What happened is that your sister was under age 59½ and took a distribution to be withheld for taxes in addition to the amount that was converted to Roth. The amount converted to Roth is reported with code 2 because Roth conversions are not subject to an early-distribution penalty. However, the portion withheld for taxes is reported with code 1 to indicate that it is subject to an early-distribution penalty unless other funds are substituted to complete a rollover or conversion of this portion.
For the code 2 Form 1099-R, indicate that it was moved to another retirement account, that she did a combination of rolling over, converting and cashing out, then indicate that the entire amount was converted to Roth. Form the code 1 From 1099-R, indicate that it was cashed out unless other funds were substituted to roll over or convert this portion.
Your sister's financial advisor didn't do your sister any favors. Someone under age 59½ using a distribution from a retirement account to pay the taxes on a Roth conversion is generally a bad idea. It's much easier to decline tax withholding on the distribution being converted, convert the entire amount distributed, then make an estimated tax payment or increase withholding from other sources to avoid a tax underpayment penalty. By using other funds to pay the taxes, the early distribution penalty is avoided and more money makes it into the Roth IRA to grow eventually tax-free.
