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

Discussion in 'Tax' started by joeu2004@hotmail.com, Mar 8, 2006.

  1. Guest

    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    also withdrawn.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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    , Mar 8, 2006
    #1
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  2. Phil Marti Guest

    <> 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 also withdrawn.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

    << ======================================================= >>
    << The foregoing is intended for educational purposes only >>
    << and does NOT constitute legal OR professional advice. >>
    << >>
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    << Copyright (2006) - All rights reserved. >>
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    Phil Marti, Mar 8, 2006
    #2
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  3. Guest

    >> 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.

    << ======================================================= >>
    << The foregoing is intended for educational purposes only >>
    << and does NOT constitute legal OR professional advice. >>
    << >>
    << The Charter and the Guidelines for submitting >>
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    << Copyright (2006) - All rights reserved. >>
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    , Mar 10, 2006
    #3
  4. Phil Marti Guest

    <> 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

    << ======================================================= >>
    << The foregoing is intended for educational purposes only >>
    << and does NOT constitute legal OR professional advice. >>
    << >>
    << The Charter and the Guidelines for submitting >>
    << messages to this newsgroup are at www.asktax.org. >>
    << Copyright (2006) - All rights reserved. >>
    << ======================================================= >>
     
    Phil Marti, Mar 10, 2006
    #4
  5. Guest

    Phil Marti wrote:
    > <> 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.

    << ======================================================= >>
    << The foregoing is intended for educational purposes only >>
    << and does NOT constitute legal OR professional advice. >>
    << >>
    << The Charter and the Guidelines for submitting >>
    << messages to this newsgroup are at www.asktax.org. >>
    << Copyright (2006) - All rights reserved. >>
    << ======================================================= >>
     
    , Mar 16, 2006
    #5
  6. wrote:
    > Phil Marti wrote:
    >> <> 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.

    << ======================================================= >>
    << The foregoing is intended for educational purposes only >>
    << and does NOT constitute legal OR professional advice. >>
    << >>
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    << messages to this newsgroup are at www.asktax.org. >>
    << Copyright (2006) - All rights reserved. >>
    << ======================================================= >>
     
    Victor Roberts, Mar 16, 2006
    #6
  7. Phil Marti Guest

    "Victor Roberts" <> 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

    << ======================================================= >>
    << The foregoing is intended for educational purposes only >>
    << and does NOT constitute legal OR professional advice. >>
    << >>
    << The Charter and the Guidelines for submitting >>
    << messages to this newsgroup are at www.asktax.org. >>
    << Copyright (2006) - All rights reserved. >>
    << ======================================================= >>
     
    Phil Marti, Mar 17, 2006
    #7
  8. wrote:
    > Phil Marti wrote:
    >> <> 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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    Drew Edmundson, Jun 2, 2006
    #8
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