Question

Contributing to a Roth IRA with Scholarship income - Is it Excess or not?

Forum|Forum|5 years ago
May 12, 2020
1 reply
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Hello,

I am the recipient of a full scholarship stipend, that goes towards both living and school expenses. As such, a large portion of the scholarship money is taxable income (about $13000 worth). My actual earned W-2 income was only around $1000 last year. I paid taxes on all of that income for 2019.

This year, I opened a Roth IRA account. I know the annual contribution limit is $6000 so I made a $6000 contribution for tax year 2019. However, now I think I may have made a mistake.

This website: https://www.investopedia.com/roth-ira-contributions-with-no-job-4770755 says that it is allowable for me to use the scholarship money in this way but other websites say I can only contribute the maximum of my earned W-2 income (so $1000) per year. I had not read about the earned income rule until after I opened up the Roth IRA account and made the contribution - I looked through several websites for information but this rule was well-hidden and I didn't realize until it was too late.

I am not sure if I made a mistake in characterizing the money for 2019. If I did, I will withdraw the excess contribution. Do you think I will need to do so? And if so, what are the penalties I will face? I already paid income taxes for 2019, but I know there's still time up until July 15th to fix things - will I owe an extra amount on my taxes for 2019?

Thanks so much in advance.

macuser_22

Employee

That reference you posted is incorrect or you misread it. It should have reference IRS Publication 590A and not 970.

Publication 590-A (2019), Contributions to Individual Retirement Arrangements (IRAs)

https://www.irs.gov/publications/p590a#en_US_2019_publink1000230355

Says Scholarships are indeed earned income for IRA contributions but *only* if shown in box 1 of Form W-2. In your contributions are limited to the $1,000 of your earned income. Anything contributed in excess of that is an excess contribution that must be removed as a "return of contribution" before the due date of the tax return to avoid a penalty.

What Is Compensation?

[quote]

Generally, compensation is what you earn from working. For a summary of what compensation does and doesn’t include, see Table 1-1. Compensation includes all of the items discussed next (even if you have more than one type).

Wages, salaries, etc.

Wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services are compensation. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**

M

maniiAuthor

Okay, thank you for the clarification.

How do I go about doing this:

Anything contributed in excess of that is an excess contribution that must be removed as a "return of contribution" before the due date of the tax return to avoid a penalty.

I know I will have to remove 6000-(the amount I contributed). I assume I will also have to remove the earnings on that amount - how should I calculate that?

And do I have to report this on my taxes? I filed my tax return back in March 2020. But I opened the Roth IRA account and made the contribution for 2019 in April 2020. So I'm not sure if I need to file an amended return or leave everything as is.

I know I'll have to claim the excess earnings as income - can I just do that in 2020 to make things easier and avoid having to file an amended return?

macuser_22

Employee

@manii wrote:

I know I will have to remove 6000-(the amount I contributed). I assume I will also have to remove the earnings on that amount - how should I calculate that?

And do I have to report this on my taxes? I filed my tax return back in March 2020. But I opened the Roth IRA account and made the contribution for 2019 in April 2020. So I'm not sure if I need to file an amended return or leave everything as is.

The account custodian is required to calculate the earnings on the excess. You only need to remove $5,000 excess if you had a W-2 with $1,000 in box 1. Be sure to tell them that it is a "return of excess contribution" so they will remove the earnings and report it properly and not just as a normal distribution.

Since you already filed then you will have to amend, but not until next year after you receive the 2020 1099-R that reports the return of contributions with a code JP in box 7, next January. That 2020 1099-R code JP must be reported on a 2019 amended tax return but only if box 2a contains an amount of taxable earnings. If no earnings (or a loss) then amending will not be needed since the returned contribution itself is not reportable - only the earnings, if any, are.

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**