3669 / What is the penalty for making excess contributions to an IRA?

Editor’s Note: The SECURE Act 2.0 created new statutes of limitations (SOLs) for the penalties that apply to excess IRA contributions and missed RMDs.  The SOLs will now start to run immediately while, under prior law, the clock did not begin until the taxpayer filed Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts (meaning that the IRS often had an unlimited amount of time to act if the taxpayer did not file the form).  However, the Tax Court recently ruled that the new SOL on excess contribution penalties was not retroactive (so did not apply for cases where the penalty was incurred prior to the enactment of SECURE 2.0 on December 29, 2022).¹  The case serves as a warning for clients with missed RMDs or excess contributions from years prior to 2022 that have not yet been corrected.

If contributions are made in excess of the maximum contribution limit for traditional IRAs ( Q 3656) or for Roth IRAs ( Q 3659), the contributing individual is liable for a nondeductible excise tax of six percent of the amount of the excess for every year the excess contribution remains in the IRA (not to exceed six percent of the value of the account or annuity, determined as of the close of the tax year).² A contribution by a person ineligible to make the contribution is an excess contribution even if it is made through inadvertence.³

In the case of an endowment contract described in IRC Section 408(b), the tax does not apply to amounts allocable to life, health, accident, or other insurance.⁴ It also does not apply to premiums waived under a disability waiver of premium feature in an individual retirement annuity.⁵

The penalty tax does not apply to “rollover” contributions to a traditional IRA or “qualified rollover contributions” to a Roth IRA.⁶ It does apply, however, if the “rollover” contribution does not qualify for rollover. The Tax Court did not accept the argument that an IRA created in a failed rollover attempt is not a valid IRA and, thus, the six percent penalty should not apply.⁷ Likewise, a failed Roth IRA conversion that is not recharacterized is subject to the six-percent penalty (the right to recharacterize IRA-to-Roth IRA conversions has generally been eliminated for tax years beginning after 2017, although recharacterizations to correct an excess contribution should remain permissible absent further guidance to the contrary).⁸