The deadline for correcting an excess IRA contribution for the 2018 tax year is coming up. If the excess amount is not removed according to a special formula, a penalty tax of 6% will accrue on excess amounts that remain in the owner’s IRA.
An excess IRA contribution occurs when an IRA owner contributes more than the statutory limit to their IRA in a given year. For the year 2018, the IRA contribution limit was the lesser of $5,500 or 100% of earned income. An additional catch up contribution of $1,000 is available for individual’s age 50 or older.
An excess contribution can occur when an IRA owner simply contributes too much to their IRA in one tax year, such as by contributing more than the lesser of $5,500 or 100% of earned income.
For example: Say that in 2018, Mr. Smith, age 62 and single with earned income of $5,000 and rental income of $34,500, contributed $6,500 to his traditional IRA. Mr. Smith has made an excess contribution of $1,500 to his IRA ($6,500 minus the $5,000 limit). The contribution limit is the lesser of $6,500 or 100% of earned income. In this case, the rental income of $34,500 is not earned income.
Correcting an Excess IRA Contribution After Due Date
Individuals who contribute too much to their IRA have until their tax-filing deadline, including extensions, to correct any excess contribution. Individuals who file their tax returns by April 15th and file for an extension have six months to remove the excess amount, which for calendar year taxpayers is October 15, 2019.
If the excess amount is not removed according to a special formula, which determines the amount of the excess contribution plus interest or other income earned on the excess contribution, a penalty tax of 6% will accrue on excess amounts that remain in the owner’s IRA.