If it’s the end of January, there must be 1099s in your mailbox. And while they come every year, this year has one more complexity because of Coronavirus-Related Distributions (CRDs). So maybe this is the time to do a deeper dive into 1099s.
Form 1099 is nothing other than an “information return” that you use to report certain types of income to the IRS. Whereas a W-2 reports wages, salaries and tips, a Form 1099 reports other types of income.
The IRS lists four pages of forms and instructions for 1099s, but our focus will be on the 1099-R.
Who gets 1099-Rs and why
Form 1099-R is issued each year – perhaps by an IRA custodian or an employer plan administrator – to each person who has “made a designated distribution” of $10 or more from:
- profit-sharing or retirement plans,
- any individual retirement arrangements (IRAs),
- insurance contracts,
- survivor income benefit plans,
- permanent and total disability payments under life insurance contracts,
- charitable gift annuities,
- death benefits from employers not made as part of a pension, profit-sharing or retirement plan
- and others.
- The disruption caused by Corona caused more and more people to change jobs, roll over retirement accounts or retire. As a result, they are more likely to see 1099-Rs, whether issued for a distribution from an IRA or employer retirement plan.
The form itself is pretty self-explanatory. All the boxes are essential, but we will focus on Box 7, where you will find the code that indicates the type of distribution being reported. Of the 29 possible codes, the most common include:
- Code 1: “Early distribution, no known exception.” Here the IRA owner is below age 59½ at the time of distribution. IRA custodians are not required to determine if the individual qualifies for an exception. If you have an exception, you can file Form 5329.
- Code 2: “Early distribution, exception applies.” This code will be used for Roth conversions, governmental 457(b) plan distributions, 72(t) distributions, and employer plan distributions where the employee has separated from service at age 55 or later (age 50 for certain public safety employees). Also used for IRS levies.
- Code 3: “Disability.” Used when a qualified disability triggers a distribution.
- Code 4: “Death.” This code is used for all distributions to beneficiaries, including an estate or trust. Also, some death benefit payments made by an employer.
- Code 5: “Prohibited transaction.” You have a BIG PROBLEM if you see a Code 5 distribution on your 1099-R. It indicates a prohibited transaction, which may make the entire IRA account balance taxable for the year of the prohibited transaction.
- Code 7: “Normal.” Here the distribution was made to an owner after age 59½, so there are no penalties; only income tax is due on this type of distribution.
- Code G: “Direct rollover and direct payment.” This code is used for most employer plan distributions that go directly to another eligible retirement plan.
- Code K: “Distribution of traditional IRA assets not having a readily available FMV (fair market value).” This code is used to indicate that an IRA distribution contains hard-to-value assets, such as real estate, privately held stock or partnerships not traded on an exchange, interest in an LLC or option contracts.
1099-Rs under specific situations
Under all of the distribution scenarios reported on 1099-Rs, the safest action is to consult with your accountant, tax preparer or other tax expert to be sure you have complied with all IRS regulations. Misreporting can result in unnecessary delays and penalties.
Rollovers – Even though the funds will have been rolled over into another qualified account, the distribution will still be reported to the IRS. As the IRA owner, you will be responsible for indicating on your Form 1040 that it was a rollover and what amount was rolled over.
NOTE: If you had taken your annual RMD in 2020 before the CARES Act waived the requirement to do so, and you repaid the funds as the IRS allowed, you might be surprised to see the original distribution listed on a 1099-R. Your remedy is the same as for a rollover.
Qualified Charitable Distributions (QCDs) – Your custodian will issue a 1099-R for a QCD, even though it was not a taxable event. It will appear as a normal distribution. As in the case of a rollover, you will have to note on your Form 1040 that it was a QCD to avoid taxation.
Coronavirus-Related Distributions (CRDs) – The IRS allowed distributions of up to $100,000 to be taken from IRAs and other plans with two advantages: (1) they were penalty-free, and (2) you could spread the taxation over three years. Your 1099-R will not reflect this fact. You will have to file the new Form 8915-E with the IRS to report the distribution, avoid the 10% penalty and indicate if you want to access the 3-year taxation option.
Your responsibility with 1099-Rs
When 1099-Rs are issued, your custodian does not know what you will do with the funds. That explains the need for you to report further information to the IRS on your Form 1040 and other forms. That includes rollovers, QCDs, CRDs, and any exceptions.
Exceptions might include the 10% early distribution penalty where funds are used for a first-time home purchase, medical expenses, qualified higher-education expenses or because of a disability, among other things.
Some exceptions have specific codes (for example, a qualified disability would merit a Code 3 instead of a Code 1 on the 1099-R), but the custodian may not have indicated it.
Other issues with 1099-Rs
Incorrect 1099s are not uncommon. That makes it essential for you to review any 1099s (including 1099-Rs) when you receive them, while you still have time to reach out to the issuer to correct the error. The same holds if you don’t receive a 1099-R at all when you know you took a distribution.
If you receive no satisfaction from the responsible issuer by the end of February, the IRS is prepared for you to call at 800-829-1040 for them to follow up with the issuer and to send you a form with instructions.
If your issue is not resolved satisfactorily, be sure to advise your tax expert so you can file what you believe to be correct. Don’t let the negligence of others cause you to miss filing deadlines or underreport.
Use your professionals to get it right. Your goal is to avoid paying extra taxes or penalties at all costs.
This article originally appeared in Wicked Local.