Excessive contribution to a traditional IRA

[Guest criesi]

I have made excessive non-deductible contributions to a traditional IRA in the years 1997 ($4000), 1998 ($4000) and 1999 ($4000) [don't ask me why I was so stupid!]. I understand that I have to pay a 6% penalty for each year I did not correct these mistakes, but the following issues are not clear to me:

1. If I remove these contributions in January 2002, do I have to pay the 6% penalty for 2001 (I do not remove the excess contributions in the calendar year 2001, but I will remove it before the deadline for the tax year 2001 in April 2002) [it is clear that I have to pay penalties for the years 1997 --> $240, 1998 --> $480, 1999 -> $720, 2000 --> $720]?

2. As the excess contributions were higher than $2000, do I have to add the removed excess contributions (plus any gains) to my taxable income (they were not deducted from my income in the corresponding years), and if yes, in which year, i.e. the complete sum to the taxable income in the year 2001, or to the years I made the excess contributions?

3. Can I put forward some of these excess contributions and apply them as contributions for 2001 and 2002 (of course still paying the 6% penalty for the years 1997, 1998, 1999 and 2000, and depending on the answer to 1. for 2001)? Can I select these amounts so that I reduce the excessive amounts for two years [let's say 1997 and 1998] to $2000, so that the amount to be removed would be $2000 or less for these two years, and therefore not to be added to my taxable income? Could I even go further this way, leave the excess contribution for 1999 in the account, pay the penalty for 2002 and apply part of it in 2003 as a contribution for 2003, and so also reduce this excess contribution to $2000?

[Appleby]

First I have a question. Is the entire $4,000 excess ?

Answer to question number 1- If you remove the excess contribution in January 2002, you will be required to pay the 6% penalty for 2001. (The 6% penalty will apply to any excess contribution still remaining after December 31)

The only exception to this rule are excess contributions removed by tax filing deadline , plus extensions, of the year the excess was made

Answer to question number 2- . Attributable earnings must not be removed with excess contribution that are removed after the tax filing deadline (as stated above). This means that at this point, only the excess should be removed.

Had the excess been $2,000 or less, you would not have been required to add it to your income. However, for excess contributions over $2,000 the amount must be added to your income for the year it was removed from the IRA. This means that you will be owe not only ordinary income tax on the excess, but the 10 % early withdrawal penalty if you are under age 59 ½.

Answer to question number 3- .An excess contribution for one year may be applied to a future year for which you did not make a contribution. You would still need to pay the 6% penalty for the years before the year you applied it towards. To allocate an excess contribution form one year to the next, you must file IRS Form 5329 (consult your tax advisor for assistance with completing the form). This form is also filed to pay the 6% penalty/

[Guest criesi]

Thank you for your reply.

To answer your first question: The entire $4,000 is excess. The situation is the following. My wife and I are foreigners. My wife had been working in the United States until 1994. During that time she had set up a traditional IRA account. When we got married she moved abroad. I wanted to keep up her retirement savings contribution, and after she had not contributed for some years, we increased the contribution, not understanding the rules of an IRA. Therefore we contributed $4,000 per year to her IRA account while we were abroad and did not have US income (except interest and dividends). The custodian of the IRA account every year sent the form 5498 with the excess amount to the IRS, without raising a flag. Late 1999 we came to US again. When filing our tax return for 1999 early 2000, after I had read the IRA rules, I asked our tax advisor concerning this issue, and whether or how we have to correct this. But was told that this is no issue and does not need any correction (and you want me to consult the tax advisor for assistance). I only learned that this is a problem when I recently surfed on the Internet.

Anyway, I understand now that we have to correct this situation, and that we just missed another deadline, the end of the 2001 tax year.

Your answers to my questions 1 and 3 make sense to me. But I am curious about question 2. I do not understand why the attributable earnings do NOT have to be removed, but the excess contributions, which had never been deducted from a taxable income (i.e. have already been taxed), have to be added to the income, i.e. will so be taxed twice (beside the 10% penalty).

In the mean time I studied the IRS publication 590. But as English is not my native language, and these forms are complex enough, I might misunderstand them. There, on page 42 under 'Excess Contributions Withdrawn After Due Date of Return' is written:

In general, you must include all distributions (withdrawals) from your traditional IRA in your gross income. However, if the following conditions are met, you can withdraw excess contributions from your IRA and not include the amount withdrawn in your gross income.

1) Total contributions (other than rollover contributions) for 2001 to your IRA were not more than $2,000.

2) You did not take a deduction for the excess contribution being withdrawn.

The withdrawal can take place at any time, even after the due date, including extensions, for filing your tax return for the year.

Would our situation not fulfill these conditions [1) no excess contribution for 2001, 2) no deduction taken for the excess contribution withdrawn]?