Help...IRA tax problem

[tarawa52]

Hello all,
  Well I did a rather stupid thing...good intention, poor execution. Nov '13, I opened a traditional IRA with some spare cash. I failed to read the IRS publication prior the transaction and three months later discovered contributions must be from 'earned income'. I was/am FIRE with a pension as the sole income stream. Jan '14 I converted the IRA to a non-IRA account as I did not want to break any (more) tax codes. Is there any additional penalties besides 10% of $6.5K? The traditional IRA was only 3 months old, is there a legal escape route with the IRS? To bad the agency does not accept 'face punches' as an alternative to fines. Thanks for any advice!

[TN_Steve]

Looks like you did not file a tax return with the IRA contribution on it, correct?

You appear to be ok, since you corrected it by converting everything back to regular account in Jan 2014, presumably before filing.  BTW, are you certain that the 10% penalty was/is even necessary?

Although I've not dealt with this issue before (hence, no IRS cites), Investopedia has a couple pages on point:

To correct an excess contribution, an individual must remove the excess amount and any applicable income from the IRA by the owner's tax-filing deadline, which is generally April 15. But if you miss the April 15 deadline, you may still be able to make the correction, as individuals who file tax returns by April 15 receive an automatic six-month extension on the deadline for removing the excess amount. An excess contribution that is not removed by the deadline accrues a 6% penalty for every year it remains in the IRA. ....

http://www.investopedia.com/articles/retirement/04/033104.asp  And, even more pertinent for you, I think:

3. Distribution of the entire balance is sufficient for correction of excess.
If the excess amount is the only contribution made to the IRA and no other contributions, distributions, transfers or recharacterizations occurred in the IRA, the IRA owner may correct the excess by simply distributing the entire IRA balance by the applicable deadline.

http://www.investopedia.com/articles/retirement/04/042804.asp

[tarawa52]

Thanks TN_Steve! Your post was most helpful. I was looking at the problem as a premature IRA distribution rather than, as you suggested, an excess IRA contribution. My conversion from a IRA to non-IRA account was prior to 15 April so I will be o.k. I will have to pay a small capital gains tax but nothing more. Kind regards.