March 10, 2015

Excess Contributions to an IRA Means Excise Tax, but it Doesn’t Mean it Can’t be Corrected

If a taxpayer makes a contribution to their traditional IRA or ROTH IRA and later realizes they were not eligible, they have made an excess contribution subject to an excise tax. The excise tax is 6% of excess contribution and applies each year these funds remain in the account.

Correcting Excess IRA Contributions

How do you correct this situation?

  1. You need to withdraw the excess contribution plus any earnings (or loss) by the due date of your return including extensions.  This avoids the 6% excise tax all together but any earnings are taxable.
  2. If the funds are still in your account after the due date (including extensions) of your return, you need to withdraw the excess contributions as soon as you can.  In this situation, you only need to withdraw the contributions, not the earnings.  Each year the funds remain in the account, you will need to file Form 5329 and calculate the 6% excise tax.  For example, if you incorrectly contributed $5,000 to a Roth for the last two years, you will owe $300 for the first year ($5,000*6%) and $600 for the second year ($5,000 from year 1 + $5,000 from year 2 * 6%).  As long as you withdraw the $10,000 before the end of year 3, you will owe no more excise tax. The earnings on the $10,000, however, can remain in the Roth account.

If you find yourself in this situation, please do not wait. Contact your Anders advisor to avoid unnecessary taxes.

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