There are several ways you might have contributed too much to your IRA. Maybe you contributed the full amount to both a traditional and a Roth IRA. Maybe you set up an automatic monthly contribution and forgot to shut it off before you exceeded your contribution limit. Maybe you got a graduation gift from Granny, and you plopped it into an IRA even though you were IRA-ineligible. Hey, maybe you just screwed up. It happens. Fortunately, the IRS allows you to fix your mistake. But do it quickly because the IRS also imposes a penalty, and that penalty gets applied annually until you correct the overpayment.
Excess Contribution Definition
Any amount greater than the IRS-imposed contribution limit – $5,000 in 2012 for people younger than 50 – or your earned income for the year, whichever is smaller, constitutes an excess contribution. Earned income comprises wages, salaries and tips from Box 1 of your W-2; commissions; net self-employment income minus half your self-employment tax; alimony; and tax-exempt military pay.
If the excess contribution is not withdrawn by the date your tax return is due – including extensions – you are subject to a 6 percent tax on the amount over your contribution limit. For example, if you contributed $500 more than you were eligible, the excise tax would be $30. An additional $30 must be paid for each year the extra amount stays in the IRA. Generally, you use Form 5329 to report the tax for excess contributions.
Withdrawing the Excess
If you discover the excess contribution before you file your tax return, you won't have to pay the excise tax if you withdraw the contribution and income earned on the excess contribution. The transaction must be completed by the date – including extensions – your return is due. The withdrawn contribution doesn't need to be reported as income, but you must include any withdrawn investment growth or income as part of your gross income. It will be considered an IRA distribution, which means you'll have to pay a 10 percent tax penalty on the amount as an early withdrawal if you're younger than 59 1/2.
Factoring in Investment Loss
The IRS allows you to account for any investment loss on the excess contribution when figuring the amount to withdraw. In most cases, the amount to withdraw – whatever the investment outcome of the excess contribution -- will be figured by your IRA custodian.
Applying the Excess Later
If you discover the excess contribution after you've filed your return, you can correct the mistake by using the excess contribution as part of your IRA contribution the following year. For example, if you contributed $500 too much in 2010, you can apply the $500 as part of your IRA contribution for 2011. That would cut your maximum new contribution for 2011 to $4,500 – or $500 less than your earned income total, whichever is lower. You still must pay the 6 percent tax penalty for 2010, but you won't have to go through the mechanics of withdrawing the excess contribution or dealing with investment performance. However, you can deduct only the amount actually contributed – $4,500, for example – in the current year.
Earlier Excess Contribution
If you discover an extra contribution from more than a year earlier, you must pay the 6 percent excise tax for all the years the excess remained in your account, but you can remove the excess contribution without considering it part of your gross income for that year by filing Form 1040X, an amended return. But this stuff gets complicated pretty quickly. If you find yourself in such a situation, contact your IRA custodian and a tax professional to help you get it fixed.
Combined IRA, Roth Excess
Your combined contribution to a traditional IRA and a Roth IRA determines whether you reach the annual contribution limit. If your overall contribution limit is $5,000, and you put $2,000 in a traditional IRA and $4,000 in a Roth IRA, you've contributed $1,000 too much. The IRS does not allow you to choose which contribution to fix. Contributions first are applied to traditional IRAs, so the excess must be withdrawn from the Roth IRA.