Excess IRA contribution withdrawal

[David]

Taxpayers withdrew excess IRA contributions in 2008 for excess contributions made in 2004. The excess contributions were not deducted in any prior year and the 6% penalty was assessed in prior tax years.

The excess contributions was a result of no "earned income" since the AGI was from S Corp profit and no officer compensation was reported.

The excess contributions were reported as non-deductible IRA on Form 8606- I don't think this is correct, is it?

The financial institution issued a 2008 1099-R with distribution code 1.

The financial instituion will not issue a corrected 1099-R with the correct code. Since the 1099-R has been issued to the IRS with code 1, doesn't the distribution and the incorrect code have to be reported in the TP's return so it will match the IRS records?

How is this corrected in the tax return in the ATX program so that the distribution isn't taxed? I don't see an option to correct this in the 1099-R input section.

Thanks.

[jainen]

>>issue a corrected 1099-R with the correct code<<

What do you think would be the correct code? This certainly sounds to me like a Code 1 early distribution. Since you have filed Form 8606 (presumably every year) it is easy to determine the non-taxable basis of the distribution. Note that double-taxation can hit in some cases of excess contributions. Too bad.

[David]

Wouldn't the correct code be 8 since the excess contributions were never deducted?

Yes, it would be best if a corrected 1099-R was issued, but the financial institution won't issue one.

>>issue a corrected 1099-R with the correct code<<

What do you think would be the correct code? This certainly sounds to me like a Code 1 early distribution. Since you have filed Form 8606 (presumably every year) it is easy to determine the non-taxable basis of the distribution. Note that double-taxation can hit in some cases of excess contributions. Too bad.

[jainen]

>>Wouldn't the correct code be 8<<

Code 8 is only for 401(k) and other qualified plans, not IRA's. At least, that's how I read the Instructions to Form 1099-R at http://www.irs.gov/pub/irs-pdf/i1099r.pdf . In a qualified plan the participant does not have as much control. Code 8 usually represents an inadvertent excess contribution determined after the books have been closed. For example, it is used for highly compensated employees whose contribution must be adjusted in proportion to the total payroll. But right then, not four years later.

In the original post, the investor knew about the excess contribution so he must have had a particular reason to leave it in place. Now he's stuck with the implications of that choice.

Edited December 20, 2009 by jainen

[TAXBILLY]

J;

Your link doesn't work because there is a period at the end of the link.

Page 11 says code 8 is used for IRAs as well as other qualified plans.

taxbilly

[jainen]

>>link doesn't work<<

Fixed it, thanks.

>>Page 11 says code 8 is used for IRAs<<

Well, yes, but that is irrelevant here because it's only in reference to section 408(d)(4), the title of which is "Contributions returned before due date of return."

[David]

The TPs DIDN'T know they had excess contributions. Their previous CPA didn't tell them anything and continued to assess the additional tax. It was brought to their attention by me when I picked them up as new clients.

Again, since they never took a deduction for the excess contributions the correcting distribution is not taxable. How do I report this so the TPs aren't taxed since the 1099-R shows code 1? Do I simply leave box 2a (taxable amount) blank even though the 1099 filed with the IRS shows an amount in that box?

Thanks.

>>Wouldn't the correct code be 8<<

Code 8 is only for 401(k) and other qualified plans, not IRA's. At least, that's how I read the Instructions to Form 1099-R at http://www.irs.gov/pub/irs-pdf/i1099r.pdf . In a qualified plan the participant does not have as much control. Code 8 usually represents an inadvertent excess contribution determined after the books have been closed. For example, it is used for highly compensated employees whose contribution must be adjusted in proportion to the total payroll. But right then, not four years later.

In the original post, the investor knew about the excess contribution so he must have had a particular reason to leave it in place. Now he's stuck with the implications of that choice.

[TAXBILLY]

I would include it as income with the code 1 and deduct it on the IRA adjustment line.

To remove the code 1 penalty I would file Form 5329 and deduct the amount on line 2 with an attached explanation.

That should keep the IRS computers happy.

taxbilly

[David]

Thanks for your help on this. Where is the IRA adjustment line in the ATX program? Isn't the only way to do this in the ATX program is to not show an amount in box 2a as taxable amount?

Also, I will be filing an amended 2008 tax return to exclude the amount of IRA taxable income since the original tax return was filed showing the correcting distribution as taxable and also showing the distribution as subject to the 10% penalty. This is because of the distribution code 1 on the 1099-R.

In this case, maybe all I need to do is change the AGI and the other taxes line on the 1040X to reduce the tax distribution amount and the 10% penalty?

Is my thinking correct on this that none of the distribution is taxable since the TPs are pulling out the excess contributions made in 2004? Remember, the TPs never realized they had excess contributions since they were never told by their tax preparer. They would have pulled the amount out of their IRAs back in 2005 if they had known.

Thanks.

I would include it as income with the code 1 and deduct it on the IRA adjustment line.

To remove the code 1 penalty I would file Form 5329 and deduct the amount on line 2 with an attached explanation.

That should keep the IRS computers happy.

taxbilly

[TAXBILLY]

Form 1040, line 32.

taxbilly

[jainen]

>>the correcting distribution is not taxable<<

You got a sympathetic post in this thread, but it doesn't cite any actual authority for your position. I think the distribution is only non-taxable in proportion to the basis tracked on Form 8606--that's why you filed that form. And unless you come up with some other rule, the 1099 must be treated as correct, and an early distribution penalty assessed in the normal way. Form 5329 only has certain specific exceptions, and your clients' situation is not one of them. You didn't mention if they calculated and withdrew the earnings as well, a important point of consistency for the position you are trying to support.

As for both taxpayers not paying attention to what they are declaring under penalty of perjury for years and years, that's not much of an excuse.

[David]

I never filed Form 8606 for the TPs. The previous CPA did. Instead of filing Form 8606, I would have advised them to withdraw their contributions before filing the 2004 tax return.

Also, since there was no "earned income" (subject to self employment tax - remember they had no W-2 income and had S Corp income)they were not eligible to make any IRA contributions. Form 8606 wouldn't be appropriate in this case would it? If they were not eligible to make any IRA contributions due to income limitation, then Form 8606 would be appropriate.

Thanks for your help.

>>the correcting distribution is not taxable<<

You have many sympathetic posts here, but none have cited any actual authority for your position. I think the distribution is only non-taxable in proportion to the basis tracked on Form 8606--that's why you filed that form. And unless you come up with some other rule, the 1099 must be treated as correct, and an early distribution penalty assessed in the normal way. Form 5329 only has certain specific exceptions, and your clients' situation is not one of them. You didn't mention if they calculated and withdrew the earnings as well, a important point of consistency for the position you are trying to support.

As for both taxpayers not paying attention to what they are declaring under penalty of perjury for years and years, that's not much of an excuse.

[jainen]

>>Form 8606 wouldn't be appropriate in this case would it? <<

I will answer your question after you tell us the amount of the excess contribution.

[David]

Each TP had excess contributions of $3K in 2004 and $4K in 2005 for a total of $7K each.

>>Form 8606 wouldn't be appropriate in this case would it? <<

I will answer your question after you tell us the amount of the excess contribution.

[jainen]

>> David <<

Did you happen to notice that, although I fussed about somebody else, I didn't cite any authority for my own position either? The answer to your question, on the appropriate use of Form 8606, is to READ THE INSTRUCTIONS.

[David]

i did READ THE INSTRUCTIONS. That's why I am saying that the Form 8606 should have never been filed for the excess contributions.

>> David <<

Did you happen to notice that, although I fussed about somebody else, I didn't cite any authority for my own position either? The answer to your question, on the appropriate use of Form 8606, is to READ THE INSTRUCTIONS.