ROTH IRA Excess Contributions and Associated Earnings

[Guest freeness]

I need to remove my 2007 ROTH IRA contribution because my MAGI is too high. I had purchsed 100 shares of stock at $40 per share with the contribution. In December of 2007 I received 5 shares as capital gains. Today the shares are worth $50. I have instucted my broker to move 105 shares out of my ROTH IRA and into taxable account. The IRS says I have to pay taxes and the 10% penalty on the associated earnings of the contributions.

My question is are the associated earnings just the capital gain of 5 shares or that plus the $10 per share appreciation of the stock on the day I moved them.

Andy

[jevd]

I need to remove my 2007 ROTH IRA contribution because my MAGI is too high. I had purchsed 100 shares of stock at $40 per share with the contribution. In December of 2007 I received 5 shares as capital gains. Today the shares are worth $50. I have instucted my broker to move 105 shares out of my ROTH IRA and into taxable account. The IRS says I have to pay taxes and the 10% penalty on the associated earnings of the contributions.

My question is are the associated earnings just the capital gain of 5 shares or that plus the $10 per share appreciation of the stock on the day I moved them.

Andy

All of it.

[Guest freeness]

I need to remove my 2007 ROTH IRA contribution because my MAGI is too high. I had purchsed 100 shares of stock at $40 per share with the contribution. In December of 2007 I received 5 shares as capital gains. Today the shares are worth $50. I have instucted my broker to move 105 shares out of my ROTH IRA and into taxable account. The IRS says I have to pay taxes and the 10% penalty on the associated earnings of the contributions.

My question is are the associated earnings just the capital gain of 5 shares or that plus the $10 per share appreciation of the stock on the day I moved them.

Andy

All of it.

Ok, then I assume when I sell the shares I can adjust my cost basis for the added taxes. Also, are the gains straight income or are their long term/short term issues. The money had been in my Roth for 16 months before I removed it.

Andy

[jevd]

Generally speaking, all income from IRAs is ordinary income. I can't address your cost basis issues. Maybe one of the accountants on the boards has an opinion.

[masteff]

Maybe one of the accountants on the boards has an opinion.

My opinion is go see a professional tax advisor. That or take the distribution in cash and then reinvest it as you will.

[John G]

Some of the above has me confused on the details. Accountants!

1. Can the IRA holder return the shares or must this be a cash transaction?

2. In the initial example above, is there an immediate tax obligation or only when the shares are sold?

3. If the contribution is "unwound", is there a 10% penalty? I know that applies to pre-retirement distributions, but is an unwinding prior to tax deadline considered a distribution?

[jevd]

Some of the above has me confused on the details. Accountants!

1. Can the IRA holder return the shares or must this be a cash transaction?

2. In the initial example above, is there an immediate tax obligation or only when the shares are sold?

3. If the contribution is "unwound", is there a 10% penalty? I know that applies to pre-retirement distributions, but is an unwinding prior to tax deadline considered a distribution?

1. The IRA holder may receive the excess contribution in cash or in kind as long the net value received reflects the gain/loss while the amount was in the IRA. If a gain, it is taxable whether it is received in cash or in kind. If the individual is under 59 1/2, it may be penalized unless an exception is available (Death, Disability).

2. There is generally an immediate tax obligation, however the income (if any) is taxable in the year for which the contribution was made not the year received if the correction occurs within tax filing deadlines.

A correction after tax filing deadlines would not include the income/loss. See IRC 408(d)(4) & (5).

3. Yes but only on the income. The principal amount is not taxed as long as it is removed by tax filing deadline and no deduction was taken on the return for the year of contribution. As this is a Roth, The Principle would generally not be taxed in any circumstance.

Amended returns may need to be filed depending on when the correction takes place.

That being said, I'm not an acountant and the individual should seek the advice of a competent professional.

[masteff]

First, I agree w/ jevd's answers.

Some of the above has me confused on the details. Accountants!

John, I think part of your confusion arises from the original poster's confusion in mixing Schedule D tax concepts with IRA/Roth IRA tax concepts. Code Section 408 says an individual account trust is exempt from taxation under the entire Code subtitle (except UBIT); so the rules on investments are inapplicable inside the IRA/Roth. This creates the complexity of what happens w/ in-kind assets when they are distributed from the IRA/Roth (remember that distributions are generally subject to Code Sec 72 except as provided in 408A).

Note: this article at CNN Money has what I believe to be the right answers to the OP's questions on basis and holding period (see the 7th paragraph).

[txdd]

Freeness,

To figure out taxable earnings on a corrective IRA distribution, you ignore the terms: stock, dividend, capital gain, shares, buy, sell. The only thing that matters is the appreciation of the IRA account during the period it contains the contribution. That appreciation includes the entire account, not just the particular investment of the contribution. See the worksheet on page 33 of the 2007 Pub 590 for the procedure although many custodians will calculate the earnings for you.

Unfortunately, the earnings are taxed and possibly penalized in the year of the contribution, 2007 for you. That means an amended return and maybe some additional interest owed to the IRS. If the earnings are significant, you should consider recharacterizing the contribution to a traditional IRA even if the contribution is non-deductible. That move avoids reporting any new income but still requires an amended return to report the traditional IRA contribution (either deductible or non-deductible).

[Guest freeness]

Freeness,

To figure out taxable earnings on a corrective IRA distribution, you ignore the terms: stock, dividend, capital gain, shares, buy, sell. The only thing that matters is the appreciation of the IRA account during the period it contains the contribution. That appreciation includes the entire account, not just the particular investment of the contribution. See the worksheet on page 33 of the 2007 Pub 590 for the procedure although many custodians will calculate the earnings for you.

Unfortunately, the earnings are taxed and possibly penalized in the year of the contribution, 2007 for you. That means an amended return and maybe some additional interest owed to the IRS. If the earnings are significant, you should consider recharacterizing the contribution to a traditional IRA even if the contribution is non-deductible. That move avoids reporting any new income but still requires an amended return to report the traditional IRA contribution (either deductible or non-deductible).

Ok, so now I am confused more. In the year the $4000 was in my Roth the stock I bought with that years contribution has gone up, but my over all Roth has done down. I had my broker remove the shares I bought with the $4000, which are now valued at $5000. So what you are saying is that was incorrect and I need to use this workshhet in Pub 590 to figure out how much I should remove?

Andy

[Appleby]

Yes. When you calculate the earnings on an excess contribution, the earnings is based on the performance of the entire IRA for computation period, which is the period beginning immediately prior to the time that the contribution being returned was made to the IRA and ending immediately prior to the removal of the contribution. Only after you have figured out the earnings will you know how much to remove, i.e. the excess amount ( plus earnings or minus losses).

You may also find this helpful http://www.irs.gov/pub/irs-regs/td9056.pdf.

The amount removed need not be the asset in which the contribution was invested. The only requirement is that the amount removed is equal to the value of the excess plus earnings or minus losses

Edited to add...While the asset in which the contribution was invested may have done well, there could still be a ‘loss’ on the contribution if all the other assets performed so poorly that it results in a 'loss' for the IRA during the computation period (computation period is defined in the document at the link above).