Bad IRA Contribution

[taxriv]

In 2012, Mr. S calls up Company X and asks if he can open an IRA in one of their products paying 3% fixed. Mr. S doesn't know that since he and his wife are both retired and have no earned income, they can't do it. Needless to say the person at Company X doesn't ask Mr. S if he's still working. So he now has this IRA for over a year. I tell him to call Company X and tell them to close out the IRA and give him back his money and, on the eventual 1099-R, that only the earnings should go in Box 2a as taxable income since the principal was created with after tax money that was never used on his 2012 return. Does anyone know if the Distribution Code on the eventual 1099-R should be 5, 8 or other?

I've had situations where people opened IRA's with no earned income and I caught it a few days after it happened. They basically just had to go back to the bank and get their money back.

[ttbtaxes]

I don't know the 1099-R code but you should be excepted from the 10% penalty. Take a look at IRC Sec. 408(d)(5)(A) which contains the rules related to withdrawing excess contributions after the due date of the return has passed.

[TaxGuyBill]

I think it will have code "P" and possibly combined with code "1". It would be reported on the 2012 tax return.


Publication 590 has an example, adjusting the years to fit your circumstances:

Maria, age 35, made an excess contribution in 2012 of $1,000, which she withdrew by April 15, 2013, the due date of her return. At the same time, she also withdrew the $50 income that was earned on the $1,000. She must include the $50 in her gross income for 2012 (the year in which the excess contribution was made). She must also pay an additional tax of $5 (the 10% additional tax on early distributions because she is not yet 59½ years old), but she does not have to report the excess contribution as income or pay the 6% excise tax. Maria receives a Form 1099-R showing that the earnings are taxable for 2012.

http://www.irs.gov/publications/p590/ch01.html#en_US_2013_publink1000230883

[sandigi]

where do you report the earnings?

Gee, I feel stupid about now.

2013 client made $6500 contribution to Roth IRA. He has no earned income.
We called Fidelity to remove the excess contribution and earnings. This will be done by due date of 4/15/14.
They will calculate the earnings on that excess contribution and he will have that figure in 2-3 days.


Do I show the $6500 anywhere?
Where do I report the earnings? Form 8606 - 5329 - or just call the IRS and tell them to make a note of it? (this last part is my feeble attempt at humor. Sorry, I cannot be more clever today . . . )

[FEDUKE404]

Fidelity can do that ?

Gee, I feel stupid about now.

2013 client made $6500 contribution to Roth IRA. He has no earned income.
We called Fidelity to remove the excess contribution and earnings. This will be done by due date of 4/15/14.
They will calculate the earnings on that excess contribution and he will have that figure in 2-3 days.


Do I show the $6500 anywhere?
Where do I report the earnings? Form 8606 - 5329 - or just call the IRS and tell them to make a note of it? (this last part is my feeble attempt at humor. Sorry, I cannot be more clever today . . . )

I'm impressed with Fidelity. . .

In reality, you won't see any "paperwork" in the form of a 2014 Form 1099-R until sometime next year. Format will be of the type "x+earnings" withdrawn and "earnings" taxable. There likely will be a need to amend 2014, or perhaps 2013 also? The rules are messy, and earnings depend upon when the funds went into the account and how well the market performed on a daily basis from then onward.

I would think the best you can currently hope for is NOT having to figure the penalty for excess contributions on the 2013 tax return.

And I remain impressed with Fidelity if they told you that. I have a client, in virtually the same scenario with another well-known national firm, and even though they stuck a finger in the dam (removed the offending funds on time) they told him no further information/documentation would be available until tax-filing season next year.

FE

[Bees Knees]

If the IRA had a good rate of return and the client wants to keep it in a tax deferred IRA, you could have the client pay the 6% excess contribution penalty for 2012 and 2013, and then have the client go out and get a part-time job in 2014 until he/she earns enough to make a 2014 IRA contribution. Then the 2014 earnings and the 2014 IRA contribution will cancel each other out and the client gets to keep the IRA plus earnings tax-deferred inside the IRA.

6% of a $6,500 contribution = $390 X 2 years = $780. So for a cost of $780 in penalties for 2012 and 2013, the IRA plus its earnings can remain as is. The $780 penalty is not so bad when you consider you get to keep the $396 of earnings plus the $6,500 contribution inside the tax deferred IRA.