1099-R with box 7 = 2

[dlandersnc]

I made an excess (non-deductible) Traditional IRA contribution in 2020, discovered my error, and asked for the contribution to be returned shortly afterward.  I received my 1099-R (from Vanguard) with Box 7 having a "2" entered. (early withdrawal, special case applies).  The turbotax easy step interview says good news, no taxes are owed, yet the full amount of the withdrawal has been added to my income. It also doesn't ask anywhere to account for the slight interest gain between the amount of the original submission (5K) and the gain ($2).  

Am I not answering something correctly?

[dmertz]

Code 2 would never be used  to report  a return of contribution from an IRA.  When the Form 1099-R reporting a distribution from a traditional IRA (IRA/SEP/SIMPLE box is marked) has code 2, the Form 1099-R is typically reporting a Roth conversion.  The only other reason that in 2020 code 2 might be used is if the custodian is indicating that the distribution is a Coronavirus-Related Distribution, but IRA custodians generally don't do this because that don't what to take any responsibility for determining if you were qualified to receive a CRD.

[dlandersnc]

dmertz, I appreciate your comment, but I'm sure Vanguard processes thousands of these, so far be it for me to tell them they have filled it out wrong.

What I don't understand is that in the interview, Turbotax says I owe no taxes on this, yet when I look at the 1040 form, the funds have been added into income.

I 

[ToddL99]

Where do you see that these funds are included in taxable income?

They will show on Line 4a of your Form 1040, and in the total income column of your Income Summary, but not in Line 4b  of Form 1040 (taxable IRA Distributions.

[dlandersnc]

They are listed in both 4A and 4B of my 1040

[dmertz]

When you select code 2, TurboTax tells you that you owe no "additional taxes" on the distribution.  "Additional taxes" refers to a 10% early-distribution penalty, an excise tax.  It does not refer to income taxes.

Was the contribution in question made for 2019 or for 2020?

If the contribution was made for 2019, was the distribution that was reported on this Form 1099-R made after October 15, 2020?  (Apparently not since you said that the distribution was made shortly after having made the contribution.)

The only thing I can think of that might explain the code 2 without it being associated with a Roth conversion is if Vanguard considered this to be a regular distribution that is coronavirus-related.  To do that Vanguard would have to have asked if the distribution was coronavirus-related.  Absent that, there is clearly something amiss regarding this Form 1099-R.

[dlandersnc]

The IRA was opened with a $5K contribution on 01/07/2020 as a 2020 contribution.  Vanguard processed the withdrawal on 01/14/2020. ($5002), which was the total amount of funds in the IRA.  It was made with after tax $$$

[dmertz]

Then code 2 makes no sense at all since none of the coronavirus-related accommodations happened until well after that, so Vanguard could not have asked if this was coronavirus -related.  Vanguard clearly goofed something up, it's just not entirely clear what or how.  This form is reporting a regular distribution, not a return of contribution.

A correct Form 1099-R reporting this as a return of contribution would have:

• Box 1 = $5,002
• Box 2a = $2
• Box 7 = codes 1 and 8
• IRA/SEP/SIMPLE box = marked