Manually changing the taxable amount on form 1099-R to reduce tax liability

[Skifourfun]

I received a 1099-R  for an annuity contract.  The annuity premium was funded from a Traditional IRA that I funded with after-tax dollars.  

The insurance company only knows that the annuity was funded from a qualified IRA account.  From their viewpoint, the entire amount of the annual annuity payment is taxable.  Based on my documentation, my annuity premium included 15 percent of after-tax dollars.

If I manually enter 15% of the Taxable amount in Box 5, TurboTax will not reduce the taxable amount of the annual annuity payment.  In addition, if I manually reduce the Taxable Amount by 15% in Box 2a, my tax  liability in TurboTax does not change.  BTW - Box 2b is checked - "Taxable amount not determined".

I would like to avoid paying double taxes on the 15% portion of my annuity payment that was funded with after tax dollars.  Any suggestions or ideas are welcome.  Thank you.

[BillM223]

When you have "basis" in a pension or annuity (the after-tax dollars), when you have a qualified plan (most common), the basis is not distributed to you all at once, but over time along with earned dollars.

Thus, your annual annuity payment will be partially basis (tax-free) and partially (actually, usually mostly) taxable income.

In the screens after you enter the 1099-R numbers, you will be asked a series of questions so that TurboTax can apply the correct rule to calculate the taxable amount of your annuity. Most taxpayers will use the Simplified Method, which spreads the amount of basis out over some actuarial amount of time, so that each year's distribution is part basis and part taxable amounts.

Indeed, in many cases, if the person had been with the pension the entire time, then the pension administrator could do this calculation themselves, knowing how much after-tax contributions there were. In this case, the pension administrator puts the taxable amount in box 2a. The difference between box 1 and box 2a is the "return of basis".

Since the annuity was wholly funded from this IRA (if I understood you correctly), you might call the annuity administrator and remind them that they should know the amount of basis (I assume that you know what the basis was in the IRA), and tell them if they don't know. They may be willing to issue a corrected 1099-R listing the actual taxable amount in box 2a, which would save you some work (you just have to tell TurboTax to use the amount in box 2a).

Not to worry, TurboTax doesn't want you to be double-taxed; this is just often a problem for taxpayers who have no idea what their basis is (or what the definition of basis even might be).

[Skifourfun]

Bill - Thanks very much for your thoughtful response.  My annuity is from a private insurance company - not my employer.  The annuity company would not know the basis.  They just received the funding from Fidelity as a qualified transfer from my IRA.  In addition, Fidelity would also not know that my contributions were all after-tax.

I agree that my annuity is mostly taxable - except for the 15 percent basis that I have calculated and documented.   Unfortunately, I do not have a pension administrator who would know the amount of the basis because the annuity is from an insurance company.

I believe it is unlikely that the insurance company would rely on my word that 15% of the premium was funded with after tax dollars and issue a corrected 1099-R.

Thanks again for  your prompt response and engagement here.  I am really at a loss on how to avoid the double taxation on the 15% basis.  Any other ideas you may have would be welcome.

[Skifourfun]

I forgot to mention that the questions on screens after I enter the 1099-R information do not appear to make any reference to a calculation of the taxable amount - unless I am doing something incorrectly.  Thanks again for  your help.

[dmertz]

Box 5 is not permitted to be used for a distribution from a traditional IRA, including an IRA annuity.  The Form 1099-R is required to have the same amount in box 2a as is in box 1 and have the IRA/SEP/SIMPLE box marked, and is required to be entered into TurboTax as received.  The taxable and nontaxable portions of the distribution are required to be calculated on Form 8606, which TurboTax will prepare given the information that BillM223 indicated TurboTax will ask for.

[Skifourfun]

Thanks for your response and appreciate  your help.  Form 8606 is for a single tax filing year. The annuity is from a private insurance company and the premium was paid by a partial transfer from a Traditional IRA that was funded during a period of 29 years with after-tax dollars. 

The form 8606 was completed each tax filing year that I made an after tax contribution to my IRA. I am currently retired and my last after-tax contribution to the IRA was in 2023.

I have documented that  15 percent of the premium was funded by my after-tax dollars.  The other 85% percent was based on stock market gains within the IRA.  Thus each year that I receive an annuity payment from the insurance company, 15% of it should not be taxed - because I already paid the taxes on that portion.

Unfortunately your answer does not help me, but I appreciate your response.  Thanks again. 

[dmertz · Accepted solution]

If the annuity is an IRA annuity, it was funded by IRA dollars without any regard to your basis in nondeductible traditional IRA contributions.  The basis in nondeductible traditional IRA contributions only comes into play when your receive and report distributions from your IRAs.  When you have basis in nondeductible traditional IRA contributions, the nontaxable and taxable amounts of the distributions from your traditional IRAs, including IRA annuities, are determined on Form 8606 as explained earlier.

[Skifourfun]

Thanks for providing further clarification.

What you have explained now makes sense in that the non-deductible contributions only come into play when I report a distribution from the IRA.  Unfortunately in my case, I did a direct transfer from the Fidelity IRA to the Insurance company to pay the premium.  It was considered a qualified transfer - not a distribution.

In retrospect, I should not have used the IRA to fund the premium, given that it included after-tax dollars.  I should have used my Rollover IRA to fund the premium.

I actually compounded my error when I merged the remaining balance in my IRA with my Rollover IRA for simplicity - completing forgetting that the IRA included after-tax dollars. 

You have been a big help with your explanation.  Fortunately, my basis percentage is only 15 percent, given the growth of the IRA.

Thanks again.

[dmertz]

"In retrospect, I should not have used the IRA to fund the premium, given that it included after-tax dollars.  I should have used my Rollover IRA to fund the premium."

Makes no difference.  Your basis in nondeductible traditional IRA contributions belong to you, not to any particular one of your IRAs.  With regard to your basis, all of your IRAs are treated in aggregate as if they were one large IRA.

"I actually compounded my error when I merged the remaining balance in my IRA with my Rollover IRA for simplicity - completing forgetting that the IRA included after-tax dollars."

Again, this makes no difference.  All of your traditional IRAs are treated in aggregate.  Line 6 of Form 8606 requires the value of all of your traditional IRAs combined.