Is there an error in Turbotax when entering non-taxable distributions from an inherited Roth IRA?

[TaxTriumph-]

I entered a $79,000 distribution from an inherited Roth IRA that should be non-taxable into turbotax - and my tax due number jumped by $19,000. Is this a bug? My understanding is that the distribution should be entirely non-taxable as the original account holder contributed to the fund for more than 5 years and would be over 65 now.

[DianeW777]

It's a little more complicated than that, and we can sort it out for you. You should show a taxable amount that would represent only earnings in the Roth IRA.  See the following information for more details.  If you believe the earnings amount is incorrect in Box 2a, you should immediately contact the organization who issued the Form 1099-R.

Roth IRA beneficiaries can withdraw contributions tax-free at any time. This is about Roth IRA contributions. 

• Earnings from an inherited Roth can also be withdrawn tax-free, as long as the account had been open for at least five years at the time the account holder died.

The five-year rule is critical: If the Roth IRA was less than 5 years old at the original owner’s death, you’ll owe taxes on the earnings you withdraw.

Since death is an exception to the early withdrawal penalty (10%), when a Roth IRA owner dies, beneficiaries who take a distribution will not pay a penalty—no matter whether the distribution is principal and/or earnings.

Death does not, however, eliminate the 5 tax-year rule for earnings to be tax-free. If you, as a beneficiary, take a distribution from an inherited Roth IRA that was not held for 5 tax years, the earnings will be subject to tax."

What Are Qualified Distributions?  (IRS Publication 590b)

A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

1. It is made after the 5-year period beginning with the first tax year for which a contribution was made to a Roth IRA set up for your benefit.

2. The payment or distribution is:

   1. Made on or after the date you reach age 59½,

   2. Made because you are disabled (defined earlier),

   3. Made to a beneficiary or to your estate after your death, or

   4. One that meets the requirements listed under First Home under Exceptions in chapter 1 (up to a $10,000 lifetime limit).

@TaxTriumph-

[Edited: 02/11/2022 | 9:08a PST]

[dmertz]

This Form 1099-R should have either code T or code Q in box 7 and box 2a should be blank.  Edit the form in TurboTax and and make sure that you answer Yes when TurboTax asks if the account was inherited.

[TaxTriumph-]

Thanks for this, @DianeW777 - but the taxable amount showing on my 1099-R is zero - which is correct, because the Roth IRA had been held for more than 5 years by the original account owner at the time of her death, so both the contributions and the earnings should be tax free. Any ideas on why Turbotax would still be calculating tax on the full amount of the withdrawal?

[TaxTriumph-]

Ah ha! @dmertz, you're a wizard! I went in and double-checked, and the 1099-R has a code T in box 7 and box 2a is blank - and so I had left the box 2a in Turbotax blank as well, which is how it imported. However, when I edited the form to insert a ZERO in box 2a instead of leaving it blank, the tax recalculated itself properly! I still think this is kind of buggy and the good Turbotax folks should figure out how to fix it so it doesn't calculate tax on a blank 2a, but at least my problem is solved 🙂

[TaxTriumph-]

Problem solved! Apparently the software didn't like a blank box 2a and needed me to insert a zero instead. Thanks for the helpful background info that helped me get there!

[dmertz]

TurboTax seems to have gone back and forth over the years on its treatment of a blank box 2a on a code-T Form 1099-R.  My opinion is that TurboTax should not make an assumptions about how much is taxable and should treat the lack of an explicit entry of the taxable amount as an error.  It's almost never the case that the distribution is fully taxable.  It's quite common for the distribution to be nontaxable, but that's not guaranteed without gathering additional information, so TurboTax leaves it up to the recipient to determine the taxable amount.