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How To Handle Excessive IRA Contributions With An IRA Recharacterization – Deadline Oct 15th

How To Skillfully Navigate Past An Excessive IRA Contribution and Avoid A 6% IRS Penalty?

There are still some IRA related tasks that can be made now that can apply to the previous tax year if you time it right. There are some of the more usual ones, like Traditional and Roth IRA Contributions, and SEP, SIMPLE and 401k Qualified Plan Contributions, but what if you need to recharacterize a contribution?

How to handle Excessive IRA Contributions

How To Properly Handle An IRA Recharacterization – Reach Out To A Professional

Mistakes Happen

Let’s face it! We all make mistakes and sometimes it is with our own money.

One particularly important transaction concerns correcting an excessive IRA contribution.  If, for example, when completing your personal tax return you find you have made an excess IRA contribution, regardless of the reason, thankfully, IRS penalties can still be completely avoided!

The IRA Holder should immediately contact his or her tax consultant and IRA Custodian/Trustee. If the excess IRA contribution is corrected by the due date of your personal tax return, April 15th, PLUS extensions, October 15th, the IRS penalty of 6% can be avoided.

The excess contribution must be removed with a pro rata portion of the IRA’s net income. This is a fairly complicated IRS formula, which your IRA Custodian or Trustee and/or your tax counsel can help you solve. If the excess is not properly corrected, the penalty of 6% becomes 6% PER YEAR.

This correction can even be accomplished after you file your tax return. It might mean you will need to amend your tax return later, but by correcting any excess contribution by October 15th, ALL IRS penalties can be avoided.

What Is An IRA Recharacterization and How Does It Work?

recharacterization is when an investor changes how a certain contribution or investment is treated. This typically refers to how taxes apply to the investment. Most often, recharacterizations occur when you change your contribution type from a Traditional IRA to a Roth—or a Roth back to a Traditional.

In addition, some excess contributions can be corrected by re-characterizing the contribution from the previous year in the following year. For instance, you may not be eligible for a Roth IRA Contribution due to excessive income, but you are eligible for a Traditional IRA Contribution. In that case, you can re-characterize the Roth IRA Contribution to a Traditional IRA Contribution. Note, you can NOT change tax years!

Another situation could be you have made a Traditional IRA Contribution for even though you attained age 70½. That IRA contribution can be re-characterized to a Roth IRA Contribution since there are no age restrictions on Roth IRA Contributions.

Or, you might just want to change a Traditional IRA Contribution to a Roth IRA Contribution, or a Roth IRA Contribution to a Traditional IRA Contribution. Again, it must be for the same tax year.

IRA Recharacterizations Are Due By October 15th – Sorry No Exceptions

According to the IRS, the process of treating a contribution (or a portion of a contribution) or conversion made to one type of IRA as being made to another type of IRA is termed “recharacterization.” The method of moving the contribution and the earning attributable from one IRA to another is a trustee-to-trustee transfer, as indicated in IRC Sec. 408A(d)(6), according to the BYSYS IRA Training and References Manual.

This is a reminder that the deadline to make recharacterizations for last year is October 15th. The date applies not only for people who filed for extensions but also for those of you who timely file your federal income tax returns.

If you have questions about how to determine the amount of your recharacterization, be sure to speak with a CPA. You will not only have to account for the amount of the original contribution/conversion, but you will also have to calculate the net income attributable (NIA).

The method to recharacterize a contribution follows the same procedure as the one used to correct an excess IRA contribution. So again, the method has a fairly complicated formula to calculate the net income that must also be re-characterized, so look for the assistance of a tax professional.

Terry White

About Terry White

I started my business career after getting my degree in Accounting from the University of New Mexico in 1983. My first job was as a controller for a local title company, and in 1987 I started First Financial Escrow, Inc. Over the years I played a part in several startup companies including First Financial Equities, Inc., First Financial Trust, Inc., First Financial Marketing, Inc. and Asset Ventures, Inc. In 1997 First Financial Escrow, Inc. was able to purchase the escrow accounts from Sunwest Bank and changed its name to Sunwest Escrow. As the market changes, Sunwest has grown and changed along with it. Besides my wife, Sheila, we have three boys, two daughters-in-law, one grandson, another grandson on the way and a future daughter-in-law. Sunwest is my passion, and I enjoy coming to work every day to see what will happen next. I enjoy fly fishing, spending time in Colorado, biking and watching my boys play soccer.