Rollover IRA - Tax and Penalty on Excess Contributions

[Guest garvey_agg]

What are the individual tax ramifications to a former qualified plan participant of an invalid IRA rollover contribution? (A portion of the rollover is invalid because the employer failed discrimination testing several years ago and is now correcting the errors via EPCRS.

How and when will the excess contribution be taxed to the former plan participant?

Will the IRC Section 4973(B) 6% excise tax be assessed against the former plan participant for each year that the invalid rollover was not corrected?

What forms does the former plan participant have to file to correct this error?

[Guest P A Weick]

As to whether there is an excess contributions tax for each year the overage is in the IRA, check out Section 408(d)(5)(B) of the Code. It seems to give you some relief from relying on bad information. Presumably, once you have good information you could remove the offending sums plus earnings and avoid any excess contribution penalty.

[Guest franky]

I believe that the relief in 408(d)(5) is for double taxation. Unfortunately, if excess was not corrected by tax-filing deadline, 6% penalty will apply for each year. Also, in such cases, the earnings on the excess do not have to be withdrawn.

[Appleby]

The ineligible rollover becomes an IRA excess contribution the year it is rolled to the IRA.

If the individual is eligible to make an IRA participant contribution and has not already done so for that year, the amount can be redesignated as an IRA participant contribution.

In any event, the correction process requires the full excess amount to be redesignated an IRA participant contribution for the year the amount was credited to the IRA.

If the amount results in an IRA excess contribution, it must be corrected by tax filing date (including extensions) for the year it was credited to the IRA. The earnings must be removed and will be taxable in the year the contribution was made to the IRA.

If it is not corrected by the deadline stated above, a 6 percent penalty would apply for every year the excess remains in the IRA. The client must file IRA Form 5329 to report and pay the 6 percent penalty. No earnings would be removed with the excess amount

It is removed after the deadline as stated above, either of two things would happen.

1- If the amount is $2,000 or under, the 6 percent penalty will apply

2- If the amount is over $2,000, the 6 percent penalty will apply PLUS

The amount will be added to the individual's taxable income

Plus, if the individual is under the age of 59 ½, the 10 percent early withdrawal

You want to make sure the excess is timely corrected, especially if it exceeds $2,000

Anytime the 6 percent apply, IRS Form 5329 must be filed

[Guest P A Weick]

Franky and Appleby-

Not sure I agree with your reading.

The flush language of 408(d)(5)(B) appears to cover this and does not appear to have anything to do with double taxation. You might check out Dave Baker's IRA Tax Management portfolio (number 355 at III.A.5), Prop. Regs Section 1-408-4(h)(5), Example 2, and PLR 9118020. Presumably this participant received a 1099 showing the amount eligible for rollover. If it was incorrect (some portion was not eligible for rollover) and they relied on that I think there may be some relief available.

Then again that's only my opinion and I could be wrong. Please correct me if I am.

[Appleby]

I'll take you up on the offer:-

I am sure you already know that letter rulings cannot be used as precedent. [iRC § 6110(j)(3)]- though I will also cite one as a taxpayer who wants to use the rulings to support his or her position may treat the rulings (or reasoning based on the rulings) as “substantial authority.” [Treas Reg §§ 1.6661-3, 1.6662-4(d)]

Ineligible rollover contribution assets are automatically deemed a regular year IRA contribution in the year of contribution PLR 8952011). Rolling over any ineligible rollover distribution amounts as defined in Treas. Reg. 1.402©-2, Q&Q 1-4 and 11 may create these ineligible assets

[Guest franky]

408(d)(5)(A) states that if the excess contribution is returned after the tax-filing deadline, paragraph 1 (taxation) does not apply if total contribution for the year of the excess was at or below 219 limit ($2,000). (B) simply increases that $2,000 limit by the amount rolled over if rollover was due to erroneous info that the taxpayer relied on. (B) offers no relief for 6% penalty. In fact 6% penalty is in 4973, not 408. I refer to "Double taxation" because funds are taxed when they are distributed from IRA and, in most cases, they were already after-tax dollars; hence, double taxation.

[Guest P A Weick]

Again my apologies, but I am not convinced.

Yes, Appleby, PLRs are not precedent. That said, we cite them all the time and use them in planning. Further this one seems well reasoned and is beneficial to the taxpayer. Thus, I think the Service will follow it. As to the Regulations you cite I do agree they state the general rule. But, as you know, tax law is practiced in the exceptions and I think 408(d)(5) is one for this set of circumstances.

Franky, you are correct. Section 408 is not an excise tax section. But it is incorporated in Section 4973 in calculating what precisely is an excess contribution in present and prior taxable years (See Section 4973(B)(1)(A) and (2)(B)).

Also, while this is not conclusive, it seems the only fair result where the IRA holder, through no fault of his own rolls over moneys which he has every right to believe are eligible for rollover. Yes, I know there are cases to the contra where the Code clearly requires an unjust result, but where the matter seems fairly debateable, equity does play a role.

As usual this is not legal advice to anyone in particular (including the poor soul who is in this predicament). Anyone with this problem needs to seek tax counsel as soon as they can.

[Guest IRA SPECIALIST]

PA Wick- Appleby is right- what more can I say.

You raised some valid ppoints- and you both used PLRs which obviously contradict each- so much for PLRs.

To be safe- the client must get their own PLR-