I withdrew 20k from my ROTH account and the IRS is attempting to tax those funds opposed to applying a early withdrawal penalty. How do I correct this?

[NCperson · Accepted solution]

@mrs-jackson0701 

I assume you are under 59.5 years old (otherwise, there can't be a 10% penalty)

when funds are withdrawn from a Roth, the IRS assumes the money was withdrawn from these buckets in this order: 

1) Contributions - there is no tax or 10% penalty when you distribute these dollars.  All have to be distributed before moving to bucket 2. 

2) Conversions - these are dollars that came from a Trad IRA.  There is no 10% penalty on these dollars as long as the money was in the Roth IRA for 5 years.  There is no tax on these dollars. All have to be distributed before moving to Bucket 3.

3) Earnings - these dollars are all subject to both tax and the 10% penalty. 

which bucket(s) did this $20,000 come from and what code was in Box 7 of Form 1099-R.  When did you first open this Roth IRA (or any other Roth IRA if it is older than this one) - please provide the year. 

what tax year are you asking about and did your tax return include form 8606?  did the IRS send you a letter or are you working on your 2022 tax return and you can see there is tax due on this distribution? Did you complete form 8606? please provide more background. 

[mrs-jackson0701]

Hello,

Yes, I’m under 59 1/2. The withdrawal came from the contributions portion. Box 7 has letter J. We were sent a CP2000 form. The Roth has been open for more than 10 years. So I’m not certain why they’re attempting to collect tax on the withdrawal. I understand the penalty portion. Should I just send the statement from the Roth account with the CP2000?

[NCperson]

did you attach form 8606 oriignally?  you will need that as part of your response.  Provide what they ask for since you are disputing it. 

there should be no tax and no penalty if the $20,000 came from 'contributions".  there is never a 10% penalty on withdrawals of Contributions,

[dmertz · Accepted solution]

Since your distribution is a a nonqualified distribution, as NCperson said, Form 8606 Part III is required to calculate the taxable portion, which will be zero if line 22 is greater than line 19.  Being nontaxable, this portion will also not be subject to penalty.  Without this form being provided to the IRS by you, code J indicates that your entire distribution is subject to tax and early-distribution penalty.

[Critter-3]

Note the CP2000 is auto generated by the IRS computers that look for missing income on the return.  Reply to the IRS with the info they need to negate the notice. 

[dmertz · Accepted solution]

Note that in addition to Form 8606 being needed, the gross amount of the distribution must also be included on line 4a of Form 1040.  It's still reportable income even though it is nontaxable income and its inclusion on line 4a indicates that it is being reported.