IRA Reporting: Excess Contributions and Recharacterizations - Tax Year “During Which” vs. Tax Year “For Which” | Wolters Kluwer
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  • IRA Reporting: Excess Contributions and Recharacterizations - Tax Year “During Which” vs. Tax Year “For Which”

    Robert Skomars Insights

    by Robert Skomars, Consultant, Tax Advantaged Accounts, Wolters Kluwer

    Published February 20, 2019



    Overview

    If you ask someone who works with individual retirement accounts (IRAs) what “tax-year reporting” for IRAs entails, he/she would probably indicate that it means to accurately identify on Internal Revenue Service (IRS) Form 5498, IRA Contribution Information, the tax year for which an IRA regular contribution is made — which is true.

    However, is it possible that “tax-year reporting” could be applicable to other IRA transactions? The answer is yes, there are two distribution types that from a reporting standpoint may be reported using one of two different codes in Box 7 of IRS Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. This article will examine how to report the removal of an IRA excess contribution, and a recharacterization distribution, both of which from a distribution reporting standpoint are dependent on the year of the original deposit vs. the year of distribution.

    Excess Contribution Removal

    In order to avoid a six percent penalty tax on an excess contribution, an IRA owner must correct the excess contribution prior to his/her tax-filing due date, including extensions. This date is generally October 15 of the year following the year for which a contribution was made.

    Example:

    John Johnson, age 45, made a $6,500 traditional IRA contribution for 2018 on January 10, 2019. When John completed his 2018 tax return in April 2019, he learned that $1,000 of his contribution was not eligible. John decides to correct the excess contribution by removing it, with the attributable earnings. John has until October 15, 2019 to correct the excess contribution and thereby avoid a six percent penalty tax on the $1,000 excess contribution.

    How will the custodian/trustee of John’s traditional IRA report the distribution of John’s excess contribution on a 2019 IRS Form 1099-R?

    The 1099-R reporting instructions provide two codes (i.e., 8 and P) for reporting the removal of an IRA excess contribution when completed before an IRA owner’s tax-filing due date. The appropriate distribution reporting code is determined by considering when the distribution takes place when compared to when the contribution was originally made. If a contribution is made and removed in the same calendar year, report using Code 8. If a contribution is made during one calendar year but removed in the following calendar year (before the tax-filing deadline, including extensions), report using Code P.

    In our example of John Johnson’s $1,000 excess IRA contribution, since the contribution was made and removed in the same calendar year the appropriate distribution code in box 7 of the 2019 IRS Form 1099-R is “8”. Additionally, a “1” should accompany the “8” (i.e., Code 81) since John was younger than age 59½ at the time of distribution.

    Recharacterization

    Recharacterization allows an IRA owner to treat an IRA regular contribution made to one IRA type as a contribution made to the other IRA type (i.e., traditional IRA to Roth IRA or Roth IRA to traditional IRA). If an IRA regular contribution is recharacterized to the other IRA type, an IRA owner is essentially changing the nature, or “character” of the IRA that received the initial contribution, not the tax-year for which the contribution was made. Furthermore, recharacterization of a contribution must be completed by the IRA owner’s tax-filing deadline, including extensions of the tax year for which the initial contribution was made. A tax year designation is not made for a recharacterized contribution. However, the year for which a contribution is made and subsequently recharacterized is important in determining the appropriate distribution code (i.e., R vs. N) used in Box 7 of IRS Form 1099-R.

    Example:

    Alan Peterson, age 53, made a $6,500 traditional IRA regular contribution for 2018 on January 10, 2019. When Alan completes his 2018 tax return in April 2019, he learns that his contribution is not deductible. Alan decides to recharacterize his 2018 traditional IRA regular contribution as a 2018 Roth IRA regular contribution. Alan has until October 15, 2019 to complete the recharacterization with his IRA custodian/trustee.

    In this case, since Alan’s traditional IRA regular contribution was made for 2018 and is being recharacterized in 2019 the appropriate distribution code is “R” on the 2019 Form 1099-R.

    If Alan’s contribution had been made in 2019 for 2019, and subsequently recharacterized in 2019, the appropriate distribution code would be “N” on the 2019 Form 1099-R.

    Conclusion

    Working with IRAs can seem especially tricky for anyone working on the front lines who may not be knowledgeable about reporting. When trying to determine which IRS reporting code applies to the removal of an excess contribution (i.e., P or 8) vs. recharacterization (i.e., N or R) it may help to consider that reporting the removal of an excess contribution takes into account the year during which a contribution was made whereas a recharacterization takes into account the year for which a contribution was made.

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