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rated:
Due to certain unforeseen circumstances, I am ineligible to contribute to my ROTH IRA for 2016. I contributed the maximum amount in the first week of 2016. My broker has reversed the contribution, and sent me a confirmation. Now the hard part is reporting this mistake to the IRS.

ROTH Contribution: $5500
Eligibility: $0
Earnings on the $5500: $848

Here are the two forms that I am filling out:

IRS-8606
Line 19: $6348
Line 22: $5500
Line 25: $848

IRS-5329
Line 1: $848
Line 4: $85

Line 23: $5500
Line 25: $330

This results in a total penalty of $415. It seems awfully excessive, which is making me question whether or not I completed the forms correctly. Has anyone made this mistake before?

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rated:
nasheedb said:   Due to certain unforeseen circumstances, I am ineligible to contribute to my ROTH IRA for 2016. I contributed the maximum amount in the first week of 2016. My broker has reversed the contribution, and sent me a confirmation. Now the hard part is reporting this mistake to the IRS.

ROTH Contribution: $5500
Eligibility: $0
Earnings on the $5500: $848

Here are the two forms that I am filling out:

IRS-8606
Line 19: $6348
Line 22: $5500
Line 25: $848

IRS-5329
Line 1: $848
Line 4: $85

Line 23: $5500
Line 25: $330

This results in a total penalty of $415. It seems awfully excessive, which is making me question whether or not I completed the forms correctly. Has anyone made this mistake before?

  I don't know what you mean by "reversed the contribution".
Assuming you had earned income and are eligible to make a (traditional) IRA contribution, the way to handle this would be to recharacterize the contribution. That makes it as if you made a traditional IRA contribution to begin with (instead of a Roth IRA) and there should be no tax penalty. Just that you will have 6348 in your trad. IRA. Your contribution may or may not be deductible, depending on your situation.

However, if you didn't have any earned income, you may not be able to make any IRA contribution. If so, perhaps taking the money out might be the way to go. 

ETA: If it turns out you just had to take the money out of the Roth IRA (recharacterization is not an option), you will not have to pay the 6% "additional tax" (line 25 in your calculation). See IRS linky; scroll down to the "Tax on excess IRA contributions" section. As long as you fix the error by the due date of your return (which you have done), the 6% additional tax should not apply.

rated:
That's correct, I had no "earned" income, so recharacterization is not an option.

rated:
no form to fill out, since you've removed the contribution and the earnings by filing deadline
Just treat the $848 as regular capital gain (S/T or L/T) and add to your income.

rated:
DeGlass said:   no form to fill out, since you've removed the contribution and the earnings by filing deadline
Just treat the $848 as regular capital gain (S/T or L/T) and add to your income.

  
Based on what I read here: http://www.investopedia.com/articles/retirement/04/042804.asp this doesn't appear to be correct. There is definitely a penalty.

rated:
DeGlass said:   no form to fill out, since you've removed the contribution and the earnings by filing deadline
Just treat the $848 as regular capital gain (S/T or L/T) and add to your income.

  The removed profits count as ordinary income, not capital gains, and are subject to penalty.  You could also just leave the excess contribution in and next year not contribute.  This gets you hit with a 6% penalty for the year, which stops when you correct it by not contributing the next years' worth.

http://www.obliviousinvestor.com/correcting-an-excess-roth-ira-c... 
https://www.bogleheads.org/forum/viewtopic.php?t=112185 

And for more messy examples:

https://www.financial-planning.com/news/a-tax-nightmare-excess-ira-contributions 
https://www.bogleheads.org/forum/viewtopic.php?t=206946 

rated:
And once again, the lesson from these threads is STOP doing IRA contributions until AFTER you've computed your taxes.

rated:
xerty said:   
DeGlass said:   no form to fill out, since you've removed the contribution and the earnings by filing deadline
Just treat the $848 as regular capital gain (S/T or L/T) and add to your income.

  The removed profits count as ordinary income, not capital gains, and are subject to penalty. 

Last time I checked, S/T gain = ordinary income, except the S/T gain can be used to absorb any losses carried forward from years past.
Cite the code where removing {2016 contribution + earnings attributable to the 2016 contribution} by Oct 15 2017 requires a 6% penalty on the earnings; otherwise, stop making stuff up.
xerty said:   
You could also just leave the excess contribution in and next year not contribute.  This gets you hit with a 6% penalty for the year, which stops when you correct it by not contributing the next years' worth.

That's just asking for trouble. Distribution of excess Roth contributions along with earnings should be the default protocol at retail brokerages; 1099R's will be issued and an amended filing may be needed.
The smart way is to remove the excess contribution along with the earnings, then decide to re-contribute after finishing taxes in 2018.

Asking brokerages to override the default procedures and leaving the excess profits behind is asking for trouble.

rated:

'xerty' said:
The removed profits count as ordinary income, not capital gains, and are subject to penalty.

DeGlass said:
Last time I checked, S/T gain = ordinary income, except the S/T gain can be used to absorb any losses carried forward from years past.

Cite the code where removing {2016 contribution + earnings attributable to the 2016 contribution} by Oct 15 2017 requires a 6% penalty on the earnings; otherwise, stop making stuff up.

You're being imprecise about short term capital gains - they are a separate kind of income and subject to NIIT and potentially other considerations in addition to possible offsets against any type of prior year carryforward losses or present year long term losses for that matter.

IRA distributions aren't capital gains, nor are they related to the trading activity that generated those funds except in very rare and specific circumstances.  The excess earnings will come out like any other IRA distribution and, since I don't think OP is 59.5 yet, those will be "early" IRA distributions and subject to the 10% penalty.  I didn't say it would be subject to the 6% annual excess contribution penalty - you're assuming something that won't apply if OP resolves his situation in a timely fashion.

xerty said: 
You could also just leave the excess contribution in and next year not contribute.  This gets you hit with a 6% penalty for the year, which stops when you correct it by not contributing the next years' worth.

That's just asking for trouble. Distribution of excess Roth contributions along with earnings should be the default protocol at retail brokerages; 1099R's will be issued and an amended filing may be needed.

The smart way is to remove the excess contribution along with the earnings, then decide to re-contribute after finishing taxes in 2018.

you're welcome to your own opinion, but your proposal is often not "the smart way" to handle this situation nor is it required.  Here's a nicely laid out description of the 4 possible options for resolving this type of situation:

http://fairmark.com/retirement/roth-accounts/contributions-to-ro... 
When you choose this method of correction [timely withdrawal of excess and associated earnings], you’re required to report and pay tax on the net income attributable to the excess in the year of the contribution, even if you take it out during the following year, before the return due date. The earnings will be taxed like any other taxable distribution of earnings from a Roth IRA, and will be subject to the early distribution penalty if you’re under 59˝ unless an exception applies.

If one has made meaningful investment gains on an excess distribution, paying 6% and using next year's non-contribution to resolve the excess allows all those profits to be retained in the IRA at the cost of 6% in non-retirement assets.  It's been an up market and this could well apply to OP.

 

rated:
OP - you've done a good job working on this so far.  If you want confirmation you've done it correctly, you might post it here on Ed Slott's IRA forum:

https://www.irahelp.com/forums/ira-discussion-forum 

and hope Alan S will reply to you.  He's the resident expert.   You can also search the archives there for many similar situations and their advice.  Some examples:

https://www.irahelp.com/forum-post/14433-figuring-out-earnings-excess-roth-contribution
https://www.google.com/search?q=slott+ira+alan+excess+ira+site:w...

rated:
Had the exact same issue, no earned income but made a Roth IRA contribution in January 2016. Here's what I did to fix it (filed with TurboTax):

1) Requested broker to remove the $5500 excess contribution and the associated earnings, which was around $1200.
2) Reported the entire withdrawal as a Roth IRA distribution (as a dummy Form 1099-R)
3) Only the earnings are taxable, $1200 in my situation.
4) Used code 8 and J
5) Since the excess contribution is removed, on Form 5329, "Excess Contribution to ROTH IRAs" should be blank.
6) Early distribution is subject to a 10% tax penalty, unless you have qualified expenses (higher education, home purchase, medical bills, etc.)
7) Attach a statement to explain the situation (TurboTax will prompt you for it)
8) When actual Form 1099-R for tax year 2017 is received next year, just discard it.

rated:
I have adjusted my tax return. Here is what it looks like now:

IRS-8606
Line 19: $6348
Line 22: $5500
Line 25: $848

IRS-5329
Line 1: $848
Line 4: $85

IRS-1040
Line 15a: $6348
Line 15b: $848

I feel pretty comfortable with this, and I think I will submit it this way. Thanks everyone for the help.

rated:
DeGlass said:   no form to fill out, since you've removed the contribution and the earnings by filing deadline
Just treat the $848 as regular capital gain (S/T or L/T) and add to your income.

  I suppose that as long as you don't get audited, you can just do anything, although I wouldn't recommend it.

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