By Beverly DeVeny
Director of Retirement Education
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There are certain events that will require the filing of special forms or tax documents when you file your income tax return. If you have received a distribution from any retirement account, real or deemed, during the year, or if you have done a Roth IRA conversion - even if you did a total recharacterization - or if you have incurred a penalty or additional taxes in a retirement account during the year, you will have to tell IRS about any of these events. Following is what you need to know:
Retirement Account Distributions
Any time you take a distribution from a retirement account, a 1099-R must be issued to you by the IRA custodian or employer plan administrator. The 1099-R must be issued and sent by the end of January of the year after the distribution. You should always be sure that you receive a 1099-R for each account from which you took a distribution for the year and that it is accurate.
There are times when you might receive a 1099-R when you did not actually receive any funds. For example, funds were taken from your account for an IRS levy, or because you had a plan loan which either defaulted or was offset against your employer plan balance, or you had 100% of the funds withheld for income taxes. These 1099-R forms must also go on your income tax return. Even though you did not receive any actual cash in these distributions you had the use of the funds. They paid off your tax bill or your plan loan and thus are taxable income to you.
For additional reporting requirements of a Roth IRA distribution when the Roth owner is under age 59½, see the Roth IRA Conversions section.
Roth IRA Conversions
Reporting a Roth IRA conversion is not just as simple as including the amount on the 1099-R on the tax return. You also have to file Form 8606 to report the conversion - and to calculate the amount of tax on the converted funds.
Why the tax calculation? Form most individuals it is not necessary if all of their IRA funds are pre-tax funds. But when any IRA account has after-tax funds in it, any distribution from any IRA account - including SEP and SIMPLE IRAs - will mean that the pro-rata rule must be used. You cannot take a distribution of after-tax amounts only.
The pro-rata rule says that all distributions will consist of some pre-tax and some after-tax amounts. For example: Tom has $45,000 in his IRA when he makes an after-tax contribution of $5,000 with the intent of converting that $5,000 to a Roth IRA as a tax-free conversion. The pro-rata calculation on Form 8606 will show that Tom's $5,000 Roth conversion actually consists of $4,500 in taxable dollars and $500 of after-tax dollars ($5,000 / $50,000 = 10% so 10% of the distribution is after-tax dollars). The remaining $4,500 of Tom's after-tax contribution remains in the IRA to be partially included in his next distribution.
Form 8606 is also used for determining the income tax due on an early Roth IRA distribution - one which is made before the 5-year holding period is up and before the IRA owner is age 59½, or dead, or disabled, or if the distribution is for a first-time home purchase.
Additional Penalties or Taxes Due
Sometimes we make a mistake with our retirement accounts. We might forget all or some of an RMD or we might make an ineligible contribution to an IRA or a Roth IRA. Or, we might need some of those retirement funds before we are age 59½. These things trigger penalties or additional taxes.
The penalties or additional taxes are reported on Form 5329 which should be filed with our tax return for the year of the transaction. But many times we don't realize we have a problem until after the return is filed. There is no need to amend your tax return. Why? Because Form 5329 has its own signature line and is therefore considered a stand-alone tax return.
This can be good, or it can be bad. It is good that you do not have to amend an earlier return. It is bad in that if the form is not filed, the statute of limitations on the transaction does not start to run. IRS can come back to you years later and assess the penalty or tax, plus interest, and can also hit you with failure to file penalties, plus interest, and, if the mistake is large enough, you can be hit with accuracy related penalties, plus - you guessed it - interest.
The form is used for calculating and collecting the excess contribution 6% penalty which is due for each year that the excess amount remains in the IRA account. It is also used for calculating and collecting the excess accumulation (missed RMD) 50% (that is not a typo) penalty. This penalty, unlike the others, can be waived for good cause. You have to be sure that the last line on the form has a zero in it and the letters "RC" on the line. You also have to submit a request for a waiver. This request should be short and explain why you would qualify for a waiver of the penalty.
Lastly, the form is used in early distribution situations. It is used to calculate and collect the 10% penalty when it is owed on a distribution. It is also used to tell IRS when a distribution is not subject to the penalty. There is a list of exception codes on the form that you can use to avoid the penalty if you meet the requirements for the exception.
This form is sent to IRA owners at the end of May. It will give your year-end account balance and will note any contributions made to the IRA account for the prior year. A copy is sent to IRS also. This form is strictly informational and is not needed for a tax return.
This form is rarely needed. It is filed by the IRA custodian for the IRA when the IRA owes any income tax on unrelated business income or debt financed income.
You can find more information on any of these forms or their instructions on the IRS website, www.irs.gov.