Defined Benefit Payout 1099-NEC

[Troy15]

As a volunteer firefighter, I was enrolled in a defined benefit capital appreciation plan. On separation from the fire company, the benefit is distributed in 3 installments. Per IRS rules, this can be rolled over into a qualified retirement account without needing to pay tax until it is withdrawn.

However, under new rules, the municipality is issuing this as a 1099-NEC. Entering this in TurboTax as an NEC triggers the creation of a business and there is no way not to pay taxes on the amount.

This seems like a bug in the software and should have an option to allow an NEC to be treated as a non-taxable  rollover and not pay taxes. Hopefully this can be fixed for 2023 tax year.

[tagteam]

Perhaps @dmertz can handle this

[dmertz · Accepted solution]

It makes no sense to me that a distribution from a defined benefit plan that is eligible for rollover to a qualified retirement account would be reported on a Form 1099-NEC rather than on a Form 1099-R.  Form 1099-NEC reports compensation for services performed by an independent contractor, not anything that is eligible for rollover.  That compensation would need to be reported as income from self-employment and the net earnings would be compensation that could support an IRA contribution, but that would not be a rollover.

If the plan was instead a nonqualified deferred compensation plan, that distribution should have been reported in box 11 of a W-2, not a a Form 1099-NEC, but such a distribution would not be eligible for rollover.

[Troy15]

It is not employee compensation. It is a length of service award program which is a defined benefit/capital accumulation plan. It is a 'retirement' plan for volunteers, with vested monies transferable to a qualified retirement plan on the end of service. As such, no taxes should need to be paid until retirement withdrawal.

But the municipality sent an 1099-NEC not a 1099-R, citing 'new rules' for NEC and because separating volunteers have the OPTION to cash the check and pay the tax, or roll it over. So not knowing which option will be chosen, they have to send an NEC not an R.

There is no option to enter a 1099-NEC in TurboTax without paying tax and creating a business. There is no option to enter any other income without paying tax.

I ended up entering a manual/substitute 1099-R and providing an explanation on the entry in TT as I have here. We will see what the IRS says, but in this situation, it seems TurboTax needs to allow for the 'rare' instance such as this of an NEC being a non-taxable retirement plan payout eligible for rollover.

[dmertz · Accepted solution]

"But the municipality sent an 1099-NEC not a 1099-R, citing 'new rules' for NEC and because separating volunteers have the OPTION to cash the check and pay the tax, or roll it over."

That makes no sense.  Forms 1099-R have always been treated that way by simply reporting a taxable distribution on the Form 1099-R and leaving it up to the taxpayer to report on their tax return whether it was rolled over to defer taxation or not.  Form 1099-NEC is for reporting Nonemployee Compensation paid to independent contractors.  Distributions from a qualified retirement plan are not compensation.

See the instructions for Form 1099-NEC which describe the usage of Form 1099-NEC:

https://www.irs.gov/instructions/i1099mec

Absent the municipality making a correction to report the distribution properly on Form 1099-R and to issue a corrected Form 1099-NEC to show that there was no nonemployee compensation, preparing a substitute Form 1099-R is the appropriate course of action.

[taxlady28]

Go to Other Common Income
Select that 1099-NEC

Enter the information and then check the box  that comes up with question about it being sporadic activity

That will enter it without asking for it to be a business
But if you did put it into a retirement plan then you need to enter it again as a 1099-NEC but on the second entry put in the amount with a minus sign in front of it.
Then you will not be taxed on the amount.
Keep notes with your tax records in case this is ever questioned.