Morton Fox (mortonfox) wrote,
Morton Fox

Taxable Tuesday

Philadelphia Fish Hatchery and Boat Launch

It was close to 40°F during the day but the temperature dropped in the evening and it started snowing lightly.

I started doing my taxes about a week ago, but my tax information is still trickling in. I expect most of it to arrive in the first half of February. The tax refund meter still shows a positive number but since I'm only about 10% done, I don't expect it to stay that way.

In tax year 2005, I added too much to my Roth IRA. It's a Catch-22 because I actually did not know how much I could contribute until I did my taxes. On the other hand, if I waited until I knew, I'd have missed out on a year's worth of gains. (Same situation in tax year 2006 unfortunately.) But it's not a problem because I merely instructed the custodian to withdraw my excess contribution. So that's that, right?

Not quite. In January this year, I got a 1099-R for that withdrawal. Under Roth IRA rules, withdrawals of annual contributions are tax-free. However, between the time the money went into the IRA and the time the money left the IRA, there was a significant capital gain. The portion of that gain attributable to the excess contribution had to be withdrawn too. (How that portion is calculated is another story.) That is taxable. The funny thing is it is actually taxable in tax year 2005, so no matter what, I would have to file a 1040X (amended tax return) anyway. Fortunately, I hadn't yet uninstalled Taxcut 2005 (I still have Taxcut editions installed for every year since 2002!) so I used it to figure out the 1040X and the adjustments.

One problem I thought of is adjustments like this tend to cascade throughout the entire tax return and all the worksheets. So, what if the taxable gain from the 1099-R changes the amount that I'm eligible to contribute to the Roth IRA? Then I'd have to take more money out, get another 1099-R, and file another 1040X. This could continue iteratively until the adjustments fall below the phase-out $10 increment! Ugh. I don't even want to think about that. (Seriously though, there is some slack since I withdrew a bit more than was necessary in anticipation of a gotcha like this. I hope that is enough. But imagine what would happen if you were at the borderline in qualifying for certain deductions or credits, or in assessing the penalty for underwithholding. Filing a 1040X could have far-reaching consequences.)

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