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10% penalty for withdrawal of earnings on excess Roth IRA contribution?

 
 
joeu2004@hotmail.com
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      03-08-2006, 03:44 AM
IRS Pub 590 states (p.59) that you can avoid a 6% penalty on
excess contributions to a Roth IRA if you remove the excess
contributions before the due date [1]. This exception
applies only if any earnings on the excess contribution are
also withdrawn.

But if such a withdrawal of earnings would otherwise qualify
as an "early distribution", the situation above is not
listed among the exceptions to the 10% penalty (p.60).

Does the 10% penalty truly apply(!)?

It seems unlikely that the IRS would impose the 10% penalty
on a distribution that it requires you to make in order to
avoid the 6% penalty.

Can anyone point to language in Pub 590 or in law that
includes this situation among the exceptions?

-----
[1] You can also avoid the 6% excess contribution penalty by
applying the excess contribution to the contributions
allowed in a later year, to the extent possible. But
that alternative is not relevant to my question.

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Phil Marti
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      03-08-2006, 06:32 PM
<(E-Mail Removed)> wrote:

> IRS Pub 590 states (p.59) that you can avoid a 6% penalty on
> excess contributions to a Roth IRA if you remove the excess
> contributions before the due date [1]. This exception
> applies only if any earnings on the excess contribution are
> also withdrawn.
>
> But if such a withdrawal of earnings would otherwise qualify
> as an "early distribution", the situation above is not
> listed among the exceptions to the 10% penalty (p.60).
>
> Does the 10% penalty truly apply(!)?


To the earnings only.

> It seems unlikely that the IRS would impose the 10% penalty
> on a distribution that it requires you to make in order to
> avoid the 6% penalty.


Remember that the 6% penalty would apply to the entire
contribution, while the 10% penalty applies only to the
earnings.

--
Phil Marti
Clarksburg, MD

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joeu2004@hotmail.com
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      03-10-2006, 05:13 AM
>> Does the 10% penalty truly apply(!)?

> To the earnings only.


>> It seems unlikely that the IRS would impose the 10% penalty
>> on a distribution that it requires you to make in order to
>> avoid the 6% penalty.


> Remember that the 6% penalty would apply to the entire
> contribution, while the 10% penalty applies only to the earnings.


Yes, I understand all that. I feel that you are simply
restating facts that I already presented. I infer that your
opinion is, yes, the 10% penalty applies to the earnings on
excess contribution, both of which must be withdrawn before
the filing date (or allocated to a subsequent year's
contribution to the extent allowed) in order to avoid the 6%
penalty on the excess contribution.

I remain surprised. Do other experts hold the same opinion?
Does anyone have first-hand experience (through their
clients, perhaps) with this situation? Can anyone point to
an IRS example or positive or case law addressing this very
point?

If true, it would seem to make sense to contribute to a Roth
IRA only after year-end, if your compensation might be below
the contribution limit (potentially zero). That means not
getting the tax advantage on as much as one year's earnings,
if that approach proves to be unduly cautious.

Arguably, I am talking about a relatively small amount, as
long as the excess contribution is within reason. But it is
the "principal" of the matter :-).

To be honest, I started this line of thought by wondering
about "unreasonable" excess contributions -- a mind game,
not a plan that I might act on. And in that context, I can
see where applying the 10% penalty to the earnings could
serve as a deterrent to such abusive excess contributions.
So perhaps I am not as surprised now as I was initially.
But I am still looking for consensus, if not dispositive
law.

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Phil Marti
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      03-10-2006, 02:58 PM
<(E-Mail Removed)> wrote:

> Yes, I understand all that. I feel that you are simply
> restating facts that I already presented. I infer that your
> opinion is, yes, the 10% penalty applies to the earnings on
> excess contribution, both of which must be withdrawn before
> the filing date (or allocated to a subsequent year's
> contribution to the extent allowed) in order to avoid the 6%
> penalty on the excess contribution.
>
> I remain surprised.


Sorry, I thought you simply wanted to confirm the law. Had
I known you were interested in some reasoning why the law
says what it says, I would have given my standard "beats the
heck out of me." I long ago gave up trying to apply reason
to Congressional actions.

As for principle, if this is the first conflict your
principles have encountered with tax law, the line forms
well to rear of me. All discussions of principle should be
directed to your members of Congress, who can actually do
something about it. They just love to hear from
constituents, especially during election years. Be sure to
compliment them on their simplification of the law over the
years.

For confirmation that the law indeed says what the IRS says
it says, see 26 USC section 72(t), where the premature
distribution penalty is imposed and the exceptions stated.
There is no exception for distribution of earnings on excess
contributions. If you can find one somewhere else in the
law, I'll be glad to take a look at it.

--
Phil Marti
Clarksburg, MD

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joeu2004@hotmail.com
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      03-16-2006, 06:21 AM
Phil Marti wrote:
> <(E-Mail Removed)> wrote:


>> I infer that your opinion is, yes, the 10% penalty applies
>> to the earnings on excess contribution

> [....]
>> I remain surprised.


> Sorry, I thought you simply wanted to confirm the law. Had
> I known you were interested in some reasoning why the law
> says what it says


I was not looking for "some reasoning why the law says what
it says". Yes, I wanted to "confirm the law". You offered
your opinion, which is fine. But that is all you offered;
in particular, you did not offer "what the law says". I
remain(ed) surprised unless and until someone could provide
some justification for that opinion or an opposing
interpretation, based on law -- ideally, some citation to
law.

> For confirmation that the law indeed says what the IRS says
> it says, see 26 USC section 72(t), where the premature
> distribution penalty is imposed and the exceptions stated.
> There is no exception for distribution of earnings on excess
> contributions. If you can find one somewhere else in the
> law, I'll be glad to take a look at it.


Although the IRS Pubs are not law, IRS Pub 590 does state
(p.60): "If you withdraw contributions (including any net
earnings on the contributions) by the due date of your
return for the year in which you made the contribution, the
contributions are treated as if you never made them. If you
have an extension of time to file your return, you can
withdraw the contributions and earnings by the extended due
date. The withdrawal of contributions is tax free, but you
must include the earnings on the contributions in income for
the year in which you made the contributions."

If the contributions are treated "as if you never made
them", I believe the earnings would be treated "as if they
never were in the Roth IRA". We cannot have earnings within
the Roth IRA on contributions that "you never made". Ergo,
we are not making an early withdrawal of IRA earnings.
Ergo, there should be no 10% penalty.

I suspect this is not settled law. That is, unless someone
can point to a dispositive statement in the IRS code or regs
or to an IRS ruling or an appellate court decision, I think
it will remain merely an educated interpretation.

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Victor Roberts
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      03-16-2006, 10:43 PM
(E-Mail Removed) wrote:
> Phil Marti wrote:
>> <(E-Mail Removed)> wrote:


>>> I infer that your opinion is, yes, the 10% penalty applies
>>> to the earnings on excess contribution

>> [....]
>>> I remain surprised.


>> Sorry, I thought you simply wanted to confirm the law. Had
>> I known you were interested in some reasoning why the law
>> says what it says


> I was not looking for "some reasoning why the law says what
> it says". Yes, I wanted to "confirm the law". You offered
> your opinion, which is fine. But that is all you offered;
> in particular, you did not offer "what the law says". I
> remain(ed) surprised unless and until someone could provide
> some justification for that opinion or an opposing
> interpretation, based on law -- ideally, some citation to
> law.


If you want a legal opinion, perhaps you should retain an
attorney and pay for the opinion. Usenet newsgroups provide
advice at no charge from people who take their own time to
try to help others. You don't have any right to be upset if
this free advice is not as detailed as you had wanted it to
be.

>> For confirmation that the law indeed says what the IRS says
>> it says, see 26 USC section 72(t), where the premature
>> distribution penalty is imposed and the exceptions stated.
>> There is no exception for distribution of earnings on excess
>> contributions. If you can find one somewhere else in the
>> law, I'll be glad to take a look at it.


> Although the IRS Pubs are not law, IRS Pub 590 does state
> (p.60): "If you withdraw contributions (including any net
> earnings on the contributions) by the due date of your
> return for the year in which you made the contribution, the
> contributions are treated as if you never made them. If you
> have an extension of time to file your return, you can
> withdraw the contributions and earnings by the extended due
> date. The withdrawal of contributions is tax free, but you
> must include the earnings on the contributions in income for
> the year in which you made the contributions."
>
> If the contributions are treated "as if you never made
> them", I believe the earnings would be treated "as if they
> never were in the Roth IRA".


I'm not an attorney and do not play one on TV, but that
would not be my interpretation. Contributions are clearly
not earnings.

> We cannot have earnings within
> the Roth IRA on contributions that "you never made". Ergo,
> we are not making an early withdrawal of IRA earnings.
> Ergo, there should be no 10% penalty.


No ergo. You can withdraw your contributions while not
withdrawing the earnings.

> I suspect this is not settled law.


Perhaps only to you.

> That is, unless someone
> can point to a dispositive statement in the IRS code or regs
> or to an IRS ruling or an appellate court decision, I think
> it will remain merely an educated interpretation.


Yup, I suspect that no one here is going to do your legal
research for you. However, if you do pay an attorney to
answer this question, perhaps you would be kind enough to
post his opinion.

--
Vic Roberts
Replace xxx with vdr in e-mail address.

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Phil Marti
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      03-17-2006, 08:32 AM
"Victor Roberts" <(E-Mail Removed)> wrote:

>> We cannot have earnings within
>> the Roth IRA on contributions that "you never made". Ergo,
>> we are not making an early withdrawal of IRA earnings.
>> Ergo, there should be no 10% penalty.


> No ergo. You can withdraw your contributions while not
> withdrawing the earnings.


>> I suspect this is not settled law.


> Perhaps only to you.


>> That is, unless someone
>> can point to a dispositive statement in the IRS code or regs
>> or to an IRS ruling or an appellate court decision, I think
>> it will remain merely an educated interpretation.


I didn't respond to OP this morning because I was put off by
his tone. Now that the cocktail hour is upon us, I'm in
love with the world. Thus,

The distribution of *anything* from an IRA is a distribution
from an IRA.

Distributions from an IRA before the beneficiary is 59 1/2
are subject to the additional tax imposed by section 72(t),
a/k/a the 10% premature distribution penalty, unless
specifically excluded.

There is no penalty exclusion for distribution of earnings
on an excess contribution. Oddly enough, there is an
exclusion for distribution of the contribution itself.

I wouldn't think of asking OP to take my word for it. He
can go to http://uscode.house.gov/search/criteria.shtml and
research it himself. Putting "26" in the "Title" box and
"72" in the Section box will give him a link to the text.
Scroll down to subsection (t), and there you are!

Oops! There's no penalty exception there for distribution
of the excess contribution. Never fear. Those scamps in
Congress like to hide things. Think of it as a treasure
hunt. Go back to the search screen, again title 26, but
this time put "72(t)" in the "Search word(s)" box and leave
everything else blank.

Uh oh. There are 725 references. Never fear. The penalty
exception for return of excess contributions is in section

Oh dear. My glass is empty. Gotta run. Don't worry,
you'll find it.

It would be impossible to underestimate my concern for what
OP does with this information. To borrow from what we say
after reading from the Apocrypha, here ends my colloquy with
OP.

--
Phil Marti
Clarksburg, MD

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Drew Edmundson
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      06-02-2006, 04:59 AM
(E-Mail Removed) wrote:
> Phil Marti wrote:
>> <(E-Mail Removed)> wrote:


snip

> If the contributions are treated "as if you never made
> them", I believe the earnings would be treated "as if they
> never were in the Roth IRA". We cannot have earnings within
> the Roth IRA on contributions that "you never made". Ergo,
> we are not making an early withdrawal of IRA earnings.
> Ergo, there should be no 10% penalty.
>
> I suspect this is not settled law. That is, unless someone
> can point to a dispositive statement in the IRS code or regs
> or to an IRS ruling or an appellate court decision, I think
> it will remain merely an educated interpretation.


You need to re-read Phil's response. The law is settled in
this area. The distribution is subject to penalty unless
there is an exception. As Phil notes there is no exception
to the penalty. I understand your logic, but there is no
constitutional requirement that the law make sense.

Here is the penalty provision:

Section 72(t) "10-percent Additional Tax On Early
Distributions From Qualified Retirement Plans (1)
Imposition Of Additional Tax
If any taxpayer receives any amount from a qualified
retirement plan (as defined in section 4974(c)), the
taxpayer's tax under this chapter for the taxable year in
which such amount is received shall be increased by an
amount equal to 10 percent of the portion of such amount
which is includible in gross income."

There is no exception listed for the return of excess
contributions so the next thing to look at is whether the
amount is included in gross income. The return of the
excess contribution is not included in gross income but the
income on the excess contribution is included under
408A(d)(2)(C): "The term `qualified distribution' shall not
include any distribution of any contribution described in
section 408(d)(4) and any net income allocable to the
contribution."

To really get at the crux of the matter would require you to
have access to the applicable provisions of the Internal
Revenue Code or would require me to post 408(d)(4), 4974(c),
parts of 401, etc.

---
Drew Edmundson, CPA
Cary, NC

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