disaster distribution 2020

[bdotg89]

My wife took total distribution of her retirement account in 2020 and we received a 1099-R which shows federal income tax was taken out. when filling 2020 tax i included the 1099-R and said it was due to COVID-19 which was the case. so this year, when i'm doing my taxes it asking me to pay tax on the 1/3 of the full amount when in reality i already paid taxes on it to begin with since the distribution code on 1099-R is 1(early distribution). why is it making me pay tax all over again? Do i need to amend my 2020 tax return to correct the issue? i might as well pay the 10% early withdrawal penalty than pay tax on the whole amount again.

[DaveF1006]

No, you don't need to be amend because it wouldn't make any difference. Let me explain what happened. 

In the 2020 tax year, you received a 1099R reporting a distribution amount and the federal income tax that was withheld from that distribution.  

Now after you filed your return, only 1/3 of that distribution amount was taxable. However, the entire federal income tax that was withheld, was credited in the 2020 tax year. This reduced the opportunity for a future credit because it was applied to the 2020 tax return. 

I would imagine you may have received a better tax return last year and this might be because the total federal tax withheld was reported in 2020 instead of 1/3 installments.  

[Opus 17]

Any tax withheld was only an estimate.  Your actual income tax owed is calculated from your total income, deductions and credits, and you get credit for any tax payments and withholding.

You reported 1/3 of the distribution as taxable income, but you got credit for all the withholding.  Partly, that's because the law allowed the distribution to be spread out over 3 years but did not contain a provision for the withholding to be spread out over 3 years.  And you wouldn't want that anyway, since if the IRS kept your withholding for 3 years before applying it to your tax account, you would be giving them a large interest-free loan for that time.

As a result, you paid tax on 1/3 the distribution but got credit for all the withholding.  Your 2020 tax bill was smaller, or your refund larger, than it otherwise would have been.  In 2021 and 2022 you will again calculate the income tax you owe based on 1/3 the distribution plus the total of your other income, deductions and credits.  You don't get credit for the withholding because it was "used up" on your 2020 return.