Excess accumulation 50% tax -- How does IRS respond?

[Guest BoyAlex]

Is there anyone registered here who knows how the IRS responds when a client complies with their instructions? In this case, the Roth IRA is going to be cancelled and 50% of the Required Minimum Distribution for a former year is going to be sent with the form 5329 along with an explanation of how the client got sidetracked into this situation.

What will the IRS do? Will they calculate taxes due for former years and subtract them, possibly refunding the remainder? Or what?

[Ron Snyder]

Apparently the taxpayer is filing an amended return. Is that correct? Will the financial institution be reporting the change, or simply the taxpayer? Why are you sending the explanation?

This sounds like a taxpayer trying to justify undoing a Roth IRA, rather than a taxpayer who adopted and funded a Roth IRA for which he was not eligible. Nicht var? (No es cierto?)

Without more facts it is impossible to tell what you are describing and respond to your query.

[Guest BoyAlex]

The key is that "excess accumulation" (in the subject heading) is an amount in an Roth IRA that was derived in error from an ineligible source -- either more than should be because the AGI was greater than $100,000, or that it was more than was allowed from compensation, or from not taking a RMD.

When this is not discovered and corrected by the taxpayer within the period allowed for an amended return the IRS requires 50% "excise" tax on the error IN ADDITION to several other things. That does not sound like you get anything back, but there are provisions to ask for a waiver.

Since there is income tax due on the earnings of the account for a year or more -- which was sheltered in a Roth when it should not have been -- there is a possibility that IRS will do something between keeping the entire payment or waiving it all. Nevertheless, the instructions for this case are as I have mentioned.

Therefore I have posted my question in the only place I can think of to try to find out what has happened to other taxpayers who have been through this.

If anyone knows, please post.

[Appleby]

The key is that "excess accumulation" (in the subject heading) is an amount in an Roth IRA that was derived in error from an ineligible source -- either more than should be because the AGI was greater than $100,000, or that it was more than was allowed from compensation, or from not taking a RMD.

When this is not discovered and corrected by the taxpayer within the period allowed for an amended return the IRS requires 50% "excise" tax on the error IN ADDITION to several other things. That does not sound like you get anything back, but there are provisions to ask for a waiver.

Since there is income tax due on the earnings of the account for a year or more -- which was sheltered in a Roth when it should not have been -- there is a possibility that IRS will do something between keeping the entire payment or waiving it all. Nevertheless, the instructions for this case are as I have mentioned.

Therefore I have posted my question in the only place I can think of to try to find out what has happened to other taxpayers who have been through this.

If anyone knows, please post.

BoyAlex,

I must say I am a little confused.

If it was derived in error from an ineligible source --

either more than should be because the AGI was greater than $100,000, or that it was more than was allowed from compensation,

then this would be treated as an excess contribution. An excess contribution must be removed from the Roth IRA by October 15 ( assuming the individual filed the tax return on time) of the year following the year the ineligible contribution was made to the Roth IRA . If the excess is not removed by the deadline, then a 6-percent penalty applies for each year the excess remains in the Roth IRA.

The 50-percent penalty applies when a required minimum distribution is not removed from the account in a timely manner. If the individual feels that the excess accumulation was due to reasonable error, he/she must:

-Distribute the RMD amount,

-File Form 5329 by completing the applicable areas,

-Pay the 50 percent penalty

-Attach a letter of explanation and request for waiver

If the IRS approves the request, the penalty will be returned to the individual;

In any event ---for a Roth IRA- it does not appear that we could have an excess accumulation penalty occurring---even if the beneficiary elected to distribute the assets over his/her life expectancy, the 5-year rule would then apply if he/she missed the RMD for any year. Since this is the 5th year since Roth IRAs came into existence, it appears there cannot be an occurrence of “excess accumulation”

[Guest BoyAlex]

That is very encouraging to hear. Thank you for posting that.

This case is that the RMD was converted to a Roth in error. Tax was paid that year on what was removed from the traditional IRA. I suspected there would be income on the Roth the following years -- for which I thought the IRS might subtract something. It just so happens there was no income on the Roth for following years.

I have not been able to find the regulation referring to a five-year span except in the case of the taxpayer's death, i.e.:

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(b) Automatic waiver. The tax under section 4974 will be automatically waived, unless the Commissioner determines otherwise, if --

(1) The payee described in section 49 74(a) is an individual who is the sole beneficiary and whose required minimum distribution amount for a calendar year is determined under the life expectancy rule described in §1.401(a)(9)-3 A-3 in the case of an employee's or individual's death before the employee's or individual's required beginning date; and

(2) The employee's or individual's entire benefit to which that beneficiary is entitled is distributed by the end of the fifth calendar year following the calendar year that contains the employee's or individual's date of death.

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I have had difficulty in finding the regulation and cannot give you the number for this fragment which was found at www.brentmark.com/finalnewrmd.htm

[Appleby]

This would be an excess contribution (not an excess accumulation). The RMD was satisfied when the debit side of the conversion occurred. The excess occurred when the RMD amount was deposited to the Roth IRA (as a conversion). This RMD amount was ineligible to be rolled over or converted, and as with any ineligible rollover, it becomes a regular IRA contribution to the receiving IRA subject to the annual IRA contribution limit. The individual will owe a 6-percent penalty on the excess amount for each year it remains in the Roth IRA. Treasury reg. 1.408A-4 Q&A 6.

If the individual is eligible for a Roth IRA contribution for (any of ) the year the excess remained in the Roth IRA, and did not already contributed the full allowable amount to a Roth IRA or a traditional IRA, he/she may allocate the contribution to that year by filing IRS form 5329 and paying the 6-percent penalty. See Deducting an Excess Contribution in a Later Year on page 47 of IRS publication 590 available at http://www.irs.gov/pub/irs-pdf/p590.pdf

Let me know if this helps or if you need more information

[Guest BoyAlex]

Thanks for that explanation.

I am concluding that only if the Roth was held for more than five years would a part of it be an "excess accumulation."

It is hard to find details like that. I haven't yet found where I can read the regulation 1.408A-4 Q&A6.

[Appleby]

For Roth IRAs, excess accumulation would occur only for beneficiaries. For instance, if a beneficiary inherited the Roth IRA assets and elected the five-year rule for distributions, then assets remaining after the expiration of the five-years would be subject to the excess accumulation penalty.

For 1.408A-4 Q&A6 , see the final Roth IRA regulations at http://www.rothira.com/rothregsf.htm