IRA Excesses & Recharacterizations: What You Need to Know

Posted by Mark Piquette on October 7, 2014

With the deadline for correcting ineligible IRA contributions fast approaching, it’s important to know how the IRS determines what contributions are ineligible and what you can do to help your clients comply. 

Excesses and recharacterizations have certain features in common. They have the same deadline (October 15), they require knowledge of when the contribution was made and they require calculation of earnings or losses.

For excess contributions to traditional and Roth IRAs, the key consideration is whether the correction is made before the tax-filing-plus-extension deadline.

  • If the correction is made before the deadline, the excess contribution can be removed without a penalty
  • If the correction is made after the deadline, the excess incurs a 6% penalty

Clients who have made excess contributions to an SEP, SARSEP, or SIMPLE IRA should talk to a tax advisor who is familiar with the Employee Plans Compliance Resolution System (EPCRS) correction rules, as the guidelines are different for those IRAs. In some cases, the correction may be made through the Self-Correction Program; in more complex cases, the Voluntary Correction Program may be needed.

Recharacterizations are more straightforward. A recharacterization allows a taxpayer to move a current-year contribution from one type of IRA (Roth or traditional) to another. There are three main reasons why a client would recharacterize a contribution: 

  • He/she was not eligible to make a contribution (based on age or income)
  • Assets in the traditional IRA have declined in value, and he/she wants to minimize the tax burden by recharacterizing to a Roth
  • He/she simply wants to move a contribution from one IRA to another

The rules that govern recharacterizations and excesses can be complicated. Clients may be particularly overwhelmed by having to calculate earnings or losses. Fortunately, Trust Company of America is here to help. Talk to your relationship manager if you have clients who need to correct excess contributions or recharacterize from one IRA to another. You can also view a video walkthrough of the rules by watching our recent Genius Session.

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