Excess IRA contributions increasing taxpayer's basis.

• Author: Barton, Peter C.
• Position: Individual retirement accounts

In a case of first impression, the Tax Court recently ruled in Campbell, 108 TC No. 5 (1997), that an excess contribution to an individual retirement account (IRA) that had previously been taxed increased the taxpayer's basis in his IRA. Therefore, when the excess contribution was distributed to him, it was not included in his gross income a second time.

The statutory scheme determining this issue is complex. Sec. 408(a)(1) prohibits contributions to an IRA in excess of $2,000 per individual per year unless the contribution is a rollover contribution. In general, Sec 4973(b) defines "excess contributions" as contributions in excess of $2,000 per individual per year. Whether part or all of the $2,000 contribution is IRA IRA deductible depends on the taxpayer's income and participation in a qualified retirement plan. Prior to 1987, nondeductible contributions were not allowed and a taxpayer's basis in an IRA was zero. The 1986 Tax Reform Act (TRA) added Sec. 408(o), which permitted nondeductible contributions up to $2,000 per individual per year. Also, the TRA changed the rules on the taxation of IRA distributions.

For IRA distributions made after 1986, Sec. 408(d)(1) specifies that they are generally included in gross income as determined under Sec. 72. Sec. 408(d)(4) provides an exception to this rule for contributions to an IRA during a tax year that are distributed by the due date of the return (including extensions) for that year; such amounts are not included in gross income. Also, Sec. 408(d)(5) provides another exception for certain excess contributions to an IRA distributed after the due date of the return, if such contributions do not exceed $2,250. Finally, Sec. 408(d)(3) contains an exception for certain distributions that are rolled over.

In general, Sec. 402(a) specifies that distributions from qualified retirement plans are also included in gross income as determined under Sec. 72; there is an exception for certain rollovers made within 60 days of the distribution. However, Sec. 402(a)(5)(D) and (e)(4)(A) extended this exception to partial distributions only if the employee separated from the service of the employer. This requirement was repealed for distributions made after 1992.

Sec. 72(e) applies to IRA and qualified retirement plan distributions not received as annuities. Sec. 72(e)(2)(B) requires the distributions to be includible in income to the extent allocable to income on the contract and excludible to the extent...