of excess" contribution for 2021 and 2022, it was too late.  The way to remove that excess is to make a regular withdrawal of contributions, which is not taxable if it is only a return of Roth contributions, but which must be reported.  Since the withdrawal occurred in calendar year 2024, it is reported on your 2024 return, it is not retroactive.

You said they are already billing you, so you are trying to find out what the base penalty should be?

For 2021, you have $6000 of excess, the penalty should be $360.  The IRS can add interest and a late payment penalty.

For 2022, you have $12,000 of excess contributions, the penalty should be $720, plus any interest and penalties the IRS adds.

For 2023, you still have $12,000 of excess contributions.  You could only make a withdrawal of the $6500 excess from 2023 before the deadline of October 15, 2024.  If you did make that withdrawal, you must also withdraw any earrings attributable to the excess contribution, and that is reported as additional taxable income on your 2023 return.  You would need to create a substitute 1099-R with code P.  Box 1 (distribution) should be $6500 plus the taxable earnings, and box 2a is the amount of taxable earnings.  

If you also removed the $12,000 from 2021 and 2022, you ignore that for now.  The $12,000 from 2021 and 2022 is not eligible for the special procedure, and since it was removed in 2024, it is still excess for 2023 and subject to the 6% penalty.

Then on your 2024 return, you will report removing the $12,000 excess from 2021 and 2022.  As long as it is removal of contributions, it won't be taxed, and that will remove future penalties.  You don;t have to remove the earnings attributable to the excess.  If you did, that will be taxed according to the normal rules for ordering Roth IRA distributions.

[fanfare]

If you didn't have any positive earnings on the 2023 contribution, there are no earnings to remove,

the custodian should calculate the earnings, but you can do it also if you know how.

if you A) filed by Tax Day, OR  B) timely requested an extension, then you removed the 2023 contribution on time (Oct 15), but possibly not the earnings.

If you has a loss and got back e.g. 6400, you still resolved the excess of $6,500 and your 2023 Form 5329 should show this.

If you amended 2023 showing a penalty, and satisfy the above conditions, you need to amend again to correct this.

If the removals deplete your Roth IRA to zero, your penalties will be reduced.

@tomekj 

[tomekj]

Thanik you for the detailed explanation. This confirms my intuition but I'm still waiting for the IRS explanation of the additional penalty.

[Opus 17]

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@tomekj wrote:

Thanik you for the detailed explanation. This confirms my intuition but I'm still waiting for the IRS explanation of the additional penalty.

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Until the IRS issues a bill, the late payment penalty is 0.5% per month, and the interest rate is variable, from 4%-8% over the time frame indicated.

https://www.irs.gov/payments/quarterly-interest-rates

So the penalty plus interest for the 2021 excess (due April 15, 2022) would be $360, plus 43 months at 0.5% per month, plus 8% interest.  It's roughly $100 more, I think.  The penalty plus interest for the $720 that was due April 15, 2023 would be $720 plus 0.5% for 31 months plus 8% APR.  And so on.

After you get a bill, the penalty for non-payment increases to 1% per month.

You can apply for a waiver or abatement of the penalty for cause, or as a "first timer".  The interest can't be waived by law, but if the late payment penalty is waived, the interest would be recalculated.

https://www.irs.gov/payments/administrative-penalty-relief