An excess contribution results when a taxpayer has contributed more than the annual limit to a traditional IRA or a Roth IRA. If any part of the excess contribution is allowed to remain in the IRA past the due date for correcting the excess, it is subject to a 6% excise
tax (6% penalty tax). The 6% penalty tax applies each year the excess is allowed to remain in the IRA.
To correct an excess contribution, the excess contribution must be withdrawn by the due date for filing the return, including extensions. The withdrawal of the excess contribution is considered tax-free if:
• The taxpayer does not take a deduction for the contribution, and
• The taxpayer withdraws any interest or other income earned on the contribution while it was part of the IRA. For this purpose, any loss on the contribution is also taken into consideration when calculating the amount to withdraw.
If more than one contribution is made during the year, the last contribution is considered to be the one that is withdrawn first for purposes of calculating net income on earnings.
If the excess contribution is withdrawn after the due date (or extended due date), the withdrawal is generally taxable. However, the withdrawal is not taxable if both of the following conditions are met:
• Total contributions (other than rollover contributions) for the tax year were not more than the contribution limit that is not based on the taxpayer’s compensation ($5,500/$6,500 limits that apply for 2016), and
• The taxpayer did not take a deduction for the excess contribution being withdrawn.
Another way to handle an excess contribution is to pay the 6% penalty on the excess and leave it in the IRA. In the following
year, under contribute to the IRA for that year and apply the prior year excess contribution to the current year contribution. If the excess contribution carryover is still in excess of the contribution allowed for the carryover year, pay the 6% penalty on the difference
and carry the remainder over to the next year. Keep doing this until the excess is used up.
If you need assistance dealing with an excess contribution, contact Steve Siesser at steve@taxlawmd.com/div>