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notice CP2000 and avoiding double taxation


metalmagpie
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I am a retired engineer. I have a traditional rollover IRA. I am currently living off IRA distributions, which of course are considered ordinary income. Back in 2013 I had made a sizable withdrawal to cover the fourth quarter of that year. Then my father's estate cleared probate and I received a sizable check. I didn't need the money I'd withdrawn from my IRA and wished I'd not withdrawn it. Not realizing that I can only contribute earned income (i.e. W2 income), I made a contribution of $6500 back into my IRA. This was a mistake on my part.

I recently received a Notice CP2000 from the IRS. They take exception to that IRA contribution from 2013 as they should. They want me to pay now the amount I failed to pay with my 2013 taxes, but didn't because of the (erroneous) IRA contribution which I'd deducted from my 2013 income.

I don't have a problem with this. Once I send them this payment, then I will have paid the income tax for withdrawing that $6500 back in 2013. However, the money will still be in the account.

I understand that I need to withdraw not just the $6500 but also any earnings it made. I have requested the form to withdraw an excess contribution from my brokerage firm (where my IRA is). Their form states clearly that they (the brokerage firm) will calculate the earnings for me. When I make the withrawal of the excess contribution plus earnings, I wlil have to file a Form 5329 which will calculate the penalty taxes (something like 6% of the contribution) along with payment. At that point I will have paid both the income tax due me and the penalty tax.

However, when I make the excess contribution withdrawal, won't that withdrawal be reported to the IRS as taxable income? And if so, wouldn't that be double taxation?

Thanks for reading this. I've tried to be as clear and precise as I can.

metalmagpie

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I believe the $6,500 should not be taxed again when withdrawn per Section 408(d)(5)(A) of the Internal Revenue Code, and the 1099-R issued by the IRA Custodian should be coded by the Custodian to tell the IRS just that. The earnings will be taxable.

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I believe the $6,500 should not be taxed again when withdrawn per Section 408(d)(5)(A) of the Internal Revenue Code, and the 1099-R issued by the IRA Custodian should be coded by the Custodian to tell the IRS just that. The earnings will be taxable.

So as long as I file the brokerage firm's form requesting to remove an excess contribution at the time I request the IRA disbursement, they will file a 1099-R which indicates to the IRS that the disbursement isn't taxable?

Thank you, thank you!

metalmagpie

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Without research I believe what I said is correct, but of course I cannot vouch for your custodian handling it correctly. I suggest you review the pertinent section of IRS Publication 590, which you can find at irs.gov.

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So as long as I file the brokerage firm's form requesting to remove an excess contribution at the time I request the IRA disbursement, they will file a 1099-R which indicates to the IRS that the disbursement isn't taxable?

Probably, you should address this question to the IRA custodian, in advance.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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It's not their job to investigate but it is their job to report properly based on the type of distribution you requested. I think it should be Code P. I can tell you for sure that if it is Code 7, then they are reporting it as a normal distribution subject to income tax in the year distributed.

Either way, report things as you believe/know them to be correct, and if necessary, deal with the IRS correspondence later. Believe it or not, that will be easier than trying to deal with the custodian ahead of time. (In my opinion.)

Ed Snyder

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