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Tax Talk with George Saenz

Ask the tax adviser

Replacing IRA distributions

Dear Tax Talk:
Can an individual retirement account distribution be put back into an IRA without penalty within 60 days?
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 59 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.

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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,

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.

-- Posted: Feb. 16, 2001

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