If You're Over 50, Don't File Taxes Until You Double-Check This One Form
Many people will come across a tax form they may not have seen before: the 1099-R form. You typically receive it after you retire, change jobs, rollover money between retirement accounts or start taking distributions. When you see a big dollar amount on the form, it’s easy to think the whole amount is taxable.
A 1099-R reports distributions from pensions, retirement plans, IRAs, profit-sharing plans, annuities and insurance contracts. However, the form doesn’t always tell how much of that money is actually taxable.
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Before you file your return, look more closely at what the form is reporting and if it accurately reflects what happened with your money. Here are some key factors to familiarize yourself with.
Why People Over 50 Are More Likely To Get a 1099-R
Retirement and job change are two of the most common reasons a taxpayer receives a 1099-R. Leaving an employer and rolling over money from a 401(k) or 403(b) into an IRA can trigger the form even when you haven't taken a taxable distribution.
“Most people get that and panic thinking they caused something that pays tax, but we always tell our clients a rollover is reportable but not taxable,” said Caleb Moyer, financial advisor and owner of Moyer Tax Services.
Other situations that can trigger 1099-R include pension payments, retirement-account withdrawals and some life insurance distributions.
“Regardless of what causes it, the taxpayer should review Box 1 (the gross amount), Box 2a (the taxable amount), and Box 7 (the distribution code), as those three items often help understand what caused it and how much is taxable,” said Moyer.
The Distribution Code Most Filers Misread
Box 7 is one of the most important parts of a 1099-R. This box contains a code that indicates the type of distribution the financial institution believes took place. “However, it's not always the correct answer from a tax reporting standpoint,” Moyer said.
According to Moyer, Code 1, for example, is typically an early distribution that falls under “no known exception,” which is subject to a 10% penalty, even if the taxpayer qualifies for an exception the institution was not aware of. The taxpayer must claim that exception on Form 5329 separately.
He also pointed to Code 7 and qualified charitable distributions (QCDs) as other misinterpreted distribution codes.
“A person over 70.5 and doing a qualified charitable distribution from their IRA would have Code 7 showing the whole amount taxable even though it wasn't because some of it was tax-free because it went to charity.”
How Rollovers Can Look Taxable
Fewer people are doing indirect rollovers these days, but Moyer said the mistake still comes up. When a retirement plan is rolled over indirectly, the money is paid to the taxpayer’s name first, and the delivering institution is required by law to withhold 20%.
The taxpayer still must roll over the full original amount and pay that 20% withholding out of pocket, or that portion becomes a taxable distribution.
“Often, taxpayers will think they rolled over the full amount but didn't replace the 20%, and by the time it is time to report it, it's too late to do more,” he said.
Early Withdrawal Penalties Before Age 59½
“The most frequently missed exception is the Rule of 55,” Moyer said. Distributions from an employer's plan can be taken without the 10% penalty if the employee retires during or after the year he or she turns 55, but only if the money is kept in the employer's plan.
Rolling it into an IRA voids the exception, which is why Moyer’s firm frequently keeps some of the client’s retirement savings in the employer plan between ages 55 and 59½.
Roth Conversions Can Make the 1099-R Confusing
A Roth conversion can look like a withdrawal because that's basically how it's reported on the 1099-R. If you convert $50,000 from a traditional IRA into a Roth IRA, you could receive a 1099-R for the $50,000 distribution.
If it’s a Roth conversion, the financial institution will know that, and Moyer said the distribution code will probably be Code 2, which identifies an exception to the additional 10% tax penalty.
However, that doesn't automatically mean the conversion is tax-free. Generally, the taxable portion of the converted amount must still be included in income.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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