If you have received a Form 1099-R from your retirement plan or IRA, you may be wondering what it means and how it affects your taxes. Form 1099-R reports the distributions you received from your retirement accounts during the year, such as withdrawals, rollovers, conversions, or transfers. Depending on the type and amount of the distribution, you may owe income tax and/or penalties on it.
One common situation that may cause confusion is when you receive a 1099-R distribution that is less than the rollover check you deposited into another retirement account. This may happen when the payer of the distribution withheld some federal or state income tax from the amount you received. For example, if you requested a $10,000 distribution from your 401(k) plan and rolled it over to an IRA, but the plan withheld $2,000 for federal taxes, you would receive a check for $8,000 and a 1099-R showing a gross distribution of $10,000 and a taxable amount of $2,000.
In this case, you may think that you only need to report the $8,000 that you actually received and rolled over, and that the $2,000 withheld is not taxable. However, this is not correct. The IRS considers the entire $10,000 as a distribution, and expects you to roll over the full amount to avoid taxes and penalties. If you only roll over the $8,000, the IRS will treat the $2,000 as an early withdrawal, subject to income tax and a 10% penalty if you are under age 59 1/2.
To avoid this outcome, you have two options:
- You can make up the difference by adding $2,000 from your own funds to the rollover amount within 60 days of receiving the distribution. This way, you will have a complete rollover of $10,000, and the $2,000 withheld will be credited as a tax payment when you file your tax return.
- You can report the $2,000 as a taxable distribution on your tax return, and pay the tax and penalty on it. You will still have a partial rollover of $8,000, which will not be taxed or penalized.
The following table summarizes the tax consequences of these two options:
| Option | Rollover Amount | Taxable Amount | Tax Withheld | Tax Due | Penalty Due |
|---|---|---|---|---|---|
| 1. Add $2,000 from own funds | $10,000 | $0 | $2,000 | $0 | $0 |
| 2. Report $2,000 as taxable | $8,000 | $2,000 | $2,000 | $0 | $200 |
As you can see, option 1 is more advantageous, as it allows you to defer taxes on the entire distribution and avoid the penalty. However, option 2 may be more feasible if you do not have enough cash to make up the difference.
To report your 1099-R distribution and rollover on your tax return, you will need to fill out Form 1040 and attach Form 5329 if you owe the penalty. You will also need to enter the code in box 7 of your 1099-R, which indicates the type of distribution you received. For example, code 1 means an early distribution, code 2 means an exception to the penalty applies, and code G means a direct rollover.
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