By Theresa Fry, Senior Vice President and Manager, IRAs, Retirement and Education Planning
With tax season in full swing, it’s that time of year when your daily trip to the mailbox likely includes tax form after tax form. If you have taken distributions from an IRA, one of those forms will be Form 1099-R. Receiving a 1099-R for your IRA doesn’t necessarily mean your distribution will result in a tax liability. Some types of IRA distributions require you to self-report special circumstances on your income tax return. A few common scenarios where this might happen are:
- Rollovers between your IRAs;
- Qualified Charitable Distributions;
- Distributions of non-deductible contributions; and
- Certain exceptions to the 10% early withdrawal penalty if you are younger than age 59 ½.
Rollovers Between Your IRAs
Rollovers between IRAs are tax-free if you roll the distribution you received from your IRA back into the same or another IRA within 60 calendar days and you have not completed any other IRA-to-IRA rollovers in the past 12 months. The rollover must be made into the same type of IRA and must be of the same property you received. For example, you cannot take a distribution of shares of a security from your traditional IRA, sell the shares, and roll over the cash proceeds you received from the sale into your traditional IRA.
The distribution you take from the IRA is reported on Form 1099-R to you and the IRS by the financial institution that holds your IRA. At the time the distribution is issued, there is no way for a financial institution to know if you will be able to meet the conditions of a tax-free rollover. Therefore, codes that are used in Box 7 of the 1099-R will only reflect if it is a “normal” distribution (because you were age 59 ½ or older at the time of the distribution), or “early, no known exception” (because you were younger than age 59 ½ at the time of the distribution).
When you complete your income tax return, you or your tax professional will have to self-report the rollover to the IRS. IRS instructions for completing your tax return provide details on how to do this. The rollover deposit itself is reported on a separate tax form – Form 5498 – to you and the IRS in May. Form 5498 is not available at the time you complete your tax return for the year of the rollover, so it 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 self-reported it.
Qualified Charitable Distributions
Qualified Charitable Distributions (QCDs) are gifts of up to $100,000 made directly from your IRA to a qualified charity. QCDs are not included in taxable income on your federal income tax return if you are age 70 ½ or older at the time of the distribution. They also count toward any required minimum distribution (RMD) you have for the year. If you are charitably inclined and don’t need your RMD to cover your living expenses, a QCD can be very attractive, especially if you don’t itemize. If you do, keep in mind that you cannot exclude a QCD from income and take a tax deduction for the charitable gift.
QCDs are also reported as “normal” distributions on Form 1099-R. There is no special code used to indicate that a gift was made directly to a qualified charity. Therefore, QCDs have to be self-reported on your tax return. Because you have to self-report, make certain that the charity is aware the gift was made from your IRA. The charity should provide you with a receipt for the gift they received to retain with your tax records.
Distributions of Non-Deductible Contributions
Non-deductible contributions are also self-reported on your income tax return. When you make a contribution that you cannot take a tax deduction for, you complete Form 8606 to report those after-tax dollars are in your IRA.
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 from the IRA, Form 1099-R will not reflect if any part of the distribution includes after-tax dollars. Therefore, the withdrawal of non-deductible contributions also must be self-reported. IRAs that include non-deductible contributions are taxed on a pro-rata basis, so a portion of the distribution would reflect taxable dollars being distributed to you and a portion would be considered a return of your after-tax dollars. The same form, Form 8606, is used 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 a number of exceptions to the 10% early withdrawal penalty, some of which are connected to what you use the distribution for. For example, maybe you used the IRA distribution when purchasing your first home, or to help pay for your or a loved one’s college education. Perhaps you live in an area that was impacted by a hurricane, wildfire, or other federally-declared disaster or became disabled during the year. These types of distributions and several others may qualify for an exception to the 10% penalty tax if you meet certain conditions established by the IRS.
These types of exceptions also require self-reporting on your income tax return. Financial institutions will generally report your distribution as “early, no known exception” to you and the IRS on Form 1099-R because you were younger than age 59 ½ at the time of the distribution. When you complete your tax return, you can include Form 5329 which is used to calculate the amount of additional tax you owe on the early distribution or to document the appropriate exception that applies in your situation.
Benjamin F. Edwards & Co. 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.