How to Reduce 2A Taxable Amount on the 1099-R

Many distributions from retirement accounts are taxable.

If you receive a distribution from your retirement account -- including from a pension, a traditional or Roth 401(k), or a traditional or Roth IRA, but not including Social Security -- you should receive a Form 1099-R from the payer early in the following calendar year. The 1099-R reports to both you and the IRS the amount of money you received (plus any withholding for taxes), and the portion of that amount that should be taxed, based on the information available to the payer. The taxable amount is reported in Box 2a.



Assuming the payer is correct in its assessment of the 2a taxable portion, you will need to include the 2a amount as taxable income on your tax return. There are ways that you can plan ahead to reduce the 2a amount. Note, however, that each of these methods still requires that you pay the tax owed on that income. You will just be paying at a different time.

Instructions

1. Verify that the 2a taxable amount in your 1099-R is correct. If the payer is mistaken, contact them to have a corrected 1099-R issued.

2. Check to see whether the "Taxable amount not determined" box is marked in Box 2b. Sometimes this box is checked even if the payer has entered an amount in Box 2a. If this box is checked -- whether or not there is an amount in Box 2a -- determine the taxable amount in order to complete your tax return properly.

3. Eliminate the 2a amount from future 1099-Rs by rolling your account over to a Roth IRA. If you do this, you will owe taxes on the full amount of the rollover now, but your future distributions will not be taxable.

4. Set up withholding from your retirement distributions, by filling out IRS From W-4P and sending it to the payer, as an alternative. This will not reduce the 2a amount itself, but will reduce the financial impact the 2a amount has on April 15th. Your retirement checks will be lowered by the amount withheld, but you will owe that much less when tax time comes.

Tips & Warnings

• The taxable amount of a retirement account distribution is determined by your investment in the account and whether that investment was made with pre-tax or after-tax dollars. The basic rule of thumb is that all your income will be taxed, but it should only be taxed once. For example, in a traditional 401(k) or IRA your contributions should all be pre-tax dollars. When you retire, the full amount of your distributions will be taxable. Conversely, in a Roth 401(k) or IRA, your contributions should be from after-tax dollars. Distributions from this type of account should not be taxed upon retirement.

• You can plan ahead to reduce or eliminate the 2a taxable amount. Make your retirement contributions using after-tax dollars to a Roth-type account, if this is a choice available to you. You will be paying income tax now on your contributions, but when you retire the 2a taxable amount will be $0. You may also be able to roll your traditional retirement accounts over to a Roth IRA. This will eliminate the 2a amount from future 1099-Rs. If you do this, you will owe taxes on the full amount of the rollover now, but your future distributions will not be taxable.

• If you rollover your traditional retirement account to a Roth IRA, you will need to pay income tax on the full amount of the rollover. If you cannot afford to pay these taxes using separate funds, you have a few options. First, you may be able to roll over just a portion of your traditional account and pay the taxes owed only on that portion. This would not eliminate the 2a amount in future years, but it would reduce it. Second, for some tax years, you may be able to spread the tax burden out and pay over more than one year. Third, you could take a portion of the retirement account as an early distribution, and use this amount to pay the taxes owed. The downside to this third option is that early distributions are subject not only to regular taxes, but also to significant penalties.

References

• IRS: Publication 17, "Tax Guide 2010"; 2010
• IRS: Publication 560, "Retirement Plans for Small Business"; 2010
• IRS: Publication 575, "Pension and Annuity Income"; 2010
• IRS: Form 1099-R, "Distribution From Pensions, Annuities, Retirement . . ."; 2011
• IRS: Form W-4P, "Withholding Certificate for Pension or Annuity Payments"; 2011