Did you take money out of your IRA last year? Or did you move money between IRAs, recharacterize the tax status of your contribution, or convert assets to a Roth IRA? If you took any of these actions in 2021, your IRA custodian must report this transaction to the IRS on a 2021 Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. You should have received a copy of the Form 1099-R from your IRA custodian around January 31, 2022.
The IRS will be expecting you to pay taxes on the dollar amount reported as “taxable” on Form 1099-R, unless the form indicates that you meet an exception to taxation, or you made a subsequent transaction with the IRA assets to defer taxation (like completed a rollover). In most instances, you’ll have to explain your actions and including any exception to tax with your income tax return. A good starting point for telling your tax story is to make sure the Form 1099-R the IRS receives accurately describes your actions.
Form 1099-R is an important tax tool for the IRS – you’ll want to understand what it’s telling them. Make sure you agree with all the information reported on your Form 1099-R or contact your IRA custodian right away to discuss your questions and make any necessary corrections.
1. Gross distribution
Your IRA custodian will report the total dollar amount taken out of your IRA, even if it’s not the amount you ultimately received (e.g., some of the distribution was withheld for taxes). An exception to this general rule is if your custodian withdraws investment or transaction fees from the IRA. Although these withdrawals reduce the value of your account balance, they are not generally reported as a distribution on Form 1099-R.
2. Taxable amount
With a Traditional, SEP, or SIMPLE IRA distribution, you generally must include the entire distribution in your taxable income for the year. But there are instances in which some or all of the distribution will not be taxable, such as when you have basis in your IRA, or when you have completed a rollover within 60 days. Your IRA custodian will not be aware of these extenuating circumstances, so it will report the gross distribution amount in the “Taxable amount” box. (For a Roth IRA, this box will be blank.) Your custodian will also check Box 2b, “Taxable amount not determined” to let the IRS know that an exception to taxation may apply. If the “Taxable amount not determined” box is empty, be sure you agree with the dollar amount found in the “Taxable amount” box because the Form 1099-R is reporting to the IRS that this amount is taxable (e.g., when an excess contribution is removed timely, just the earnings are taxable).
3. Federal and state withholding
You generally may elect to have a portion of your IRA withdrawal withheld and sent to the IRS or your state taxing authority as a prepayment of your tax liability on the IRA distribution. Remember that any amounts withheld are still taxable to you to the extent they would otherwise be a taxable distribution. Review the dollar amount in this box to make sure you agree with the amount withheld considering your withholding election, the amount reported as a gross distribution, and the dollar amount you received.
4. Distribution code
An IRS distribution code identifies the reason for the distribution and alerts the IRS as to whether a distribution may be included in taxable income and subject to the 10% early distribution tax. Be sure you understand the code used in Box 7 on your Form 1099-R, so you can provide the correct information with your tax return to either pay the additional tax owed or prove you meet an exception to the tax. If the incorrect code is used and it is not explained adequately on your tax return, you may be contacted by the IRS for improper reporting or improper payment of taxes. You can find a key to the IRS codes on the back of the IRS Form 1099-R or on a page 2. Here are some common codes for a Traditional IRA distribution:
- Code 1: Distribution to an IRA owner who is younger than age 59½ and does not meet any of the IRS exceptions to the 10% early distribution tax, or meets an exception that does not have its own distribution code (e.g., distributions taken to pay for medical expenses, health insurance premiums, higher education)
- Code 4: Distribution to a beneficiary – an exception to the 10% early distribution tax
- Code 7: Distribution to an IRA owner who has reached age 59½ and is no longer subject to the 10% early distribution tax
If different codes must be used for multiple distributions you have taken throughout the year, you will receive more than one Form 1099-R, even if all distributions are from the same IRA.
5. IRA/SEP/SIMPLE checkbox
If there is a check in the “IRA/SEP/SIMPLE” checkbox, the Form 1099-R is informing the IRS that you received a distribution from a Traditional, SEP or SIMPLE IRA. This means your distribution will generally be taxable to you. If you actually received a distribution from a Roth IRA, you will want to have a corrected Form 1099-R sent to the IRS because most Roth IRA distributions are not taxable.
Be sure to consult a tax professional or financial advisor if you have questions about your tax liability or tax strategies.