I was 41 years old last year. Last year, I asked my financial organization to roll over $8000 in my pre-tax 403(b) to ROTH IRA in the same organization. The organization rolled over $6400 and withheld $1600 for federal tax. Consequently, I received two 1099-R forms. The 1099-R form for the $1600 withheld federal tax has a distribution code "2" for Box 7. My understanding is that the $1600 is subject to the 10% penalty so the distribution code should be "1". I contacted the financial organization and they refused to correct the form. My questions are:
1). Is my understanding that the $1600 tax withheld is subject to the 10% penalty correct?
2). If my understanding is correct and the financial organization refused to correct the 1099-R form, how to correctly file the my tax using the TurboTax? Should I just put distribution code "1" when I put in the information in TurboTax?
To clarify, had the employer contributed to the 403(b) and is the box for IRS/SEP/SIMPLE checked on the 1099-R?
Both employer and me (employee) contributed to the 403(b) when I was an employee there. The "IRA/SEP/SIMPLE" box is not checked.
Yes, this was not handled correctly. You should have received a 1099R reporting $8000 as the amount in Box 1. Federal income Tax in box 4 and a distribution code "G" in Box 7.
As it stands now, only $6400 has been rolled into your Roth account. A second 1099R is issued that is subject to a early withdrawal penalty. In addition, it may have been reported as taxable income on your return. You do need a 1099R to correct this mistake because this makes a huge difference in your return.
[Edited 03/26/24|4:15 pm PST]
This was handled oddly and is oddly reported on the Forms 1099-R.
First, if your intent was to roll over $8,000 from the traditional account in the 403(b) to the Roth IRA, the entire $8,000 should have been deposited into the Roth IRA as a direct rollover for which there would have been no requirement to withhold taxes. You then would have paid the increase in your tax liability using other funds.
It appears that they instead did an indirect rollover which requires a minimum of 20%, $1,600 in this case, be withheld for taxes. Why they would do an indirect rollover in-house is a mystery since it makes no sense to do that. However, given that they did an indirect rollover, only $6,400 was rolled over to the Roth IRA and $1,600 was an ordinary early distribution. It seems that they used code 2 for this rollover of the $6,400 because they knew that it went to the Roth IRA. They probably should have reported it as a direct rollover using code G, but the result with code 2 is the same as long as you tell TurboTax that the $6,400 was rolled over ("converted") to a Roth IRA.
The $1,600 reported on the code-1 Form 1099-R represents an amount distributed to you and not rolled over to the Roth IRA, so it is subject to an early-distribution penalty unless within 60 days you used other funds to complete the rollover of the $1,600.
You are very correct that this was handled oddly. When I filled out the paperwork for the rollover, I chose not to withhold federal tax but they still withheld 20%. I contacted them after and they said they made a mistake. I could submit a formal complain and they could try to get the $1600 back from IRS but they said there was no guarantee as it is easy to "send money to IRS" but it is difficult to "get the money back". Then I was like fine and I did not want to go through the hassle to change it.
They used the correct code "G" for the 1099-R for the $6400. However, they used code "2" for the 1099-R for the $1600. I think they should use code "1" for the $1600 but they said the "$1600" is not subject to the early withdraw penalty. Should I just put code "1" when I put the 1099-R information in TurboTax for the $1600 even it is code "2" on the form I have?
But only $6400 was rolled over to my Roth IRA, and the $1600 was withheld for federal tax and was not rolled over to a retirement account eventually. Shouldn't the $1600 be considered as early distribution?
Yes, the way this is reported, not only would you incur a early withdrawal penalty, but you could incur additional tax on the $1600 if this is reported as income on line 1 of the 1099R. I apologize I misread this in my earlier post.
I may have a solution to your dilemma. Here is what I suggest doing.
To exclude the income if it is reported as taxable income in your return.
Secondly, you want to receive credit for the $1600 in taxes you paid. The second 1099R did not achieve this purpose. My suggestion is to enter $1600 as taxes paid.
Of course, the best solution is to have a corrected 1099R to:
What this would have done is report this as a Roth Rollover but the $8000 is taxable because you converted some of your tax-deferred plan to a Roth account. You would not have been penalized for a early withdrawal penalty. All these extra steps I provided would not have been necessary if this had been reported correctly.
If the IRS ever questions you about this, save a copy of this email along with my recommended solution. Tell them about the circumstances regarding the reporting of your 1099R and the company refused to issue a corrected one. I stand by my recommendation to correct this.
Hope this helps!!
Thank you for all your input. I apologized as I probably did not explain the situation correctly:
Totally $8000 was removed from my pre-tax 403(b) plan. Among the $8000, $6400 was rolled over to a Roth IRA and $1600 was withheld for federal tax. I did not receive the $1600 and the financial organization said it was sent to IRS.
I received two 1099-R forms, one for the $6400 and one for the $1600. The 1099-R for the $6400 has correct information ($6400 as the "Grosse distribution" and "G" as the distribution code").
The issue is the 1099-R for the $1600 tax withheld for the federal tax. The "Gross distribution" in this form is "$1600", the "federal tax withheld" on this form is "1600" (so it does show the credit of the tax I paid), but the distribution code is "2" instead of "1". My understanding is that the $1600 should be considered as income because it was not rolled over to another pre-tax retirement plan. In addition, I should pay the 10% penalty for the $1600 because it was withdrawal from a pre-tax 403(b) plan.
I did contact the financial organization and they refused to correct the 1099-R for the $1600 as they insisted that the code "2" was correct".
That is the dilemma I have right now as I believe the code should be "1" (correct me if I am wrong). If I am correct, can I just put code "1" in when I put the information of the 1099-R form for the $1600 into TurboTax so I can pay the penalty as expected?
Got it!! Report both 1099 R's in one entry rather than two separate entries. Report $8000 as the Gross Distribution in Box 1 and as taxable in 2A. Report $1600 in Box 4 and make the distribution code G in Box 7. Do not put a code 2 in because this wasn't distributed from your Roth account but rather from your 403B plan prior to conversion.
You should not be charged an early withdrawal penalty because this is a conversion that is acceptable. There will be questions after you make this one 1099R entry asking if this was converted into a Roth. You will address this in this part of the interview.
This instruction supersedes any of my previous instructions but this is the most correct way of reporting. Remember this is taxable because you are converting part of your tax-deferred plan into a Roth, which is a plan that is funded by after-tax dollars.
Get the notion out of your head that you owe an early-withdrawal penalty. You do not !!
Based on your most updated reporting method, how is combing those two 1099-R forms as you described different from reporting them separately. If I report them separately as what they are right now, I pay tax for the $8000 (one distribution of $6400 and one distribution of $1600) with no penalty, and the $1600 withheld tax will be credited too.
So you are saying that the $1600 withheld federal tax is not subject to penalty? If that is the case, isn't the 1099-R form for the $1600 with distribution code "2" correct then?
Another piece of information that may be useful is that I did not add $1600 back to the Roth IRA with my own money within 60 days of the roll over.
Thank you very much again for your help.
Yes, if you decide to report the two1099R as separate entries and report the second 1099R with a code 2 in Box 7, this is correct. The $1600 should not be assessed an early withdrawal penalty because it should have been reported in one 1099 R form in the beginning.
Another piece of information that may be useful is that I did not add $1600 back to the Roth IRA with my own money within 60 days of the roll over. Do you think that makes a difference?
I had the impression that the $1600 withheld federal tax was subject to penalty after I read the example from IRS (https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions).
"Example: Jordan, age 42, received a $10,000 eligible rollover distribution from her 401(k) plan. Her employer withheld $2,000 from her distribution.
If you roll over the full amount of any eligible rollover distribution you receive (the actual amount received plus the 20% that was withheld - $10,000 in the example above):
The scenario from the example is roll over from a pre-tax plan to traditional IRA plan so the tax portion is different but I thought the penalty portion was the same as my scenario.
Thank you very much again. Really appreciate your help and input.
Thank you for your input. The 1099-R issuer is refusing to chang the form. I am not sure what I should do now when I am filing my return with TurboTax.
Also, you and @DaveF1006 have different opinions regarding if the $1600 is subject to the Early Withdrawal Penalty. I am quite confused what is the correct.
Your situation is exactly the same as in the example you quoted. Because the trustee made a mistake, this situation is treated for tax purposes the same as if you withdrew $8000 in the form of a check, the trustee withheld $1600, you deposited the $6400 check with a new plan, and failed to make up the $1600 difference. That $1600 is taxable income to you, plus a 10% penalty if you are under age 59-1/2. Because you would have paid income tax on the conversion anyway, the extra cost to you because of the mistake is a $160 penalty, plus the fact that you have $1600 cash in pocket instead of in a roth account for the future.
This is an interesting legal situation. Arguably, the company owes you the 10% penalty ($160) as compensation for their mistake. On the other hand, if you knew about the $1600 withholding before the end of the 60 day rollover window, you did have the opportunity of depositing an extra $1600 from other funds, and the withholding would have paid the taxes instead of needing to come up with the extra cash during tax season. So it's not clear how much responsibility each side has, and it would cost well more than $160 to litigate it. At least it is a learning experience, and you can make sure this doesn't happen again.
Thank you very much for the input.
I have no problem paying the $160 penalty and I am willing to pay the $160 when I file the return so it is done correctly. The issue is that the 1099-R uses "Code 2" to indicate the $1600 is exempt from the penalty so how to include the $160 penalty when I file the return? If I manually choose "Code 1" when I put the 1099-R information in TurboTax, I will be able to pay the $160 penalty but the code will not match what IRS's copy of the 1099-R has.
Should I choose "I need to prepare a substitute 1099-R" at TurboTax to file a "4852" and explain it?
@Hippo24 wrote:
Thank you very much for the input.
I have no problem paying the $160 penalty and I am willing to pay the $160 when I file the return so it is done correctly. The issue is that the 1099-R uses "Code 2" to indicate the $1600 is exempt from the penalty so how to include the $160 penalty when I file the return? If I manually choose "Code 1" when I put the 1099-R information in TurboTax, I will be able to pay the $160 penalty but the code will not match what IRS's copy of the 1099-R has.
Should I choose "I need to prepare a substitute 1099-R" at TurboTax to file a "4852" and explain it?
With all due respect to @DaveF1006 , I'm not sure he understood that the $1600 was not rolled over or converted. Only $6400 was rolled over, and $1600 was withdrawn. (It was sent to the IRS, but it still counts as a distribution, and you did not cover the distribution by making up the $1600 from other funds.)
I don't think it really matters if you enter the second 1099-R using code 1, or if you create a substitute 1099-R with the same information. Either way, the IRS computer will have a chance to put up a yellow flag. You might get a letter asking for an explanation. However, since your change results in you paying more tax, I suspect they will ignore it. What's more important is they will see $8000 coming out of the first plan, $6400 going into the second plan, and $1600 reported as income, which is what they will really care about.
(And to be honest, I don't think the IRS computers are all that smart after all. Just in the last week I've seen a post from someone whose elderly father neglected their RMD requirement for more than 10 years, and another post from someone who made 6 years worth of ineligible Roth IRA contributions. They are now asking how to do the right thing and fix it, but they never got red-flagged by the IRS. If you want to do the right thing and pay the $160, swap the code to #1. It's the simplest fix to get the right result.)
Thank you very much again for your input.
I think I will create a substitute 1099-R (4852) because I can put explanation in that way.
I missed the fact that the code 2 was on the Form 1099-R for the $1,600 withheld for taxes rather than the one for the $6,400 that was converted.
I agree with Opus 17. Because the code-2 Form 1099-R includes tax withholding, the details of the form will be included with your filing. If you enter code 1 instead of code 2 without doing a substitute form, you'll be appropriately paying the penalty. The IRS might flag the difference and refund the $160.
At age 41, I would be more concerned about the lost tax-free earning potential of the $1,600 than the $160 penalty. Since they made a mistake in withholding taxes, you might consider trying to complete a late rollover under IRS Rev. Proc. 2020-46 by self-certifying that this would qualify for a waiver of the 60-day rollover deadline due to financial-institution error. It's up the the financial institution to accept or reject the self-certification: https://www.irs.gov/retirement-plans/accepting-late-rollover-contributions
I like the self-certification for the exception to the 60 day rollover rule, and I don't remember it as often as I should. But one of the requirements is that the make-up contribution be made "as soon as practicable" or 30 days after discovering the error. From the previous posts, I think that probably has been exceeded here.