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How to Stand Out From the Crowd

Questions to ask your client when they receive a 1099-R.

February 12, 2009
Sponsored by Ed Slott and Company, LLC

The 1099-R is the key information form that will clue you in as to what type of retirement plan distribution your client has received, the applicable tax treatment and the tax forms that will be required to be filed with the tax return. But you already know all of that. How are you going to stand out from the crowd? It is in the questions you ask when you see that a client has a 1099-R.

Don’t assume the amount is fully taxable! Ask the client “What did you do?”

Did the client do a rollover of all or a part of the distribution? The amount rolled over will not be taxable — if it went to the correct account. This should always be checked! However, there can only be one rollover per 12 months from the distributing IRA (individual retirement account) otherwise the amount is taxable and cannot be put back into an IRA. A non-spouse beneficiary can never do a rollover of IRA funds, but they can do a direct rollover of inherited plan funds to an inherited IRA.

Did the client do a direct transfer of all or a part of an IRA distribution to a qualified charity? The amount that went to the charity is not included in the client’s income if the client satisfies the qualified charitable distribution rules. This provision expires at the end of 2009.

Does the client have any basis in the retirement plan? For IRA accounts this should be tracked by the account owner on Form 8606, for a plan participant the nontaxable amount should be noted on the 1099-R. The portion of the distribution attributable to the basis will not be taxable.

Did the client take an in-kind distribution of employer stock as part of a lump-sum distribution of his employer plan or of an inherited plan? Only the basis amount of the stock that was purchased with tax-deferred funds will be taxable under the net unrealized appreciation (NUA) rules.

Did the client do a Roth conversion? Did he qualify to do a conversion? If yes, then taxes are owed on pretax amounts that are converted. But, has the account value gone down over the past year? Maybe the client should do a re-characterization to avoid paying all the income tax. The re-characterization can be done up to October 15th of the year after the conversion. A net amount (the amount converted plus or minus earnings) is directly transferred from the Roth IRA back to a traditional IRA and is treated as though it had always been in the traditional IRA thus wiping out all the income tax from the conversion. If the client did not qualify for the conversion, then a re-characterization must be done. Don’t assume the re-characterization has been done. Make sure the funds have been transferred back to the correct type of account. A beneficiary can convert inherited employer plan assets, but not inherited IRA assets.

Did the client take a required distribution? If he is over the age of 70½ there is a required distribution (however, RMDs (Required Minimum Distribution) are suspended for 2009). Did he take the full amount? Any required distribution not taken is subject to a 50-percent penalty. That is not a misprint; it is a 50-percent penalty.

Is the client taking early distributions under a 72(t) (substantially equal periodic payment) schedule? Did he take the full distribution for the year? Is it the same amount as he took last year? Most clients should be taking out the same amount each year for five years or until they reach age 59½, whichever is later unless they are using the RMD method. Since that method produces the smallest annual distribution, most clients will not be using that method.

Did the client take an early distribution (before age 59½)? Do they qualify for any of the penalty exceptions? If not, the penalty must be paid.

Is there a code 4 in box 7? That’s the “Death” code. It means that the distribution is being made to a beneficiary. This is the $64,000 (or more) question. Was this account subject to federal estate tax in the estate of the account owner? If it was, this beneficiary qualifies for the income in respect of a decedent (IRD) deduction, which can be as high as 40 percent to 45 percent of the amount of the distribution. This one you don’t want to miss!

For more information, visit Ed Slott and Company, LLC.

Copyright © by Ed Slott and Company, LLC 2009