Roth IRA Excess Contribution in 2021

[tsfo]

Hello,

My situation - 55yr old, single, unemployed. 

• Made a $7,000 Roth IRA contribution for 2021 Tax year (did this last year April 2022)
• Thought my deferred comp qualified as earned income and I would be able to contribute to the Roth. Turbo Tax didn't pick up it was deferred income because my W2 didn't have anything in Box 12 where I should have made the note it was deferred.  
• April 2023 - processing withdrawal/distribution of the entire $7,000 excess contribution. There were no earnings.
• I understand the $7,000 is considered an excess contribution for 2021 Tax Year and I must pay the 6% penalty.

Question 1: Do I also need to pay the 6% penalty on my 2022 tax year? I wasn’t sure if that penalty is assessed if I withdraw the money by April 18, 2023. Or because the money was still in the account on Dec 31, 2022 it triggers the 6% penalty.

Q2: How do I pay the penalty for Tax Year 2021?

Q3: When do I need to pay the 6% penalty for Tax Year 2021?  Is there a time limit?

Thank you.

[Cynthiad66]

The IRS will charge you a 6% penalty tax on the excess amount for each year in which you don't take action to correct the error. You can be charged the penalty tax on any excess amount for up to six years, beginning with the year when you file the federal income tax return for the year the error occurred.

The IRS will Bill you for the penalty.  The IRS  receives notification of the IRA excess contributions through its receipt of the Form 5498 from the bank or financial institution where the IRA or IRAs were established.

You can pay when you receive your bill from the IRS.

Depending on your modified adjusted gross income (MAGI), your Roth IRA contribution may result in an excess contribution. TurboTax will calculate your MAGI and determine whether you've made an excess contribution. If this happens, you’ll be subject to a 6% tax penalty on the excess amount for every year that it stays in the account.

You can either accept this 6% penalty or take measures to avoid it before the tax filing deadline (this includes any filing extensions you may have).

If you choose to pay the penalty, you then have two options:

• Apply the excess to next year: You can leave the excess contribution in the Roth IRA and apply it to next year’s contribution. Be sure to take this into account when determining your contribution amounts for next year
• Remove only the excess contribution after your tax deadline: After you file, you can request a regular distribution to remove the excess contribution (without earnings) between October 17 and December 31, 2023. You’ll have the 6% excess contribution penalty on the 2021 return, but you can keep the earnings in the Roth account, and can avoid the penalty on next year’s tax return

If you’d rather avoid the penalty, you have two options (both must be completed before your tax filing deadline):

• Withdraw the excess contribution plus earnings: Keep in mind that the earnings are included in your taxable income for the year the excess contribution was made, so you’ll still receive a 1099-R to report these earnings on your tax return
• Recharacterize the Roth IRA contribution as a traditional IRA contribution: Contact your plan administrator for guidance on this process. After you’ve made your recharacterization, see these instructions for how to record this process in TurboTax

Check the Roth IRA contribution limits for 2022 and 2023 to avoid future excess contributions based on your filing status and MAGI.

[tsfo]

I'm confused. I know I have to pay the 2021 tax year 6% penalty.  But do I also need to pay the 6% on my 2022 taxes (not submitted yet)?  I am taking corrective action on my 2022 taxes - but the contribution was not removed until April 2023. It's before I file - but after Dec 31, 2022.

[Cynthiad66]

No, you do not have to pay a 6% penalty for 2022 because you are correcting the issue prior to April 18th.