Taxes on Inherited IRA Withdrawal

[brian_fin]

I inherited an IRA from a parent this year and decided to cash it out rather than stretch out the RMDs since it wasn't a crazy amount. The advisor at the institution withheld appropriate amounts for both federal and state. After entering my 1099-R into Turbo Tax, a percentage of the withdrawal at exactly my tax bracket is being subtracted from my potential return amount despite entering the proper fed/state withheld amounts. The software must just do this as a precaution, right? There's no way such a ridiculous amount of tax is still owed on this.

Been doing some research on this but can't find an explanation.

[KathrynG3]

It depends. Your 1099-R should have the proper distribution code for your case. Did you have Distribution code=4, for Death? If yes, then the next screen you see during your entries should have included the following:

• Did you Inherit the IRA from this person? answering yes will add
• This IRA was inherited from...select either taxpayer's spouse or someone else who passed away..then they ask for the person's first name and the year the person passed away. Click Continue
• Tell us a little more about this inherited IRA. You need to answer whether any portion of the contributions were nondeductible or if you don't know for sure. Click Continue
• Tell us when this person was born; there are date ranges to select, then click Continue
• About this Inherited Retirement Account; you will say whether the withdrawal is an required minimum distribution, or RMD and if so, what portion of it was
• Or, if any part of it was a Qualified Disaster Distribution, click Continue to end the interview.

If you have not seen these screens, please revisit your input for the 1099-R. To return to this area, follow these steps:

• From the left menu, select Federal
• Wages & Income
• Scroll to IRA, 401(k), Pension Plan Withdrawals (1099-R) and click Edit/Add
• From Your 1099-R Entries screen, scroll to the inherited IRA and click Edit

Click this link for more information: Is an inherited IRA or retirement plan taxable?

[brian_fin]

Yes Kathryn, it was Distribution Code 4 and I answered those questions, my original post answers most of them. All inherited IRA's are subjected to RMDs. Are you saying I potentially filled them out wrong? It was pretty a pretty standard withdrawal, nothing overtly odd about it. This doesn't answer my question. I withheld taxes and the software is most likely just being overly reserved about its forecast, right?

[dmertz]

The taxable amount is not determined until you prepare your tax return.  Separately, the amount of tax withholding shown on the Form 1099-R is credited to you on your federal and state tax returns.  The default withholding on an IRA distribution is 10% federal and, in most states, 0% state, so the default tax withholding usually does not cover the entire increase in your tax liability resulting from the distribution

[brian_fin]

2a lists the taxable amount, which was the full amount of the withdrawal. 2b was checked and reads "Taxable amount not determined" which seems to contradict 2a. Regardless, the whole amount is taxable of course.

So the question is when will it be credited on my returns. After I file? The refund forecast doesn't seem to take this into account, which is what my original post is speculating. For reference we did 15% federal and 5% state, so a little bit of tax should most likely be owed. However as my post states, an amount of the withdrawal at exactly my tax bracket is being deducted from my refund.

So the software doesn't credit withheld taxes, and I won't know what is or isn't owed until after I file, correct?

[dmertz]

TurboTax includes the amount from box 4 of the Form 1099-R on line 17 of 2019 Form 1040.  Line 17 is subtracted from your overall tax liability on line 16 to determine your refund or balance due.  Make sure that box 4 of TurboTax's 1099-R reflects the amount in box 4 of the Form 1099-R provided by the payer.

State tax returns operate similarly.

Your tax-bracket rate is not necessarily your marginal tax rate because of potential side effects due to the increase in AGI resulting from the additional income.  It's impossible to know your marginal tax rate on any separate item of income without taking your entire tax return into account.

"an amount of the withdrawal at exactly my tax bracket is being deducted from my refund."

Given that you had 15% withheld for federal taxes, that result could easily be explained if you have some income taxed at 0% the long-term capital gains rate without the additional income from the Form 1099-R and the additional income is pushing an equal amount of the long-term capital gains from the 0% bracket to the 15% bracket.  There are other possibilities, but with those other possibilities this coincidence is less likely.

[brian_fin]

I'm not sure what you mean by that last portion; what "other income?" Can you give me some possibilities? My situation is quite simple other than this IRA distribution; W-2, some small (less than $500) interest/dividend income I've reported. I don't even own property, and there's no way this income is pushing me into a higher tax bracket either. I'm stumped as to how this is taking away well over half my refund when I've included withheld taxes here.

[JulieS · Accepted solution]

I know it doesn't seem right, but TurboTax is calculating your refund based on what is entered on your tax return. There is no estimating or being overly conservative. 

If you have already verified that all of the figures on your 1099-R form were entered correctly, then this is the correct refund for what you have entered. 

As far as being pushed into a higher tax bracket, if you are single, you go from 10% to 12% at $9701, you go from 12% to 22% at $39,476 and from 22% to 24% at $84,201.

The other factor that may affect your refund is possibly losing tax credits or deductions.

If you were getting a Saver's Credit before and the extra income pushed you past $32,000, you would lose the credit entirely. Even if your income is lower, you may have reduced the credit amount. 

If you have a 1095-A for health insurance, the related credit can turn into a repayment with extra income added. 

If you had a Student Loan interest deduction, it may have been limited or phased completely by the higher income. If total income was above $70,000, you would have a limitation, if it was above $85,000, no deduction is allowed.

It isn't possible to explain in a detail manner exactly why your refund changed so much without have access to your entire tax return, but many people have asked similar questions and have been shocked by what a little more income does to their tax refund. 

[dmertz]

Compare your Form 1099-R with and without this Form 1099-R entered to see what amounts are changing between the two scenarios.

Qualified dividends are taxed at long-term capital gains rates.

[brian_fin]

Thank you for confirming that Julie! I looked into your excellent suggestions. Though they didn't apply in my particular situation, I appreciate them and I'm feeling more confident.

Cheers.