The Back Story
401(k)s. Retirement account contributions have special tax-favored status. The US Congress voted and approved in 1978 Title 26 U.S. Code § 1.401(k). This section of the tax code permitted employees to defer an amount of their earnings (deferred compensation) and, as a result, the tax that would normally be due on those earnings would also be deferred to a later date.
Lawmakers essentially said ‘We think it would be a good idea for people to save for retirement and here’s what we are going to do. By law, we will allow that part of an employee's earned wages can be excluded from taxation in the year the wages were earned and the tax that would be due in the current year will be deferred into the future. These deferred wages will be placed into a special tax-favored account. The tax will be paid when distributions are taken from this special account.’
IRAs. Then, in 1981, as part of Economic Recovery Tax Act Of 1981 - ERTA, Congress added to this incentive to save for retirement by allowing all working taxpayers the ability to establish Individual Retirement Arrangements, commonly called IRAs.
Special tax-favored accounts hold these monies. Today, 401(k) funds are held in qualified plans set up by employers and IRA funds are held in specially designated tax-favored accounts that can be established through any bank or credit union.
Taxation. Finally, the Pension related tax laws and the tax consequences they created were passed from Congress on to the Department of Treasury so that the mechanics of the tax implications relating to these accounts could be sorted out. The Treasury sent everything along to the Internal Revenue Service to administer the tax collection of the subsequent distributions to the accountholders.
Retirement Distributions are reported on Form 1099-R (see sample below) You can find the form number in the upper right corner in the same box as the year.
1099-R: The Basics
What do I need to know?
Basically, you need to be aware that
There are many different account types.
Not all of the funds within these accounts have been exempted from taxation
There are a number of situations where the amount that has been entered into Box 2a -Taxable amount by the issuer of the form will be changed by the tax preparer and then explained either on Form 5329 or by using the Nontaxable Distributions menu selection in the tax software.
Typically, when the Distribution code found (reported) in Box 7 is believed to be incorrect or has extenuating circumstances to explain, that is accomplished by adding Form 5329 to the tax return.
Pro Tip! It’s a good idea to use a highlighter to identify each box of the form that has an entry.
In most cases, you enter the information found on the 1099-R.
2018 Volunteer Resource Guide - Pub 4012 covers all of this quite extensively starting at page D-30.
2018 Pub 4491 covers Retirement Income in Chapter 12.
Pub 575 - Pension an Annuity Income is the publication that provides a ‘deep dive’ look at these tax-favored accounts, definitions and tax treatment - soup to nuts!
What am I supposed to be looking for on a 1099-R?
If you have looked at my explanation of Brokerage Statements, you read about the 1099 series of forms. The Form 1099-R is one of those forms. The issuer of the form sends one copy to the recipient and one copy to the IRS.
The fact presents itself; IRS computers run information matching routines to determine that all distributions reported to IRS have also been reported by taxpayers.
Our job is to pick up the information in this form completely & accurately.
The explanation for what is being reported in each of the boxes on this form is found on the back of the document in the tiniest print possible without looking like a solid mass.
You can read that here.
Below, is the list of the most common entries that we see on taxpayers forms.
Payers federal identification number - this is the field that allows the accurate match on IRS computers. It is vital that we get this number correct. Because of the Quality Review that occurs with each prepared tax return we always have a ‘second set of eyes’ that checks the accuracy of this number with careful scrutiny.
Box 1 Gross Distribution
Box 2a Taxable Amount
Box 2b Taxable Amount not determined & Total Distribution
Box 4 Federal income tax withheld
Box 5 Employee contributions/ Designated Roth contributions or insurance premiums
Box 7 Distribution code(s)
Tick Box IRA/SEP/SIMPLE
Box 9b Total employee contributions
‘Box 2b - Taxable amount not determined’, how can that be?
Even though these are distributions from tax-favored accounts, as discussed above, you cannot assume that the entire amount is taxable upon distribution. Because of the many different account types and and income phaseout rules, we need to look closely at this form
Three quick examples of when some or all of a distribution will not be taxable:
ROTH IRAs. Contributions to a ROTH IRA are taxed in the year of the contribution and never again. [This is easy to spot because Box 7 will have the code Q]
Nondeductible IRA contributions. Because of phaseout rules, some taxpayers at higher income levels are not allowed to deduct their contributions in the year they are made. The taxpayer keeps track of these amounts and when distributions are taken Form 8606 is completed and included with the return.
After-tax contributions to qualified pensions. These amounts appear in Box 9b. An employee has chosen to contribute after-tax wages to their retirement account that will end up being paid out as an annuity or pension.
Upon distribution these after-tax contributions are allocated over the projected life of the annuity or pension.
Jeff Bogart’s Annuity Calculator takes all the work out of this calculation. [If you are thoroughly enjoying this discussion, watch his video tour of this calculation. Some people are so smart!]
“How these distributions are taxed depends on whether they are periodic payments (amounts received as an annuity) that are paid at regular intervals over several years or nonperiodic payments (amounts not received as an annuity).”
For the straightforward circumstances, follow the guidance in Pub 4012 starting at page D-30.
Below are examples of some of the situations that are more complicated and can get confusing.
This AREA IS
! UNDER CONSTRUCTION !
There is a wide range of complexity with IRA distributions. Most of the time- like 99.9% of the time, you will simply transcribe the information from the taxpayer’s 1099-R tax statement into the tax software.
However, there may be ‘hidden’ information. For example, the taxpayer may have made contributions that were not deductible OR for some unknown reason there is a code 1 in box 7.
Manual adjustment of Box 2a -Taxable amount because of exceptions.
QCD - reduce Taxable amount. Explain it in Nontaxable Distributions menu.
Usually this is completely straightforward. You transcribe the numbers found in the boxes into the software, save & close. Period. And you move on.
Manual adjustment of Box 2a -Taxable amount because of exceptions.
Public Safety Officer - may reduce taxable amount by up $3,000 of insurance payments paid to the issuer of the pension.
Box 7 - Code 3. If the distributions are made to a taxpayer who is under their companies normal retirement age then This. Distribution. Gets. Moved. Into. Wages!!!
Another form of retirement income that has a few more ‘moving parts’ than the 2 types shown above is pension or annuity. Typically, the taxable amount is not shown in Box 2a of the 1099-R tax form. Or, there is an amount in Box 2a but it requires a manual adjustment by the tax preparer.
The TAXABLE amount of the distribution must be derived by formula. By following the simple instructions and entering the taxpayer’s information into Jeff Bogart’s Annuity Calculator that calculation is made for you. It is nothing short of Amazing! Thanks Jeff!
Here is his Video Tour of Annuities. (at left)