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 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; and
- 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 rollover rules for the repayment of coronavirus-related distributions that were taken out in 2020 and repayment of disaster-related distributions. These repayments, which are reported as rollovers, are tax free even if they happen outside of the 60 days or if they were not the only rollover you completed.
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. 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 of up to $100,000 made directly from your IRA to a qualified charity when you are age 70 ½ or older. Keep in mind that you can only exclude the amount from income as a QCD. You cannot also take a tax deduction for the QCD as a charitable gift.
QCDs are reported on Form 1099-R as a taxable amount like other IRA distributions. There is no special code for a financial institution to use to indicate that a gift was made directly to a qualified charity or to distinguish it from normal distributions paid after age 59 ½. Therefore, QCDs must be self-reported on your tax return and IRS Form 1040 filing instructions explain how to do this. The charity should also provide you with a receipt for the gift they received to retain with your tax records. Keep in mind that if you also made deductible IRA contributions after the age of 70 ½, the amount of the tax-free gift reported as the QCD must be adjusted.
Distributions of Non-Deductible Contributions
Non-deductible contributions are also self-reported on your income tax return. Contributions you make that are not tax deductible are reported on IRS Form 8606. It 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 the financial institution that holds your IRA does not know if you claimed a tax deduction for the IRA contributions you made, when you take a distribution, they cannot know if it includes after-tax dollars. Therefore, Form 1099-R will show the entire amount as taxable. However, 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 59 ½, 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 include IRA distributions used for:
- purchasing your first home
- qualified college education expenses
- disaster-related expenses – such as for COVID-19 coronavirus-related distributions or other federally declared disasters
- qualified birth or adoption expenses
- 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.
Exceptions like these also require self-reporting on your income tax return. Financial institutions will generally report your distribution as “early distribution, no known exception” on Form 1099-R because you were younger than age 59 ½ at the time of the distribution. When you complete your income tax return, include IRS Form 5329 to document the appropriate exception that applies in your situation.
Tax season can be a confusing and stressful time. Your Benjamin F. Edwards financial advisor is here to help and can work together with you and your tax professional as you maneuver through this tax season.
Benjamin F. Edwards does not provide legal or tax advice, therefore it is also important to consult with your legal and tax professionals for additional guidance tailored to your specific situation.