Monthly Tax Tip - September 2011

Taxpayers that want to correct an excess or unwanted contribution to an individual retirement account (IRA) for the 2010 tax year have until October 17, 2011 to make the correction if they have timely filed their tax return or have a valid extension of time to file their income tax return.

Unwanted contributions can be corrected by either withdrawal or recharacterization by October 17, 2011. Withdrawal requires that the 2010 IRA contribution along with income attributable to the contribution be returned to the taxpayer. The income attributable to the contribution is something that would normally be determined by the IRA trustee or custodian. The return of the contribution is not taxable to the taxpayer but any income attributable to the contribution must be included as income in the taxpayer’s income tax return in the year the contribution was made. Generally the income earned on the contribution is subject to a 10% additional tax unless the distribution was made after the taxpayer reaches age 59 1/2. Unwanted contributions made for 2010 cannot be corrected after October 17, 2011.

Recharacterizing a 2010 IRA conversion to a Roth IRA back to a traditional IRA (for example, because of a stock market decline) requires that taxpayer notify the IRA trustee(s) of certain information about the transfer and request a trustee-to- trustee transfer before October 17, 2011. The taxpayer cannot recharacterize and reconvert an amount back to a Roth IRA (for a second time) during the same tax year, or, if later, during the 30 day period following a recharacterization. If the taxpayer reconverts during either of these periods, it will be a failed conversion.

An excess contribution is an IRA contribution above the amount allowed by law. Excess contributions made in 2010 can be corrected if the excess contribution and income attributable to excess contribution is withdrawn by October 17, 2011. The return of the excess contribution is not taxable to the taxpayer but any income attributable to the contribution must be included as income in the taxpayer’s income tax return in the year the contribution was made. Generally the income earned on the contribution is subject to a 10% additional tax unless the distribution was made after the taxpayer reaches age 59 ½. An excess contribution for the 2010 tax year can also be corrected by withdrawal after October 17, 2011; however, a 6% excise tax will be applied to the excess contribution in addition to the taxation mentioned above.

An amended 2010 tax return is generally required to be filed if the taxpayer withdraws or recharactrizes an IRA contribution after the original filing of a 2010 tax return.

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