1099-R

[Hippo24]

@VolvoGirl @dmertz 

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.

[Opus 17]

@Hippo24 

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. 

[Hippo24]

@Opus 17 

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?

[Opus 17]

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@Hippo24 wrote:

@Opus 17 

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?

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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.)

[Hippo24]

@Opus 17 

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.   

[dmertz]

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

[Opus 17]

@dmertz 

@Hippo24 

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.