Be prepared for questions about excess contributions and recharacterizations

Posted by Linda Williams on September 24, 2013

The deadline is coming!

October 15th is the deadline to take care of excess contributions to IRAs and to recharacterize current year IRA contributions. Clients are often confused with both processes and require help. By knowing the IRS rules, you can provide that help.

Excess Contributions:

The basic rules for correcting an excess contribution in a Traditional and Roth IRA start with the question, “Is the taxpayer correcting the excess before tax-filing plus extensions or after tax-filing plus extensions?”

  • If he answers “before,” he will be able to remove the excess without a penalty.
  • If he answers “after,” he will not be able to avoid a 6% penalty on the excess amount, and depending on how he chooses to correct the excess, he also may be double-taxed on the excess.

Your client who is faced with having to correct an excess contribution may say, “But I haven’t filed for extensions, so am I too late?” Reassure her that the IRS gives two automatic extensions if the taxpayer has filed her taxes by the appropriate deadline. This automatic extension applies to both excess contributions and recharacterizations.

If your client has an excess contribution to a SEP, SARSEP, or SIMPLE IRA, he should talk to a tax advisor who is familiar with the Employee Plans Compliance Resolution System (EPCRS) correction rules. In some cases, the correction may be made through the Self-Correction Program and in more complex cases the Voluntary Correction Program may be needed.


Why would anyone want to recharacterize a contribution?

  • Made a contribution to a Traditional IRA and is over 70 ½
  • Made a contribution to a Roth and was over the income limit to do so
  • Changed his mind about whether to contribute to a Roth or Traditional IRA Converted to a Roth and the account lost money – now will have to pay taxes on an amount that doesn’t exist.

Recharacterizations allow a taxpayer to move a current year contribution from one type of IRA to another without penalty as long as any earnings are moved with the contribution or losses are subtracted from the contribution amount. In other words, the taxpayer is essentially pretending that the original contribution had always been in the second IRA.

For both excess and recharacterization transactions, the taxpayer needs to know a sometimes complicated process. Your guidance can make the process seem easier.

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