IRA Alert

Ed Slott

Now is the time to review and correct 1099-R tax forms

Identify clients who had these types of retirement distributions and then check for these common errors

Jan 19, 2017 @ 5:11 pm

By Ed Slott

Your clients are now receiving 1099-Rs for distributions they received in 2016 from their retirement accounts. However, there is a good chance the form contains an error. This can cause IRS problems for the client later on, since IRS also receives a copy and relies on what it says, right or wrong. Now is the time to look for errors and have them corrected before they become etched in stone.

Most advisers should know which clients took distributions from their IRAs or company plans during the past year. The most common types of retirement distributions are for rollovers, annual RMDs, Roth conversions, early distributions and returns of excess contributions.

Identify clients who had these types of distributions and then check the 1099-R for these common errors:

Box 7, Code 1 — Early distribution, no known exception

The IRA custodian or plan issuing the 1099-R, does not generally know if an exception applies, so they use this code. IRS will assume a 10% early distribution is due. You might know that an exception actually does apply, since you may have been consulted, for example, on the need to take an early IRA distribution for higher education, which is an exception to the penalty. Alert the client's tax preparer, to file Form 5329 and enter the exception code. That will correct the reporting to show that there was a penalty exception.

Box 7, Code 7 — Normal distribution

This is the code for a regular IRA distribution where no penalty applies (age 59 ˝ or over). IRS will assume this is taxable. But the distribution may have been a rollover from a company plan which is not taxable, but miscoded as 7 instead of G. This should be corrected by the plan issuing the 1099-R. Change it to code G. That's the code to use when the rollover was a direct rollover from the plan to an IRA.

An IRA distribution may actually be a return of excess contributions, for IRA (or Roth IRA) contributions made in excess of the amounts allowed, including ineligible IRA contributions, for example, a second 60-day rollover within 365 days. This distribution may be erroneously coded as a normal distribution (code 7), when code 8 for a return of an excess contribution should have been used. This too, needs to be corrected by the IRA custodian, since the excess may not be taxable, if the excess was timely returned. In addition, if the excess was not timely corrected, a 6% penalty would be due and code 7 would not reflect that. However, if the IRA custodian was not informed that the distribution was a return of excess, code 7 will be the correct distribution code.

Direct IRA transfers

Direct transfers from one IRA to another should not be reported on a 1099-R, but they sometimes are and may be coded G, as a rollover. Code G is a code for employer plans and should never be used for an IRA transfer. In some other cases, the rollover is coded 7 as a normal distribution. That needs to be corrected by the IRA custodian.

Qualified Charitable Distributions (QCDs)

This one is tricky, because there is no code on the 1099-R for a QCD. It will likely be reported using box 7 as a normal, taxable distribution. It isn't. You and the CPA will have to know from the client if an IRA distribution was actually a QCD. Otherwise the client will end up incorrectly reporting the IRA distribution as taxable income.

Box 6 — Net Unrealized Appreciation (NUA)

If a client takes advantage of the tax break for NUA, check that box 6 “Net unrealized appreciation in employer's securities” shows the correct amount. Box 6 should reflect the appreciation. Sometimes the full fair market value is entered instead. That's a big mistake and wipes out the tax benefit. NUA distributions are usually for large amounts, so make sure the reporting is correct.

Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group. He can be reached at irahelp.com.

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