Excess IRA contribution

[Acownt4it]

On client's original 2004 return a $2400 IRA deduction was deducted from AGI. An amended 1040 was filed and consequently all of the IRA became nondeductible. Form 8606 was filed for this excess contribution. Client is over 59 1/2. Their MAGI is $86,658.

The way I understand the rules to correct this is if the total IRA contribution for 2004 is $3500 or less and there are no employer contributions (there weren't), the excess amount can be withdrawn at any time and not be included in gross income provided it was not taken as a deduction. The $2400 was a deduction, but the 1040X corrected the deduction. The 6% excise tax will apply each year the excess contribution remains in the IRA.

Should the client recharacterize the excess $2400 and earnings to a Roth-IRA? or withdraw the $2400 and earnings? or Convert the excess $2400 and earnings into a Roth-IRA?

Any input will help my confusion.
Thanks

[abby]

mix of terms

I think there is some confusion if this an excess contribution or simply not eligible for deduction.

Excess contribution applies to a contribution that is not allowed because it is more than, say, the income earned for the year. If your earned income total was 3000 and you made a 3500 IRA contribution, then 500.00 would be an excess contribution.

Excess would also mean that you went over the allowed limit - if you contributed more than the allowed 20% to a SEP say.

If the contribution was not excess, but can not be deducted because of a pension, then you would have an option to name it non-deductible on an 8606, or, perhaps, recategorize it as a ROTH.

I'm not sure if it's non-deductible or excess. What changed on the amended return that caused the problem?

[Acownt4it]

Well heck,

this is the reason I post these questions, I just get caught up in the wrong loop of information.

The reason for the change is because their MAGI changed from $68,099 to $86,658 because of estate distributions to the wife. His IRA ($2400) is the one that comes into question because he contributes to a 401(k) plan.

So, it sounds like you are right Abby, it is a nondeductible IRA. So....

should he convert or recharacterize it?

[Mark Goldberg]

Recharachterization

If your client was on second extension and you live in a disaster area there may still be time to recharacterize. Otherwise the final date for doing a recharacterization was Oct 17, 2005 dor 2004.

[abby]

non-deductible

I agree with Mark - except to add that you might want to check, or have the client check, with whoever holds the IRA. I've often found that they are a great help in knowing what is and isn't possible in these circumstances.

I think what you've already done (amend and declare the contribution as non-deductible with the 8606) is the simplest. Then the distributions at retirement will have a non-taxable portion as he recovers this basis. The 8606 is filed each year to track this non-taxable basis.
Converting to a ROTH, if possible, will give him the tax free earnings down the road and the ability to hold the fund without minimum distributions after 70=1/2.

If the contribution was made in 2005 for 2004, sometimes you can simply recharacterize it to the current year.

Whether it's worth going beyond what's been done already might depend on how much is already in IRAs and what his future plans are. Again, I'd have a chat with the Administrator of the IRA and see what they have to say.