Sometimes clients make Roth IRA contributions when they don’t qualify, for example if their income is too high, or if they don’t have any earned income. By entering the Roth contribution, most professional tax programs contain diagnostics that will check this and send out a warning to the tax preparer that the client does not qualify for a Roth contribution. Then that excess contribution can be either recharacterized as a traditional IRA contribution (if the client qualifies) or removed in a timely manner as an excess Roth IRA contribution so the client can avoid the 6% penalty.

If the Roth contribution is not entered and the client didn’t qualify, there would be no diagnostic report sent and this could be missed. We just came across a case where Roth IRA contributions were made for 19 years and the client, who had too much income, didn’t qualify in any of those years. A new advisor on the case picked this up and consulted us on fixing this up for all the back years. What a mess. I guess maybe the client was doing his returns by hand, happily contributing to a Roth each year, even though he never qualified.

B) Basis

When Roth IRA contributions are entered into a program, it can keep track of Roth IRA basis in case a client needs to take early withdrawals. Once a Roth IRA owner reaches age 59½ and has had a Roth for at least five years, all of the Roth funds are qualified and can be withdrawn totally tax- and penalty-free. But if distributions are taken before then, the client (and the CPA) will need to know the basis to determine how much can be withdrawn tax- and penalty-free. When the client enters Roth contributions, the tax program will track the basis available to be withdrawn tax- and penalty-free.

Under the Roth IRA distribution ordering rules, the first dollars out are deemed to come from Roth IRA contributions and are always free of taxes and penalties regardless of the client’s age or reason for the early withdrawal. The professional tax programs that most CPAs use keep the history on this and carry it over to each succeeding year. So if a client made Roth contributions years ago but is still under age 59½, the program will show the basis but only if annual Roth contributions are entered into the tax preparation program.

C) Retirement Saver’s Tax Credit

When the Roth contribution is entered, the tax program will know if your client qualifies for the Retirement Saver’s Tax Credit of up to $1,000 per person (up to a 50% credit, depending on the income, of the contribution amount, capped at $1,000 per person). See IRS Form 8880 for details on the tax credit. The credit is nonrefundable.

Granted, this only applies to lower-income workers, generally younger workers on their own after they have started out in the workforce, but anyone age 18 or over who is not a full-time student can qualify, as long as he or she is not somebody’s dependent.

We had a situation once where a client asked us to prepare his child’s tax return now that the child was working and on his own (a very common favor for clients). The client made the full Roth contribution for the child and because we entered that contribution in the program, the child qualified for an $800 tax credit. That would have been missed by a firm not entering that Roth IRA contribution even though it appeared to have no effect on the tax return. It did, and the client was thrilled. This one item will make a client remember you, as well as the CPA.

3. Check RMD Shortfalls