How to Report Excess Traditional IRA Contribution

[LSGM]

Client made a nondeductible contribution of $6,500 to a traditional IRA on 4/13/22 for the 2021 1040 but had no earned income on 2021 1040.  (It was mistakenly treated as a SEP contribution on 2021 1040 which was also not deductible.)  The $6,500 excess was NOT withdrawn before 12/31/22 and is still in the traditional IRA account as of 3/10/2023.  

1.  Should the 2021 1040 be amended to show the excess $6,500 on form 5329 and $390 additional tax due, i.e., 6% penalty on excess?   (10% penalty not applicable as client is over 59 1/2.)

2.  If #1 is the correct approach, and contribution is not deductible on 2022 1040, can it be withdrawn before April 15, 2023 and avoid the 6% penalty for 2022?

3. If not, is it reported on 2022 1040, line 15 of Form 5329, with another penalty due on line 17?

4.  By what date should it be withdrawn to avoid further penalties?

Input will be greatly appreciated.

[qbteachmt]

I need to break this down a little...

"It was mistakenly treated as a SEP contribution on 2021 1040 which was also not deductible.)"

Which means it is not also a nondeductible Traditional IRA contribution, as you put in the title. It isn't both. And that is associated to a business return, so are you sure it isn't (for instance) part of the Sched C info? Specifically, which account Type did this get put into, and how it is listed on the 1040?

"The $6,500 excess was NOT withdrawn before 12/31/22"

If it is for tax year 2021, you have until the tax filing due date of the return plus the time of extension to be considered timely filed (Oct 2022). However, that goes back to the employer, which typically means amending the return. Now that would include amending 2021.

"and is still in the traditional IRA account as of 3/10/2023."

Then the error carries over for 2022, as well.

"1. Should the 2021 1040 be amended to show the excess $6,500 on form 5329 and $390 additional tax due, i.e., 6% penalty on excess? (10% penalty not applicable as client is over 59 1/2.)"

The over 59 1/2 would apply at the time of distribution. But that doesn't go back to the employee. You'll have to do some research.

"2. If #1 is the correct approach, and contribution is not deductible on 2022 1040, can it be withdrawn before April 15, 2023 and avoid the 6% penalty for 2022?"

I think you are trying to apply some sort of carry over rule? "Excess contributions left in the employee's SEP-IRA after that time will be subject to the 6% tax on the employees' IRAs, and the employer may be subject to a 10% excise tax on the excess nondeductible contributions."

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-seps

"4. By what date should it be withdrawn to avoid further penalties?"

ASAP. That stops the bleeding.

I've not run into this for SEP, so am not much help; you need to do the research. This reply assumes you are working for "taxpayer as employer/employee."

[LSGM]

So sorry, I did not explain the SEP mix-up clearly.      It isn't both...it is not a SEP.  It is a traditional IRA contribution only.  Contribution mistakenly categorized as a SEP contribution and entered on the proseries tax year 2021 SEP worksheet as SEP contribution for the Schedule C.    Because there was no self-employment income after expenses on the Schedule C, it did not appear anywhere on the 2021 1040.  total $6,500 was to be withdrawn so no action taken to treat it as excess on the return.    Diagnostic said "no self-employment income for pension plan...contribution deduction will not calculate until self-employment income is present....treat as excess contribution to a SEP."  

Since the tax filing due date for the 2021 1040 of 10/15/22 has already expired, taxpayer can no longer withdraw contribution before that date and avoid penalty.  Hence the question:  shouldn't it be reported on 2021 1040X and 6% penalty paid. 

Carryover:  Because excess was not withdrawn in 2021, it carried over to the 2022 1040.  If it can be deducted on the 2022 return, will the 6% penalty for 2022 apply?

Will continue to research.  I've not run into IRA or SEP excess contribution issue...hence the request for critique and input.

[qbteachmt · Accepted solution]

Okay, here's how I would do it:

An SEP would be based on the business income. That amount isn't SEP, but IRA limit ($6,500). Clearly an error. The 2021 tax return reported it as SEP, so you would amend that.

Next, it was, in fact, excess = disallowed. That means reporting it and paying the excise tax(es).

That amendment would change it from SEP to disallowed IRA. Now you straightened out the nature of the error and can get on with corrective actions. Typically, that would be: Take the corrective action(s) in 2023. Penalty will be incurred in 2023. Address it on the 2022 tax return. For 2023, there will be a 1099-R for the distribution for P = prior year.

If the person can apply the excess to 2022, that allocation (call it early contribution) will eliminate needing to be removed. Otherwise, it needs to be removed (or allocated to 2023). Plus earnings, although things are not going well right now.