Correcting Overpayment to IRA

If you're not careful with your records -- and if you have multiple IRAs -- it can be easy to exceed the yearly IRA contribution limit. As of 2012, that limit is $5,000 for those under age 50 and $6,000 for all others. If you make an IRA contribution from your savings and then fail to earn at least the amount of the contribution during the tax year, you could also end up with an overpayment. To correct this issue, you have to withdraw not only the principal but also any earnings, or net income attributable. The IRS considers the NIA as taxable income for the year, so it must be calculated and reported.

Step 1

Find the IRA ending balance for the month before you made your excess contribution. For calculation purposes, this is the starting balance. You can check your monthly statement online or in print, or phone the IRA trustee to get the information. For example purposes, our starting balance is $100,000.

Step 2

Get the most recent month-end IRA account balance. This is the ending balance. Deduct the amount of your overpayment plus any contributions since the date of the overpayment, from the ending balance. If you have taken money out of the IRA since you made the overpayment, add those amounts to the ending balance. Continuing with the example, our ending balance is $105,000. We'll deduct an overpayment amount of $800 plus a separate contribution of $200. We'll add a distribution amount of $1,000. Net ending balance is still $105,000.

Step 3

Deduct the starting balance from the result. If you have made no contributions or distributions since the date of the overpayment, just deduct the starting balance from the ending balance. In our example, $105,000 minus $100,000 equals $5,000.

Step 4

Divide the resulting figure by the starting balance figure. In our example, $5,000 divided by $100,000 equals 0.05.

Step 5

Multiply the amount you overpaid by the result. The outcome is the net income attributable. To continue with our calculation, we'll use the overpayment figure of $800. $800 X .05 equals $40. Our net income attributable is $40. As to determining the amount of the overpayment, if you put $2,500 in an IRA but did not end up earning at least $2,500 during the tax year, the IRS views the $2,500 as an overpayment because IRA contributions must come from earned income. If your limit is $5,000, but you inadvertently contributed $5,800, your overpayment is $800.

Step 6

Add the NIA to the amount you overpaid. If your net income attributable is a negative figure, you reduce the overpayment amount accordingly. In our example, $800 + $40 equals $840. If the NIA had been -$40, the equation would be $800 - $40 = $760.

Step 7

Take a distribution in the amount of the NIA plus overpayment. The distribution must come out of the IRA to which the overpayment was made. You have to withdraw the money in time to meet the tax-filing deadline, typically April 15 of the year following the excess contribution. Those who apply for an extension of time to file have until October 15 to correct the overpayment. If you fail to correct the overpayment by the tax-filing deadline, you are liable for a 6 percent penalty. The 6 percent penalty remains in effect from year to year until the overpayment is corrected.

Step 8

Report the NIA amount as income when you file your income tax return. Most IRA owners who are not yet 59 1/2 also owe a 10 percent penalty tax on the NIA. If your NIA is a negative figure, you do not need to report that figure on your tax return.

Zacks Investment Research

is an A+ Rated BBB

Accredited Business.