Remedies to Correct the Excess Contributions to the Roth IRA Account
The easiest remedy to correct an excess contribution is to withdraw the amount prior to one's filing of tax return during the year that the over-contribution occurred. Inasmuch as no statement or report has been submitted yet, the excess contribution can simply be withdrawn as if it did not take place.
Otherwise, any of the following remedies may be taken accordingly:
1. If the taxpayer-account holder has already filed his tax return for the year, he still has 6 months, counting from the due date of the tax return, to remove the excess contribution from his Roth IRA investment. However, this action requires the filing of an amended tax return for excess contribution to Roth IRA and properly labeled with the notation “Filed pursuant to Section 301.9100-2" written at the top.
The amended return shall contain the necessary changes related to the excess contribution withdrawn from his Roth IRA account and shall be accompanied by a separate explanation for the withdrawal. This in effect, will reduce the total contribution as if no excess amount took place during the tax year.
2. In the event that the excess contribution was discovered after the deadline, and after the 6 months grace period for filing of tax returns and its amendment, the excess amount can be withdrawn and applied as contribution for the succeeding year. The taxpayer however, should make sure that this remedial action will not result to another excess annual contribution.
The 6% excise tax is now enforceable and the amount due shall be computed as follows:
Example: Excess contribution of $500 made in 2008 – rectification was made in January 2011; deadline for filing of tax return is April 18.
Amount of Excise Tax to be Paid on or before April 18, 2011 = ($500 x 6%) x 3 years = $90.00
3. If the account owner’s combined contributions for his entire IRA investments do not exceed the maximum allowable contributions, he can perform the so-called re-characterization procedure. This denotes the conversion of one type of IRA investment into another. As a remedial course of action, therefore, the excess amount will be added as contribution, usually to the traditional IRA account. Still, the 6% excise tax shall be due and payable during the tax year that the corrective action was made.
4. If the withdrawal of the excess amount will result to another round of over-contribution once applied and added to the subsequent year, the taxpayer’s remaining course of action is to withdraw the excess amount. However, this will be treated as an early distribution and a 10% withholding tax shall be paid. This is in addition to the 6% excise tax due as penalty for contributing beyond the allowable limit; all of which shall be paid during the tax year that the corrective action was taken.
As a note, the withdrawal in this case, is not included among those provided as exceptions to the 10% withholding tax.
Using the same example as above, the $500 excess amount will be subject to a 10% withholding tax, which is equivalent to $50. The total amount of tax due on or before April 18, as a result of this remedial action is $140, comprising $90 for excise tax and $50 for withholding tax.
After knowing the consequences and the remedies for excess contributions to Roth IRA account, your next area of concern should be the preventive measures to avoid its recurrence.
Find out how by proceeding to the next page.