Roth IRA Early Distribution Taxed at Full Amount?

[Guest HTaylor]

Hi All,

I received notice from the IRS stating that I had income from my 2009 Tax Returns improperly reported (not reported).

The income was from my Roth IRA early distribution (I am under 59yrs of age)

When I was withdrawing the funds, my account manager advised me that that since I had the account for over 5yrs it was likely that I wasn't going to be penalized for the withdrawal (which it appears I wasn't). Nothing was mentioned as to how it would be taxed.

Now, 2yrs later, I recieved notice from the IRS that I was to be taxed on the full amount of the withdrawal (account was closed).

My questions is, is this correct?

I thought that when I invested funds into the account it was "AFTER TAX" money (meaning I already paid taxed on it).

I am not understanding how I can be taxed 'again' on the amount that I invested. I can understand being taxed on any of the "gains" made over and above what I originally invested. Since this action has a ripple affect on other portions of my Tax Return (i.e., Child Tax Credit, etc) I am being told that my adjusted return shows me owing over $4,500, when the total amount of the withdrawal was only $7,850.

Can someone shed some light on the fully taxable question for me? Am I supposed to be taxed on the $7,850 or should I be taxed on the few hundred dollars of earnings that's included in that $7,850?

Thanks in advance.

Henry

[masteff]

I can't give you tax advice but here are some thoughts to point you in direction of a solution:

Even if it's not a taxable distribution, it still has to be shown correctly on your tax return. If done wrong, the IRS will likely presume that the entire distribution is taxable.

In your 2009 tax return, you need to look at line 15 of your form 1040 (or line 11 of 1040A) and at forms 8606 and 5329.

1040 Instructions: http://www.irs.gov/pub/irs-prior/i1040--2009.pdf

8606 Form: http://www.irs.gov/pub/irs-prior/f8606--2009.pdf

8606 Instructions: http://www.irs.gov/pub/irs-prior/i8606--2009.pdf

5329 Form: http://www.irs.gov/pub/irs-prior/f5329--2009.pdf

5329 Instructions: http://www.irs.gov/pub/irs-prior/i5329--2009.pdf

Since you're under 59 1/2, depending on your personal circumstances, you may be subject to regular tax on any earnings and to 10% early withdrawal penalty. You might want to review IRS Publication 590 (see page 64 "Are Distributions Taxable?") http://www.irs.gov/pub/irs-prior/p590--2009.pdf

The IRS has local Taxpayer Assistance Centers, although sometimes the lines can be a bit long. http://www.irs.gov/localcontacts/index.html

[Guest HTaylor]

Hi Masteff,

Understood about not providing Tax Advice.

Thanks for the reply and clarification.

I am reviewing the forms you mentioned and I am also in-touch with the IRS trying to resolve the issue.

Unfortunately, the IRS referred me back to the Investment Co that the distribution came from.

The Investment Co referred me back to the IRS stating that they could only code the 1099-R form as "J", and that any changes were to be done when my taxes were filed. I'm assuming that's likely one of the forms you mentioned.

Hopefully I can understand them and if applicable, submit them with my response to the IRS and get things straight.

Again, Thanks for the assistance, it is greatly appreciated!

Henry

I can't give you tax advice but here are some thoughts to point you in direction of a solution:

Even if it's not a taxable distribution, it still has to be shown correctly on your tax return. If done wrong, the IRS will likely presume that the entire distribution is taxable.

In your 2009 tax return, you need to look at line 15 of your form 1040 (or line 11 of 1040A) and at forms 8606 and 5329.

1040 Instructions: http://www.irs.gov/pub/irs-prior/i1040--2009.pdf

8606 Form: http://www.irs.gov/pub/irs-prior/f8606--2009.pdf

8606 Instructions: http://www.irs.gov/pub/irs-prior/i8606--2009.pdf

5329 Form: http://www.irs.gov/pub/irs-prior/f5329--2009.pdf

5329 Instructions: http://www.irs.gov/pub/irs-prior/i5329--2009.pdf

Since you're under 59 1/2, depending on your personal circumstances, you may be subject to regular tax on any earnings and to 10% early withdrawal penalty. You might want to review IRS Publication 590 (see page 64 "Are Distributions Taxable?") http://www.irs.gov/pub/irs-prior/p590--2009.pdf

The IRS has local Taxpayer Assistance Centers, although sometimes the lines can be a bit long. http://www.irs.gov/localcontacts/index.html

[mbozek]

Htaylor:

1. what the amount of your Roth contribution?

2. what is the amount of the distribution received in 2009?

3. If 2 is greater than 1 you have a taxable distribution because you were not 59 1/2. Code J is the symbol for early distribution. If 1 is greater than 2 you have a loss deductible on schedule A as a misc. expense.

4. If you have other Roth IRA accounts that were not cashed out in 2009 you need to follow the procedures in IRS pub 590 P 67, ordering rules for distributions, to determine taxation.

[ETA Consulting LLC]

True. The key is understanding that the IRS is going to send you a bill with the worse case scenario and place the onus on you to prove that you owe only a fraction of that. Mbozek is basically having you to differentiate your original contributions from the investment gains for which the taxes and penalties will apply; and you would base your calculations from that. (MBozek, I think that's what you are getting at )

You may need historical records of your Forms 5498 to show your Roth IRA contributions for the years where Roth contributions were made. This will defend your contribution basis to the IRS and the remainder will be earnings.

Good Luck!

[mbozek]

True. The key is understanding that the IRS is going to send you a bill with the worse case scenario and place the onus on you to prove that you owe only a fraction of that. Mbozek is basically having you to differentiate your original contributions from the investment gains for which the taxes and penalties will apply; and you would base your calculations from that. (MBozek, I think that's what you are getting at )

You may need historical records of your Forms 5498 to show your Roth IRA contributions for the years where Roth contributions were made. This will defend your contribution basis to the IRS and the remainder will be earnings.

Good Luck!

That's what I am geeting at. Taxes are due on gains if its not a qualified distribution.