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The New Rule for Correcting IRA Excesses in 2018

Susan Diehl

First, let’s look at an operational procedure we have all used since the inception of IRAs, specifically the timely correction of an excess IRA contribution under Internal Revenue Code Section 408(d)(4). This section of the law provides a timeframe in which a contribution can be returned to the participant that will not result in a taxable distribution provided that three requirements outlined in subparagraphs (A), (B) and (C) are met.

The first sentence of 408(d)(4) must be read very carefully in order to understand the three requirements in those subparagraphs. It states:

“…Paragraph (1) [dealing with taxation of distributions] does not apply to the distribution of any contribution paid during a taxable year (year in which) to an individual retirement account or for an individual retirement annuity if:

(A) such distribution is received on or before the day prescribed by law (including extensions of time) for filing such individual’s return for such taxable year [referring to the year during which the contribution was made],

(B) no deduction is allowed…, and

(C) such distribution is accompanied by the amount of net income attributable to such contribution [with such net income attributable being treated as taxable].

The next sentence also provides that any net income attributable is “deemed” to have been earned and received in the year in which such contribution is made. Again, this is consistent with the deadline to return such a contribution.

Note: The interpretation and statutory intent was always very clear: the individual has until his or her tax return deadline, including extensions, of the year in which the contribution was made to avoid that amount being treated as a taxable distribution from the IRA. Section 408(d)(4) not only relates to removing a true excess, but also to removing any “unwanted” contribution.

New IRS Interpretation for 2018 and Beyond

The IRS has re-interpreted the language in Section 408(d)(4), changing the method of timely correcting an excess IRA contribution. The pending regulations will describe this in detail, but this change will affect tax reporting (and likely programming), your administrative forms, and IRA disclosures.

Under the new interpretation, the corrective distribution of an excess IRA contribution (or unwanted contribution) under Section 408(d)(4) must paid to the individual no later than the deadline to file their federal income tax return (including extensions) for the year for which such contribution was made.

Example: Janice makes a 2017 contribution on March 2, 2018. For a timely correction, Janice must remove the excess or “unwanted” contribution by October 15, 2018 (the deadline for 2017 plus extensions).

Comparing the above example to pre-2018:
Old Interpretation: the deadline for filing the Federal income tax return (including extensions) for the year during which such contribution was made.

Example: Looking at the example above, the timely correction for Janice would have been by October 15, 2019 (the 2018 tax filing deadline (plus extensions).

Some things did not change. The timely distribution must still include the earnings (or loss) attributable to the returned contribution. Earnings are still taxable in the year during which the contribution was made rather than the year it was distributed. The IRS suggests that you inform the participant about the taxation of the earnings at the time of the distribution. Use Code 8 (current year) or P (prior year) to indicate the year the earnings are taxable.

Update Your Institutions Forms!

Take the time now to update your IRA documents, specifically the disclosure and any forms that may be incorrect beginning 1/1/2018. Also make sure that your system, if applicable has the appropriate changes.

IRA Proposed Regulations

Under the Treasury/IRS Agenda (RIN Number 1545-BL99), the new IRA proposed regulations are slated to be issued on 12/00/2017 (Not a typo!). They will be issued in proposed format and may possibly contain other changes as well as new financial disclosure data. We will certainly keep you posted!

Susan D. Diehl, CPC, QPA, ERPA, is President of PenServ Plan Services, Inc. and Chair of the NTSA Communications Committee.

Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA or its members.