Tax Penalty For Excess IRA Contributions
Any contribution to an IRA (either deductible or non-deductible, but not including rollovers) that is more than allowed for the year is an excess contribution and subject to a 6% penalty.
Post-70-1/2 Contributions (Tax Years Before 2020)
Contributions made for the year a taxpayer turns age 70-1/2 (or a later year) are considered excess contributions. The penalty is calculated on the excess contributed and on any interest it may have earned. The penalty can’t be more than 6% of the value of the account and continues to apply each year the excess is allowed to remain in the account. Use Form 5329 to calculate the penalty.
Contributions After 2019
Taxpayers will no longer be subject to this penalty because of their age, starting with contributions for 2020, because the age cap for making contributions was eliminated by the SECURE Act. However, the penalty will still apply in other situations when an excess contribution is made.
Withdrawing an Excess Contribution Before the Return Due Date
If the excess, including interest (or other earnings), is withdrawn by the extended due date of the return and no deduction was taken for the excess:
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No penalty is assessed on the excess or the interest.
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Include the interest on the excess in income in the year of excess contribution (or a taxpayer may return the interest or other earnings paid on the account).
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10% premature distribution penalty may be charged on interest or other earnings, only if taxpayer is under 59-1/2(2021 IRS Publication 590-A, page 34).
Withdrawing Excess Contributions After the Return Due Date
If total contributions for the year were not more than the annual contribution limit amount (including excess contributions) AND the taxpayer did not claim any deduction for the excess, a taxpayer may withdraw the excess after the extended due date of the return, without having to include the withdrawal in income. A taxpayer who timely filed their return for the year the excess contribution was made, but who didn’t withdraw the excess before filing the return, may make a withdrawal of the excess within 6 months of the original due date of the return and then file an amended return to (1) exclude the deductions for the excess contribution and (2) include the earnings on the excess. On the top of the amended return, write “Filed pursuant to section 301.9100-2” (2021 IRS Publication 590-A, page 34).
Excess Cannot Be Applied to an Earlier Year
A taxpayer cannot avoid an excess contribution penalty by applying the excess against an earlier year in which he/she claimed less than the maximum amount allowable.
Excess Applied to Later Year
The excess amount can be applied to a later year’s contribution. While this allows the taxpayer to avoid a withdrawal from the IRA account, it does not avoid the 6% penalty on excess contributions that might remain in the taxpayer’s account at the end of the year.
Example - Excess IRA Contribution - Jan’s 2023 compensation was $1,000, and her 2024 compensation was $15,000. She made a $1,400 IRA contribution in 2023 ($400 more than the amount she was allowed) and wants to make a $1,500 contribution for 2024. The extra $400 Jan put into the 2023 IRA is subject to the 6% excess contribution penalty. However, she would not have to pay that penalty if the excess (including earnings) was withdrawn before the extended due date of her 2023 return. Jan can correct the excess contribution problem by withdrawing the $400. However, she could instead make the correction by leaving the $400 in the account to apply to her 2024 IRA contribution. If she does the latter, she will make a cash deposit of $1,100 for her 2024 contribution. Her 2024 IRA deduction will be $1,500 ($400 applied from 2023 and $1,100 in cash).
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Excess Contributions Due to Erroneous Rollover Information
If a taxpayer received incorrect information from a pension plan administrator and, as a result, rolls over an erroneous amount to an IRA, the taxpayer is allowed to withdraw the excess contribution. No amended return is necessary to show the change; the corrective withdrawal does not need to be included in the taxpayer’s income.
Statute of Limitations for Excise Tax on Excess Contributions
To provide finality for taxpayers in the administration of the excise tax on excess contributions to an IRA, SECURE 2.0 Act, Section 313, provides that the period of limitations runs 6 years from the date Form 1040 is filed.
In general, this change is intended to ensure that there is a reasonable period of limitations for violations of which taxpayers were not aware and thus did not file an excise tax return (Form 5329).