I made a IRA contribution for 2006 before realizing I could not deduct it for 2006 taxes. Can I undo it?

Question

Unfortunately, I made the contribution in time for April 17 deadline, but had not yet done my taxes. When finally doing them, I realized I had exceeded AGI limits for deducting the contributions. Since I can't deduct, I'd like to just cash out the IRA, but obviously don't want to pay a penalty to do so.

Any guidance? thanks

Appreciate the info so far. Publication 17 tells me, under TAX ON EARLY DISTRIBUTIONS (p. 74) that "This tax applies to the part of the
distribution that you must include in gross income." Earlier, there was discussion that only the interest would be taxable. Doesn't this imply then that only the interest would be subject to 10% penalty? Or am I reading it the way I want it?

Answer 1

Here is the information from an IRS publication:

In general, if the excess contributions for a year are not withdrawn by the date your return for the year is due (including extensions), you are subject to a 6% tax. You must pay the 6% tax each year on excess amounts that remain in your traditional IRA at the end of your tax year. The tax cannot be more than 6% of the value of your IRA as of the end of your tax year.

1. Excess contributions withdrawn by due date of return. You will not have to pay the 6% tax if you withdraw an excess contribution made during a tax year and you also withdraw interest or other income earned on the excess contribution. You must complete your withdrawal by the date your tax return for that year is due, including extensions.

2. How to treat withdrawn contributions. Do not include in your gross income an excess contribution that you withdraw from your traditional IRA before your tax return is due if both the following conditions are met:
* No deduction was allowed for the excess contribution.
*You withdraw the interest or other income earned on the excess contribution.

You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income you must withdraw may be a negative amount.

3. How to treat withdrawn interest or other income. You must include in your gross income the interest or other income that was earned on the excess contribution. Report it on your return for the year in which the excess contribution was made. Your withdrawal of interest or other income may be subject to an additional 10% tax on early distributions, discussed later.

4. Excess contributions withdrawn after due date of return. In general, you must include all distributions (withdrawals) from your traditional IRA in your gross income. However, if the following conditions are met, you can withdraw excess contributions from your IRA and not include the amount withdrawn in your gross income:
*Total contributions (other than rollover contributions) for 2006 to your IRA were not more than $4,000 ($5,000 if you are 50 or older).
*You did not take a deduction for the excess contribution being withdrawn.
*The withdrawal can take place at any time, even after the due date, including extensions

Answer 2

If you filed after 4/17, I assume that you filed an extension. If so another approach is this: Since you have till 10/15 to withdraw the funds you might do so, and if there is any growth, pay tax on it in 2007. Also, since the contribution was made in 2007 it is possible to count it as a 2007 contribution (if deductible in 2007). Contact the institution holding the IRA to find out whether and how this can be done.

One other approach might apply: if you included form 8606 with your tax return, you have established a "basis" in the IRA. That amount has already been taxed, and will not be taxed again when withdrawn. Depending on other of your circumstances, it migh be advantageous to convert this traditional IRA contribution to a Roth IRA.

What is best for you depends on many nuances, so unless you want to take the money and run, paying the penalty on the growth, if any, you might want to engage a pro to help you figure this out.

Good luck!

Answer 3

Sorry, but you cannot remove the funds after the due date of the return including any extensions. Assuming that this is not an excess contribution (an amount over and above the contribution limit for the year) but just a non-deductible one it will be partially subject to tax and penalty if withdrawn from the IRA. Since the contribution itself was not deductible, that portion will not be taxed but any gain since the funds were deposited will be fully taxed. Then entire distribution will be subject to the 10% penalty if you are under age 59 1/2.

Answer 4

If you contributed to a Traditional IRA you might be able to roll it over into a Roth IRA. You need to speak to the company or bank who handles your IRA.

Then again, it just might be a good idea to keep the money in the IRA.