Form 5329 6% penalty for excess IRA contribution

[momona]

New tax client.

MFJ-both taxpayers have a retirement plan that they participate in and their AGI is over $222,000 so they cannot contribute to a Roth or a traditional IRA. Spouse has had an auto debit each month from 2018 to present going towards a traditional IRA. They couldn't participate in either IRA in 2018, either.

In 2018 I see a nondeductible traditional IRA but no Form 5329 showing a penalty. In 2019, she recharacterized the traditional to a Roth (value went down between contribution and rollover). Because she isn't allowed to participate in any kind of an IRA, do I fill out form 5329 for 2018 and 2019?

I'm assuming (but please tell me if I'm wrong!) that if she keeps her 2019 IRA contribution or recharacterizes it, it is also subject to a 6% penalty.

[kathyc2]

You've got a mess.
The penalties are cumulative.
The 2018 excess funds add a penalty to the 2018 tax return. And the same funds add a penalty to the 2019 tax return.
The 2019 excess funds add a penalty to the 2019 tax return.
Until things are resolved, both the 2018 and 2019 contributions will add a penalty to the 2020 tax return.

And all of this is in addition to having to deal with accompanying 1040X issues.

I'm not sure how you are getting that from original post. OP said in heading excess, but we don't know if it really was excess. AGI was to high to have a deductible IRA, but unless they put more than 6000/7000 into a nondeductible IRA there is not an excess.

Momona- if they were within the limits of 6000/7000 there is not an excess and no 5329. However, there should be a 8606.

[Lion]

Anyone (with earned income or spousal earned income) can always contribute to a Traditional IRA. The only restriction is that it could be non-deductible under conditions such as income and retirement plan at work. And, there is no income restriction on converting a Traditional to a Roth IRA. (If she has other Traditional IRA accounts, you have some computations to do.) That's called a back-door Roth.

[ATSMAN]

That's called a back-door Roth

I just did the calculation for a family member. Make sure you get all the IRA bank or brokerage statements to figure out the gains. Gains are taxable.

[momona]

Thank you for your help. This is a first for me and I have been doing this for a while. So here's my next question:

In 2019, she made a non-deductible traditional IRA contribution. I'm going to do the 8606. From the posts, it looks like it doesn't matter if she recharacterizes it as a Roth but would it be okay if she just left it there?

It is my understanding that if she does move it to a Roth, she needs to pay the tax on any gain (it looks like she has made a loss every time).

I am assuming that when she reaches the minimum age of 59 1/2, all distributions will be tax free.

[kathyc2]

Thank you for your help. This is a first for me and I have been doing this for a while. So here's my next question:

In 2019, she made a non-deductible traditional IRA contribution. I'm going to do the 8606. From the posts, it looks like it doesn't matter if she recharacterizes it as a Roth but would it be okay if she just left it there?

It is my understanding that if she does move it to a Roth, she needs to pay the tax on any gain (it looks like she has made a loss every time).

I am assuming that when she reaches the minimum age of 59 1/2, all distributions will be tax free.

Does she have any other non-Roth IRA's from years past? That determines how the conversion would be taxed.

[Lion]

She can leave funds in a non-deductible traditional IRA. But, unless she has gains in her traditional IRAs, she'd be better moving it to a Roth now, starting the clock ticking, so that any future gains won't be taxed. If she expects to be in a lower bracket in future years or expects her contributions to remain stable or lose, she might want to wait to convert. I think the coronavirus is hitting the markets, so 2020 might be a good year to convert. If you have a crystal ball.

If she has gains in her traditional IRAs, you have to prorate any conversion into non-deductible contributions and into her taxable earnings/contributions, so you will need to do some computations to see what her tax would be. Then your client can decide if it's worth it to her to pay that tax now to have future non-taxable distributions, or not.

[momona]

Thank you for your postings. There was conversion of traditional to Roth in 2019 but the FMV at time of conversion was lower than the traditional nondeductible amount. In fact, the current 5498 shows that her traditional IRA FMV as of December 31, 2019 is lower than what she put in for 2019. So no gain to report. Easy for me.