By Theresa Cagle Fry, Senior Vice President and Manager IRAs, Retirement & Education Planning
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It’s tax season again. Whether you decide to tackle your tax return yourself or use a tax professional, it’s time to get organized as your tax forms begin arriving. If you took money out of your IRA last year, one of the forms you’ll receive will be the 1099-R. IRS Form 1099-R can be confusing because amounts reported as “taxable” don’t always result in an income tax liability, and items that may be reported as “early,” which are typically subject to a 10% IRS penalty, aren’t always subject to that penalty. Some types of IRA distributions require you to self-report your specific circumstances on your income tax return, so taxes and penalties are not applied.
If you received a 1099-R and it’s not quite what you expected it to say, don’t panic! Here are a few common situations where the 1099-R doesn’t need to be corrected, but self-reporting on your tax return is required:
- Rollovers between IRAs
- Qualified charitable distributions (QCDs)
- Distributions of non-deductible contributions
- Certain exceptions to the 10% early withdrawal penalty when you are younger than age 59½.
Rollovers Between IRAs
A distribution from an IRA that is rolled over into the same or another IRA is generally income tax-free if the rollover is completed within 60 calendar days, you have not completed any other IRA-to-IRA rollovers in the past 12 months, and you roll over the same “property” that was distributed to you.
There are also special rules for the repayment of certain types of early or disaster-related distributions. These repayments, when applicable, are not taxable to you even if they happen outside of the 60 days or you completed a rollover in the prior 12 months.
The 1099-R you receive will only report the distributions that were paid from the IRA. At the time the distribution is issued, a financial institution cannot know if you will be able to meet the conditions of a tax-free rollover or repayment. Therefore, the distribution shows on the 1099-R as taxable. When you complete your income tax return, you or your tax professional will have to report the rollover. IRS instructions for completing your tax return provide details on how to do this. The rollover deposit is reported on a separate tax form—Form 5498—sent to you and the IRS in May. Form 5498 does not have to be attached to your tax return, but it does provide verification of the completed rollover to both you and the IRS after you have reported it on your income tax return.
Qualified Charitable Distributions (QCDs)
Qualified charitable distributions are tax-free gifts made directly from your IRA to a qualified charity when you are age 70½ or older. For 2023, a QCD was limited to $100,000. In 2024, the amount increases to $105,000. Regardless of whether you use the standard deduction or itemize, a QCD is excluded from your taxable income and adjusted gross income (AGI). However, you cannot also include the QCD as a charitable gift if you itemize your deductions.
QCDs are reported on Form 1099-R as a taxable amount like other IRA distributions and must be excluded from income by you when you complete your tax return. IRS Form 1040 filing instructions explain how to do this. The charity should also provide you with a receipt for the gift for you to retain with your tax records. Keep in mind that if you also made deductible IRA contributions after the age of 70½, the amount of the tax-free gift reported as the QCD must be adjusted.
Distributions of Non-Deductible Contributions
Non-deductible contributions also must be reported by you on your income tax return. Contributions you make that are not tax deductible are reported on IRS Form 8606, which keeps track of the after-tax dollars in your IRA, so you do not pay taxes on them twice—on the way in and on the way out.
Because you keep track of your non-deductible contributions, when you take a distribution, the financial institution that holds your IRA is not able to determine how much of your distribution is taxable. On Form 1099-R, the amount will show as taxable, but with the “taxable amount not determined” box checked. Distributions from IRAs that include non-deductible contributions are taxed on a pro-rata basis. You will also use Form 8606 to compute the amount of distribution that is taxable and to determine the amount of non-deductible dollars that remain in the IRA after the distribution.
Exceptions to the 10% Early Withdrawal Penalty
When you receive a distribution from your IRA and you are younger than age 59½, the IRS may impose a 10% early withdrawal penalty tax in addition to the income taxes that are due. There are many exceptions to the 10% early withdrawal penalty, including distributions paid to you if you are disabled, or to a beneficiary after your death. But there are also some that are connected to what you use the distribution for. Examples for 2023 include IRA distributions used for:
- Purchasing your first home
- Qualified college education expenses
- Disaster-related expenses
- Qualified birth or adoption expenses
- Individuals diagnosed with a terminal illness
These types of distributions, among others, may qualify for an exception to the 10% penalty tax if you meet certain conditions established by the IRS. Financial institutions will generally report your distribution as “early distribution, no known exception” on Form 1099-R because you were younger than age 59½ at the time of the distribution.
If you are exempt from the 10% early withdrawal penalty, you must include IRS Form 5329 when you complete your income tax return to document the appropriate exception.
Tax season can be a confusing and stressful time. Your financial advisor is here to help and can work together with you and your tax professional as you navigate your way through another tax season.
IMPORTANT DISCLOSURES: The information provided is based on internal and external sources that are considered reliable; however, the accuracy of this information is not guaranteed. This piece is intended to provide accurate information regarding the subject matter discussed. It is made available with the understanding that Benjamin F. Edwards is not engaged in rendering legal, accounting or tax preparation services; therefore, it is important to consult with your legal and tax professionals for additional guidance tailored to your specific situation.