Excess IRA contribution

[Greta]

It of course produced a tax on the $1000 excess on Form 5329 and deducted only up to the net income from Sch C -- all of which I expected. But please help me with what happened with the 50K distribution that was taken out of an IRA which should be fully taxable. Instead Proseries made only 49K taxable. It subtracted the $1000. Why?

[Just-Lisa-Now-]

Looks like you started your post in the middle of a previous conversation, but....

If you had a $1000 non deductible IRA basis, then  only 49K would be taxable on a 50k IRA distribution.

[Greta]

The excess $1000 IRA was nondeductible only because it was $1000 more than client's earned income. He wasn't allowed to make a contribution higher than his earned income. I don't see how that would make his other IRA w/d less taxable by $1000. Please go over it with me one more time 🙂

[Just-Lisa-Now-]

This really isnt an area that Im extremely experienced in, but if your IRA basis worksheet shows $1000 as non deductible, thats why the program is only taxing 49 of the 50K that was distributed.

[Greta]

Con't. Could the tax code be considering the excess $1000 possibly as a return of funds withdrawn earlier from an IRA?

[Greta]

Form 8606 keeps track of "nondeductible IRAs" back in the day when a high income limit disallowed a deduction. Then it's a convoluted calculation, as a ratio out of the entire balance, not just a pure subtraction.

This, on the other hand, is excess because client didn't have sufficient earned income to contribute more than he earned. Now I'm thinking that the software is considering the excess to be a sort of return of funds that were previously withdrawn from the IRA, returned within the same tax year, hence a pure deduction. What do you think?

[qbteachmt · Accepted solution]

Because we don't know what is on the Sched C, if this person has prior basis in the Traditional IRA, if that distribution is RMD or not, if the person is over 50 and you have the additional $1,000 and also $1,000 too much, or how the 1099-R appears for the distribution, I would refer you to the Instructions for 5329 and especially the section(s) where there is both contribution and distribution:

https://www.irs.gov/instructions/i5329#idm140008386956640

[Greta]

Thank you! The keys to my puzzle were forms 8606 and 5329. Together they made sense. The excess contributed can not fully reduce the 1099-R withdrawal. Form 8606 calculates a fraction out of the total balance in all the IRAs.