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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.
Question: A husband and wife each made Roth IRA contributions in 2010. However, they have learned that they earned too much in 2010 to be eligible for Roth contributions. What are their choices to fix the situation?
Answer: For 2011, the maximum contribution an individual can make to her traditional and/or Roth IRA(s) is $5,000 if under age 50. For those age 50 and older the 2011 limit is $6,000. Any contributions greater than this maximum are excessive.
Excessive contributions are subject to a 6 % penalty tax.
A taxpayer can correct an excessive contribution and thus avoid a 6% penalty tax by taking a corrective distribution. The corrective distribution must be made on or before the due date of his tax return, including extensions, for the tax year during which the excessive contribution was made. To effectuate a corrective distribution, the individual must withdraw the excess contribution plus any income attributable to the excess amount (or minus any loss so attributable).
It is possible to apply an excess contribution from an earlier year to the current year without taking a distribution. This method allows the taxpayer to avoid making a distribution, but it does not avoid the 6% tax on excess contributions remaining at the end of the year and reduces the maximum contribution for the current year.
Here’s an example adapted from IRS Publication 590:
Teri was entitled to contribute $1,000 to an IRA in 2004 and will be entitled to contribute $1,500 for 2005. She actually contributed $1,400 in 2004. $400 is an excess contribution for 2004 and will be subject to the 6% excise tax unless withdrawn prior to April 15, 2005. Teri chooses not to make a withdrawal, and therefore owes an excise tax of $24 for the excess contribution. In order to avoid the 6% penalty tax for 2005, Teri can treat the $400 excess contribution as a 2005 contribution. That is, as long as her additional contributions for 2005 are less than $1,100 ($1,500 – $400), the $400 excess contribution for 2004 will be treated as a 2005 contribution and she will not have to take a withdrawal.
If a taxpayer does not make a corrective distribution, a 6% penalty tax will be imposed on the excessive amount, for the current year and for every subsequent year, until the excess contribution is eliminated.
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