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Question

I have made excessive Roth IRA contributions for numerous years. Are the 6% penalties assessed on Jan 1 2025 for each or after the April 15 2025 Tax filing deadline?

Forum|Forum|1 year ago
December 12, 2024
3 replies
0 views

Due to my incompetent previous Tax Preparer_I am trying to figure out how to best address this situation and I need to know when these penalties are assessed. Because I have made approximately 18 years of excessive contributions I am considering just cashing out my Entire Roth IRA and negotiating a settlement with the IRS if it comes to that. I would prefer to cash it out just prior to April 15 2025 if I was certain that another round of 6% penalties was not added as of January 1 2025. Thanks for any help/advice you may provide. There is no easy fix for this situation due to the amount and time frame of all the excessive contributions.

fanfare

Employee

The penalty is 6% per year for each year the disallowed contribution Cn is not removed by Dec 31.

SUM [ ( 6% x Cn ) x n ] sum over n

where n is from 18 to 1 by -1

and

Cn is the contribution you made in Year (2024- n )

If SUM ( Cn ) is removed in 2024 there is no penalty for 2024.

Any earnings you got on this money will remain in the Roth IRA.

@gday111

gday111Author

Thank you for your reply

Much Appreciated

Opus 17

Employee

If the excess is in the account as of 12/31/24, it will be part of your 2024 return, including any penalties that might apply.

One way to remove the excess contributions for prior years, is to simply take a regular distribution of the excess contributions. You can leave the earnings from the excess contributions in the account for now. And, removal of the excess contributions is not taxable, because you can always remove contributions from a Roth IRA tax-free.

Depending on how your investments have performed, it is possible that if the 6% penalty was calculated for every year, it would wipe out the rest of the earnings. Or, if you have earned more than 6% on average, there might be a little left over.

The statute of limitations is an interesting issue here. Normally, the statute of limitations is 3 years from the filing deadline, or 6 years in case of fraud or a misstatement of tax of more than 25%. So it is possible that the IRS can't reach back more than 6 years even if they wanted to. On the other hand, because your most recent returns are false (because they are tied to past returns that are false) that might open the door to go all the way back. I just don't know.

If you can't get legal advice before the end of the year, the most I would consider doing is a regular distribution of your excess contributions, leaving the earnings in the account while you work out what to do next. But, I would really hope you can get a full legal opinion before the end of the year.

fanfare

Employee

even if money is removed now, 2024 tax return should show resolution of the excess removed for prior years.

The current tax year is treated differently.

If you made a contribution in 2024, you can reverse this one by Tax day 4/15/2025 and pay any earnings on that amount.

The custodian has to calculate the allocable earnings.

@gday111

fanfare

Employee

Since Republicans intend to claw back the $80 billion IRS funding,

audit risk is falling again.

gday111Author

Due to the complexity of this situation over the past 18 years I am in agreement that I do not know what Statue of Limitations Rules might apply. I also know that the thought of Amending that many past Tax returns and the associated costs to do it with a Tax Professional can be excessive. The one Tax Professional I contacted about this said his rate was $400/hr

The reality is that even with all the excessive Contributions my Roth IRA has only made minimal profits due to some bad investments over all these years.

The associated costs and hassle to amend all my returns may cost as much as the penalties assessed. The amount of paperwork involved is mind boggling as I have researched this.

As I mentioned I am seriously considering just cashing out my entire Roth IRA and placing the proceeds into a CD or Money Market account and wait and see what happens with the IRS.

I would be happy to just pay a Penalty fee on the Profits made above the amount that I have contributed yearly for the last 18 years.

My thought is that If I cash out my entire Roth IRA that there would be no more yearly assessed Penalties since the money is no longer in my Roth account and I could then deal with any IRS issues after they flagged this.

1_Does anyone know what I might expect in the way of notification from the IRS after I cashed out my IRA?

Would they contact me by mail about the Penalties or assess Penalties on my next Tax Returns?

2_Is it reasonable to think that I might be able to negotiate a settlement with the IRS without still having to do all the associated paperwork after the fact of cashing out the Roth?

3_Can anyone see any potential problems with me just cashing out my Roth and taking the wait/see approach from the IRS?

4_Any further thoughts would be greatly appreciated

BTW_Thanks to All who have responded. While I blame my previous Tax Preparer for never spotting this I honestly never knew there were limitations based on Income and it amazes me that after all those years I never read anything that tipped me off to that fact. How that alluded me I will always question.

I just faithfully contributed the Max amount per year to my Roth thinking I was doing the right thing for my Retirement.

Opus 17

Employee

1. When you make a withdrawal from a Roth IRA, you get a 1099-R that you must report on your tax return. As mentioned, withdrawals of contributions are tax-free. If you are under age 59-1/2, withdrawal of earnings are subject to income tax plus a 10% penalty. Your tax software will ask you about prior contributions and prior withdrawals, to be able to calculate how much is earnings subject to tax.

Interestingly, I think that if you completely withdrew ALL Roth IRA funds and paid the tax and penalties on any earnings, that might start a final 6 year clock on audits, since your 2025 and future returns would not be carrying over any incorrect facts. But I am not a lawyer or CPA.

2. Probably not. You can't really negotiate a settlement without knowing your exposure, and I don't think the IRS would accept an offer without themselves calculating it themselves to know what they are giving up. So you would also want your own calculation.

You can do this manually, since you would only need to calculate form 8606 and form 5329 for each year. You can download prior year forms and instructions from the IRS web site. That won't include interest and penalties, but you could probably determine the base amount of the 6% penalties without too much trouble.

In fact, if you don't have any withdrawals, you probably don't need the exact forms. Your calculation might look something like this.

Year	Excess contribution	Cumulative Excess	6% penalty	Cumulative penalty
2006	$4000	$4000	$240	$240
2007	$4000	$8000	$480	$720
2008	$5000	$13,000	$780	$1500
2009	$5000	$18,000	$1080	$2580
Etc.

Of course, this assumes that you were never eligible, you contributed the maximum, all your contributions were excess, and you never made conversions and withdrawals. If your situation is more complicated you might need to use the forms. But I think that before you contacted the IRS (on your own or via a tax professional), you need at least an estimate of your exposure.

3. Not an attorney, but if you completely cashed out, paid tax and penalties on the earnings, that might start a final 6 year clock on audit issues.

4. If you do the rough calculation (which ignores penalties and interest), you can then decide whether you want to risk doing nothing, or at least talk to a professional about whether you should approach the IRS for an offer in compromise.

https://www.irs.gov/payments/offer-in-compromise

It doesn't appear you would be eligible to request an offer in compromise until you filed all the amended returns to document the amount you owe (which I suggested in #2). If you have copies of your tax returns from all those years, it might not be too hard to prepare the amended returns manually. One thing I would not do is contact the IRS before you have an idea of your exposure and a legal consultation.