For most of us, summer means the tax filing deadline sits firmly, thankfully, in the rearview mirror. However, the year-round work of the IRS continues, and mistakes made on tax returns can still catch their eye. One such common mistake is excess contributions to a tax-advantaged plan like a self-directed IRA. Fortunately, excess contributions can be corrected relatively easily.
What are Excess Contributions?
Each year the IRS updates contribution limits to a given plan, as well as income limits which, if exceeded, may impact the tax benefits of those contributions. Contributing in excess may mean exceeding the overall limit, or perhaps exceeding the available limit in accordance with one’s income. Correcting these can be fairly simple, and also prudent, as 6% penalties will be assessed each year the excess remains in the account.
How can you Correct Excess Contributions?
Taxpayers have several options when it comes to avoiding 6% penalties from the IRS:
Withdraw the Contribution
Perhaps the most straightforward method is to simply withdraw the excess deposit. Reporting the distribution as a withdrawal of an excess contribution means you won’t be responsible for taxes. However, any earnings attributable to the excess contribution must also be withdrawn and would be taxable. Calculating these earnings can be tricky, so contact your accountant or tax professional for assistance.
File an Amended Tax Return
The IRS understands individuals and businesses sometimes need more time to file their return. Accordingly, taxpayers can file an amended tax return until an extended deadline of October 15. So, even if you made an excess 2020 contribution all the way back in January of last year, you still have time to make it right. This option is only available to those who already filed their taxes. Note, however, you would also have to withdraw the excess balance as described above.
Apply the Contribution Toward Next Year
If you’d rather not deal with distributions or calculations of attributable earnings, you can leave your account balance intact. Doing so would subject you to the 6% penalty. That being said, you can avoid future 6% penalties by applying the excess balance toward next year’s contribution limit.
For instance, let’s say you make a $7,000 contribution this year when your limit is only $6,000. If you don’t want to withdraw the excess $1,000, you can leave it alone and pay the 6% penalty. To prevent additional penalties down the road, you could elect to only contribute $5,000 the following year (the annual limit minus the $1,000 excess and assuming the annual limit remains $6,000).
We’re Here for Your Account Needs
Much as the IRS provides the tools for fixing excess contributions, NDTCO provides the tools for managing your self-directed plans. To discuss your contribution and distribution options, please don’t hesitate to give us a call at 877-742-1270 or send us a message through the Client Portal.