June 2, 2023
Retirement Plan Distribution Reporting
Take-Away: The world of retirement IRA distributions if filled with acronyms like ROTH, QCD, RBD, RMD, etc. Then, the world of IRAs has its own set of Forms that have to be filed, sometimes annually, to report all activities and transactions that deal with an IRA. And some transactions do not even have a required Form, leaving to the IRA owner the burden of reporting the transaction. Such is the complex world we now live in.
Background: Some IRA transactions are not so easily identified. In fact, some transactions do not even have a formal label associated or an official IRS Form that reports the transaction. Consequently, it is possible to overlook some IRA transactions that need to be reported in some fashion by the IRA owner. Consider the following:
QCDs: IRA custodians will not separately report a qualified charitable distribution (QCD). Moreover, there is no code or box on IRS Form 1099-R that identifies a QCD. As such, it is up to the IRA owner to advise the IRS about their charitable donation using their traditional IRA on their Form 1040 income tax return. Key, obviously, is to let the account owner’s tax preparer know about these QCDs. The last thing the donor wants is for their charitable gifts to be treated as taxable IRA distributions. This omission with regard to QCDs on the Form 1099-R is intentional. IRA custodians do not want to be placed in a position of monitoring or certifying if the IRA distribution meets all of the technical requirements for a QCD, thus shifting that burden back onto the IRA owner and his/her tax advisor.
Roth IRAs: The IRS form that deals with Roth IRAs and Roth conversions is IRS Form 5498. Form 5498 requires a lot of information to be reported, including the definitive date for every Roth contribution and conversion, so it becomes an important historical record that answers many questions on the taxation of distributions.
Conversions: Box 3 of the Form deals with Roth conversions. Until the individual account owner is age 59 ½, every Roth conversion will carry its own 5-year timeline to determine if the distributions of the converted amounts to the Roth IRA are subject to the 10% early distribution excise tax. It is all recorded on the annual Form 5498. Practically speaking, a Roth IRA conversion is ‘time-stamped’ January 1 of the year that is listed on the Form. Add 5 years and the Roth IRA owner will know precisely when those Roth conversion dollars are available to be distributed excise-tax free.
Contributions: Box 10 of the Form deals with Roth contributions. Roth contributions are also effectively ‘time-stamped’ on Form 5498. There is no place on a Form 1040 to report a Roth IRA contribution by the account owner. Again, Form 5498 will provide the needed information of when the Roth IRA owner first opened their first Roth IRA, and thus started their 5-year clock running with regard to distributions of tax-free earnings from their Roth IRA.
After-Tax Contributions: IRA custodians do not keep track of after-tax contributions made to an IRA. This is so, even if the IRA owner tells the IRA custodian that the funds are after-tax contributions or the after-tax contributions are held in a separate IRA. IRA custodians do not have any way of knowing what the account owner claims on their income tax return, so that have no way of knowing if a deduction for an IRA contribution was taken, or not. Any time an after-tax IRA contribution is made, it must be reported on IRS Form 8606. Filing IRS Form 8606 alerts the IRS that an IRA distribution, or Roth conversion (e.g. a back-door Roth conversion) is not taxable. If not identified as such on a Form 8606, the IRS will simply treat the distribution as taxable ordinary income to the account owner, or the amount converted to a Roth IRA is taxable.
Conclusion: When you think about how much wealth is held in IRAs these days, you begin to realize how important these IRS Forms are, both in reporting, and in contesting future IRS efforts to tax distributions that should be tax-free.