- quote -

As far as I can tell from reading up on this, the earnings
from the excess contribution is income to the *beneficiary*,
not to the grantor. So there isn't a simple circularity for
a parent/child Coverdell ESA.

--
John Kohl <jtk+m1x[at]kolvir.arlington.ma.usHacking on NetBSD/i386 on occasion. See also <http://www.NetBSD.org/> .

<< ================================================== ===== > << The foregoing is intended for educational purposes only > << and does NOT constitute legal OR professional advice. > << > << The Charter and the Guidelines for submitting > << messages to this newsgroup are at www.asktax.org. > << Copyright (2005) - All rights reserved. > << ================================================== ===== >

There is no (runaway) circularity because contributions to a
Coverdell are not deductible and therefore do not reduce
modified AGI; conversely, therefore, withdrawals of excess
contributions will not increase modified AGI. See p.39 of
Pub. 970, 2d paragraph, beginning with "What is the tax
benefit of the Coverdell ESA."

The slight increase ocassioned by the requirement that the
income attributable to the excess contribution also be
withdrawn and included as (additional) income for the year
of original contribution will not cause a runaway
circularity; the feedback effect of that additional amount
will go to zero if you do the calculations on an iterated
basis, resulting in a final, grossed-up amount that must be
withdrawn as the excess contribution.

For example, assume that TP discovers that she contributed
$100 too much for 2005, and that she withdraws that amount,
plus the $3 of income (earned at a rate of 3% for a full
year) by June 1, 2006. That $3 increases her MAGI, meaning
that she now has another $3 of excess contributions, which
must be withdrawn, along with the income of ($3 * .03 =
$0.09) thereon. That $0.09 is further additional income,
which constitutes a further excess contribution, which must
be withdrawn, along with the income of ($0.09 * .03 =
$0.0027, which rounds to $0). Since the last amount of
additional income to be withdrawn is $0, no further
iterations are required. The total amount she must withdraw
is therefore equal to: $100 + $3 + $0.09 = $103.09, and the
$3.09 will be additional income for 2005.

Alternatively, just solve for the infinite series by
multiplying the initial excess contribution amount ($100) by
the infinite sum 1+S=(.03)+(.03)^2+(.03)^3+... = 1.03092...,
which leaves you with $103.092... which rounds to $103.09.
The solution is as follows: take the decimal rate at which
the initial excess earned income, express it as a fraction
in lowest terms (e.g., 3% = 0.03 = 3/100), take the inverse
of that amount (e.g., 100/3) and subtract 1 (e.g., 100/3 =
33.3333... -1 = 32.3333....); next, take the inverse of the
result obtained (e.g., 1/32.333....) add 1 to it (e.g., 1 +
1/32.3333...) and multiply the initial excess contribution
by that amount. The result is the total amount that will
have to be withdrawn from the account as an excess
contribution.

As you can see, assuming an initial excess of $100, the
positive feedback into MAGI quickly converges to an amount,
$103.09, that is only slightly higher than that initial
amount.

Thus, while there is a certain amount of circularity, it
isn't divergent and won't cause a spectacular meltdown.

As a practical matter, a taxpayer in the phaseout range can
either (a) slightly overcontribute during 2005, and then
withdraw the excess, as calculated above, prior to June 1,
2006, or (b) undercontribute during 2005 and then make a
fill-up contribution at year-end when her MAGI is known.
Assuming that your account is earning income, and assuming
that the withdrawal transaction fees won't be greater than
the amount of additional income that has to be withdrawn, it
might be worthwhile to overcontribute a little and withdraw
the grossed-up excess just in time to timely complete your
tax return for 2005.

<< ================================================== ===== > << The foregoing is intended for educational purposes only > << and does NOT constitute legal OR professional advice. > << > << The Charter and the Guidelines for submitting > << messages to this newsgroup are at www.asktax.org. > << Copyright (2005) - All rights reserved. > << ================================================== ===== >

John Kohl wrote:

- quote -

The cirularity is there, but minimal (unless you found a stock
that grew 10 fold during that time it was in the coverdell).

Say the return is 100% during the year. (you doubled the $2000
deposit) And your income is $205K. Well, $1000 of the $2000
is disallowed along with $1000 of earnings. The $1000 of
earnings added back to AGI disallows $67 worth of deposit (you
lose $67 for eack 1K of income since the spread from 190-220
is 30K). That $67 had $67 worth of return disallowing another
$1 worth of deduction. So it ends there.

In sum, you'd add back $1068 of earnings and withdraw the
original $1068 as well.

Of course, on can contrive a more extreme case, where your
$2000 grew to $20000, in which case the circularity indeed
would wipe out and chance to deposit.

You do realize, that you may gift the $2000 to your child,
and assuming they don't have a huge income, can make the
deposit themself. And eliminate this concern altogether.

JOE

<< ================================================== ===== > << The foregoing is intended for educational purposes only > << and does NOT constitute legal OR professional advice. > << > << The Charter and the Guidelines for submitting > << messages to this newsgroup are at www.asktax.org. > << Copyright (2005) - All rights reserved. > << ================================================== ===== >

John Kohl wrote:

- quote -

Contributions to a Coverdell ESA are NOT deductible, so there
should be no change in your AGI whether you contribute or not.
I don't see your problem. How high can the earnings be on a
$2K contribution, even if for the entire year?

<< ================================================== ===== > << The foregoing is intended for educational purposes only > << and does NOT constitute legal OR professional advice. > << > << The Charter and the Guidelines for submitting > << messages to this newsgroup are at www.asktax.org. > << Copyright (2005) - All rights reserved. > << ================================================== ===== >

IRS Pub 970 says that the earnings on an excess coverdell
contribution are taxable in the year of the excess
contribution. This sets up a circularity in the
calculation, however. AGIs between 190k and 220k (MFJ) have
a phased-out contribution limit. If MFJ taxpayers
contribute $2k in 2005, then find that 190k < AGI < 220k,
they need to withdraw the excess and its earnings before
June 1, 2006, to avoid penalties. But by withdrawing the
earnings, the AGI increases, leading to a larger excess.

It seems like it's not possible to contribute the maximum
under the phase-out this way. Instead, the taxpayer needs
to under-contribute during the calendar year, figure out the
phase-out limit, and contribute the remainder before the tax
return due date.

Any other way to contribute during the calendar year,
correct any excess contribution, and exactly meet the
contribution limit?

--
John Kohl <jtk+m1x[at]kolvir.arlington.ma.usHacking on NetBSD/i386 on occasion. See also <http://www.NetBSD.org/> .

<< ================================================== ===== > << The foregoing is intended for educational purposes only > << and does NOT constitute legal OR professional advice. > << > << The Charter and the Guidelines for submitting > << messages to this newsgroup are at www.asktax.org. > << Copyright (2005) - All rights reserved. > << ================================================== ===== >