Return of IRA Contributions (2020 Tax Year)

[dadadavis2]

Thank you so much for taking the time to read this! I really appreciate the help since I have no idea what I'm doing. Thank you thank you thank you! 

In May of 2020, I opened a Roth IRA account for the first time. However, I discovered that since I live overseas, having a Roth IRA account is going to make my taxes much more complicated than I want them to be. Therefore, I am trying to cancel my Roth IRA account by 1. selling all of my investments, 2. withdrawing my contributions (i.e. the money I put in), 3. withdrawing my distributions (i.e. my earnings, profits), and 4. closing the account. I am under 59.5 years old. I am told that it is possible to cancel my Roth IRA account according to this explanation on page 5 of form 8606 instructions:   

Return of IRA Contributions

If, in 2020, you made traditional IRA contributions or Roth IRA contributions for 2020 and you had those contributions returned to you with any related earnings (or minus any loss) by the due date (including extensions) of your 2020 tax return, the returned contributions are treated as if they were never contributed. Don’t report the contribution or distribution on Form 8606 or take a deduction for the contribution. However, you must include the amount of the distribution of the returned contributions you made in 2020 and any related earnings on your 2020 Form 1040, 1040-SR, or 1040-NR, line 4a. Also include the related earnings on your 2020 Form 1040, 1040-SR, or 1040-NR, line 4b. Attach a statement explaining the distribution. Also, if you were under age 59½ at the time of a distribution with related earnings, you generally are subject to the additional 10% tax on early distributions (see Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts).

If you timely filed your 2020 tax return without withdrawing a contribution that you made in 2020, you can still have the contribution returned to you within 6 months of the due date of your 2020 tax return, excluding extensions. If you do, file an amended return with "Filed pursuant to section 301.9100-2" written at the top. Report any related earnings on the amended return and include an explanation of the withdrawn contribution. Make any other necessary changes on the amended return (for example, if you reported the contributions as excess contributions on your original return, include an amended Form 5329 reflecting that the withdrawn contributions are no longer treated as having been contributed).

In most cases, the related earnings that you must withdraw are figured by your IRA trustee or custodian. If you need to figure the related earnings on IRA contributions that were returned to you, see Contributions Returned Before Due Date of Return in chapter 1 of Pub. 590-A. If you made a contribution or distribution while the IRA held the returned contribution, see Pub. 590-A.

If you made a contribution for 2019 and you had it returned to you in 2020 as described above, don’t report the distribution on your 2020 tax return. Instead, report it on your 2019 original or amended return in the manner described above.

Example. On May 28, 2020, you contributed $4,000 to your traditional IRA that has basis. The value of the IRA was $18,000 prior to the contribution. On December 29, 2020, when you are age 57 and the value of the IRA is $23,600, you realize you can’t make the entire contribution because your taxable compensation for the year will be too small. You decide to have $1,000 of the contribution returned to you and withdraw $1,073 from your IRA ($1,000 contribution plus $73 earnings). You didn’t make any other withdrawals or contributions. You don’t file Form 8606. You deduct the $3,000 remaining contribution on Form 1040. You include $1,073 on Form 1040, line 4a, and $73 on line 4b. You attach a statement to your tax return explaining the distribution. Because you properly removed the excess contribution with the related earnings by the due date of your tax return, you aren’t subject to the additional 6% tax on excess contributions, reported on Form 5329. However, because you were under age 59½ at the time of the distribution, the $73 of earnings is subject to the additional 10% tax on early distributions. You include $7.30 on Schedule 2 (Form 1040), line 6.

So, it sounds to me that if I sell everything, transfer all of the money out of the account, and close the account before the tax due date (May 17, 2021) it is as if I never opened a Roth IRA account in the first place and all I do is report the earnings and pay a 10% penalty. 

However, I'm not really sure how to proceed beyond that. Do I treat the months between May, 2020 (when I opened the account) and April, 2021 (when I closed the account) as all taking place in 2020? I made contributions every month until February 2021.

I have called my brokerage, and they won't be able to send me a 1099-R until January of 2022. I looked through my old statements and saw that I made about $2 in realized gains in 2020 and $470 in realized gains in 2021 (when I sold all of my investments). Do I take $2 plus $470 and report $472 of profit on my 2020 tax return, or do I report $2 of profit for 2020 and $470 for next year (2021)?   

Recap of questions:

1. Is getting a return of my contributions possible in my case? If so, does it make it as if the contributions never happened (like I had just opened a regular brokerage account instead)?

2. Is the only penalty I have to pay 10% of the earnings? Meaning there are no other penalties such as 6% for over-contributing? 

3. I made contributions to the account between May, 2020 and February 2021. I also made profits in both years ($2 in 2020 and $470 in 2021). So does that mean I treat everything as if it took place in 2020?

4. Since I won't get a 1099-R form until January, 2022, what do I have to do when TurboTax asks me for the form this year? Do I just say I don't have it and fill out the 1099-R information as best as I can by consulting old statements?

5. What code number do I enter for my reason for taking distributions? I am under 59.5 years old.

Once again, thank you so much for taking the time to answer my questions. I have been very stressed about this for the past month and even had some anxiety attacks. You are the best! 

[macuser_22 · Accepted solution]

You ask the IRA custodian to do a "return of contribution plus earnings".   That will be reported on a 2021 1099R that you will receive next January that will require that you amend 2020 to report it.

*IF* you requested a return of contributions before the extended due date of the 2020 tax return and the earnings were also returned and you know that the IRA custodian will report this as a return of contribution and not as a normal Roth distribution but as a return of contribution with a code "JP" in box 7 - then:

You can just report it now and ignore the 1099-R when it comes unless there is Box 4 Federal Tax withholding and/or box 14 State withholding. Then you must also enter the 2021 1099-R into the 2021 tax return since the withholding is reported in the year that the tax was withheld.

The 2021 code JP will not do anything in 2021 but the withholding will be applied to 2021.

You would enter the 1099-R with the total distribution in box 1 (the contribution plus the earnings),

The earnings in box 2a,

Enter code "P" in box 7 (Top) - don t worry that it will say "taxable in 2019 "

Enter code "J" in box 7 (Bottom).

On the "Which year" screen say that this is a 2021 1099-R. - That makes it taxable in 2020 and not 2019

After the 1099-R summary screen press continue.

If you are over 59 1/2 then on the "Lets see if we can lower your tax bill" enter the box 2a amount in the "Another Reason" box to eliminate the 10% early withdrawal penalty on the earnings.

Enter the explanation  that you are reporting a 2021 1099-R on your 2019 tax return to avoid having to amend in 2021.

The box 2a earnings will be taxable income reported on line 4b on the 1040 form and if under age 59 1/2 will also be subject to a 10% penalty on a 5329 form that will be reported on line 59 on the 1040 Schedule 4 form.

[fanfare]

@dadadavis2 

"having a Roth IRA account is going to make my taxes much more complicated than I want them to be."

Why is that ??

There are no reporting requirements for a Roth IRA, until you retire and start withdrawals.

[dadadavis2]

Wow, this is great! Thank you so much. A few things I noticed though...

You said to enter the code P on top and J on the bottom. I didn't have a top or bottom on my screen, the two were just next to each other. However, when I put P in the first box 7 and J in the second, it said that I owed $367 in penalties, which isn't right because it was taking 10% of all of my contributions + earnings, rather than just the earnings. When I switched it to J in the first box and P in the second, it went back to $47.

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@macuser_22 wrote:

*IF* you requested a return of contributions before the extended due date of the 2020 tax return and the earnings were also returned and you know that the IRA custodian will report this as a return of contribution and not as a normal Roth distribution but as a return of contribution with a code "JP" in box 7 - then:

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I haven't actually removed the funds from the account yet. I was waiting to hear what I should do first before I actually did anything. So, yes, I will give my bank a call and tell them to report it as a "return of contributions plus earnings."

1. TurboTax said that I need to file a substitute 1099-R if I didn't have the original. Do I really need to do this, or do I just say somewhere that I will receive the 1099-R next year?

2.

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@macuser_22 wrote:

Enter the explanation  that you are reporting a 2021 1099-R on your 2019 tax return to avoid having to amend in 2021.

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Is this the explanation that they have you fill in at the end that asks you why you're canceling the account? As of now, I have written that a Roth IRA is going to complicate my taxes, and I was canceling it just to keep things simple on my part. Do I need to change it to "I'm reporting a 2021 1099-R on my 2020 tax return to avoid having to amend in 2020"?

Once again, thank you so much! You have just saved my day!  

[dadadavis2]

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@fanfare wrote:

Why is that ??

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I live overseas, which makes the taxes more complicated. And there's no actual benefit because the country I live in taxes Roth accounts like regular brokerage accounts.

[AmyC]

You want to let them know you are reporting a 1099-R you will receive in 2021 to avoid amending 2020. The IRS can understand that better than your living situation and local taxes.

[fanfare]

@dadadavis2 

Does your country impose a wealth tax, as proposed for us by pontificating Elizabeth Warren?

If you make no withdrawals, what is taxed ?

[dadadavis2]

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@fanfare wrote:

@dadadavis2 

Does your country impose a wealth tax, as proposed for us by pontificating Elizabeth Warren?

If you make no withdrawals, what is taxed ?

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They just tax it like a normal brokerage account. They don't recognize it as a special retirement account where you only pay taxes when you withdraw. They tax on the dividends and every time you sell something.

[dadadavis2]

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@AmyC wrote:

You want to let them know you are reporting a 1099-R you will receive in 2021 to avoid amending 2020. The IRS can understand that better than your living situation and local taxes.

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There are 3 different sections where I need to write out an explanation. The first two are related to creating a substitute 1099-R (do I even need to do this?). They say, "How did you calculate your substitute amounts?" and "Explain how you tried to get a 1099-R." The final section is at the end that says "Explain the Return of Contribution." Is it here that I am supposed to say, "I am reporting a 1099-R that I will receive in 2022 to avoid amending 2020."? 

Thank you!

[macuser_22]

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@dadadavis2 wrote:

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@AmyC wrote:

You want to let them know you are reporting a 1099-R you will receive in 2021 to avoid amending 2020. The IRS can understand that better than your living situation and local taxes.

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There are 3 different sections where I need to write out an explanation. The first two are related to creating a substitute 1099-R (do I even need to do this?). They say, "How did you calculate your substitute amounts?" and "Explain how you tried to get a 1099-R." The final section is at the end that says "Explain the Return of Contribution." Is it here that I am supposed to say, "I am reporting a 1099-R that I will receive in 2022 to avoid amending 2020."? 

Thank you!

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You do NOT use a substitute because you have not yet received a 1099-R to substitute for.    Just enter as a regular 1099-R that you are just filing early.   The code P itself on a regular 1099-R allows an explanation.