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Replacing IRA distributions
Dear Tax Talk:
Can an individual retirement account distribution
be put back into an IRA without penalty within 60 days?
Thanks,
J. Garza
Dear J. Garza:
Most people are aware that they can roll
over money from one IRA to another during the year. A rollover is
tax-free if it is a direct rollover, but it is also tax-free if
you put the money back in the same IRA or another within 60 days
of withdrawal. This benefit is especially useful if you need cash
for a short period and you know that you have the funds to replace
it within 60 days, such as from a future bonus or commission. It
is subject to the 10 percent penalty on early distributions if you
don't later replace the funds, unless you were age 59½ or another
exception applies.
An IRA custodian may try to withhold tax on
the distribution if it is not a direct rollover. You can elect not
to have tax withheld by informing the custodian of your choice.
If tax is withheld you will have to replace those funds into an
IRA to avoid paying tax and possibly the 10 percent penalty on the
tax withheld. For example, suppose you withdraw $10,000 from your
IRA and the custodian withholds 20 percent or $2,000, giving you
a net check of $8,000. You need to put $10,000 into an IRA within
60 days to avoid paying tax. The $2,000 withheld is claimed as a
credit on your tax return much as other taxes withheld on other
income.
If you cannot replace all of the funds within
the 60 days, you can still avoid tax by replacing some of the funds.
You will avoid tax and penalty on the amount of funds replaced,
thereby mitigating your tax exposure.
Reporting partial exchange of an annuity
Dear Tax Talk:
I heard that a partial exchange of an
annuity under Section 1035 is a nontaxable event due to the Tax
Court ruling in Conway vs. Commissioner. Is this true? If
so, how should it be reported because insurance companies are still
reporting it as a taxable event on the 1099-R instead of a 1035
exchange?
Thank you,
Mike
Dear Mike:
As much as I can't control what the Internal Revenue Service does,
you cannot control what the insurance company does. You're right
that in a 1998 Tax Court decision in Conway vs. Commissioner
the Court ruled in the taxpayer's favor in treating a partial exchange
of an annuity contract as not taxable. When a court decision is
reached against the IRS, the agency has several options. It can
appeal the decision as in any civil matter. It can choose not to
appeal the decision and publish a notice of acquiescence or non-acquiescence.
To acquiesce means to agree with the findings of the court. Whether
the IRS acquiesces or not it issues an Action on Decision. An AOD
will spell out how the IRS will treat taxpayers in similar situations.
In the case of Conway, the IRS acquiesced to
the Court's decision.
Therefore, you can feel confident that your partial exchange of
annuity contract is not taxable. The instructions
to Form
1099-R indicate that the insurance company should report the
exchange. If the insurance company was aware of the exchange then
it should have indicated on Form 1099-R that the taxable amount
was not determined (Box 2b). If Box 2b is not checked and a taxable
amount was reported you can ask the insurer to consider revising
the 1099. Whether it does or not you need to report the gross distribution
on Form
1040 line 16a and enter zero on line 16b.
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