When a taxpayer receives a distribution from a pension plan or takes a withdrawal from an Individual Retirement Account (IRA), they will receive Form 1099-R after the end of the year. If they took the distribution before reaching age 59-1/2, the withdrawal may be subject to a 10% penalty on the amount of the withdrawal.
On Form 1099-R, the distribution code in Box 7 identifies the type of distribution, with distribution codes 1 and 2 indicating an early distribution.
In addition to code 1 or 2, Box 7 might also contain any of these secondary codes:
- 8 - Indicates a corrective distribution due to excess contributions, earnings, or deferrals in the prior tax year that should have been taxable.
- B - Distribution from a designated Roth Account
- D - Denotes annuity payments from a nonqualified annuity or a distribution from a life insurance contract.
- K - Distribution of traditional IRA assets that do not have a readily available FMV, such as stocks, ownership interest, debt obligations to name a few. Value is determined by the recipient, who may in turn pay for an appraisal.
- L - A loan using a retirement account as collateral is deemed a distribution if the value of the loan exceeds the value of the retirement account or there is a default on payments. Payments must be made at least quarterly per the IRS, and failure to adhere to the payment schedule results in the balance being characterized as a distribution subject to income tax and the 10% penalty.
- M - A qualified plan loan offset. This occurs when the plan administrator reduces the value of the retirement account by the unpaid balance of the loan. It is treated as a distribution.
- P - Excess contributions plus earnings or excess deferrals that are taxed at 6% for each year the contributions and earnings remain in the plan. Upon withdrawal earnings are taxed as ordinary income and assessed a 10% early withdrawal penalty if participant is younger than 59-1/2.
Distribution Code 1
Distribution code 1 indicates an early distribution from the retirement plan and the payer knows of no reason why the distribution would not be subject to the 10% early withdrawal penalty. However, the taxpayer may qualify for an exclusion to the early withdrawal penalty, e.g., for a qualified disaster distribution.
If a taxpayer takes an early withdrawal from a retirement account to simply pay off personal debt, the withdrawal will be subject to the 10% penalty.
Distribution Code 2
Distribution code 2 indicates the payer knows there is an exception to the early withdrawal penalty, such as in these scenarios:
- Converting a traditional, SEP, or SIMPLE IRA to a Roth IRA. See here for more information.
- A distribution due to an IRS levy under Section 6331.
- A distribution from governmental section 457(b) plan assuming none of the amount distributed is attributable to a rollover from another type of eligible retirement plan or IRA.
- A withdrawal from an eligible automatic contribution arrangement (EACA) permitted under section 414(w).
- A distribution to a participant age 55 (in the year they turned 55) or older from a qualified retirement plan after separation from service.
- A distribution to a public safety employee age 50 (in the year they turned 50) or older from a governmental defined benefit plan (section 72(t)(10)(B)) after separation from service.
- A distribution that is part of a series of substantially equal periodic payments, as described in section 72(q), (t), (u), or (v).
- Any other distribution subject to an exception under section 72(q), (t), (u), or (v) that is not required to be reported using Code 1, 3, or 4
Exceptions to the Penalty
There are exceptions to the penalty. For a complete list of exceptions refer to these two IRS Tax Topics:
- Topic No. 557 Additional Tax on Early Distributions From Traditional and Roth IRAs
- Topic No. 558 Additional Tax on Early Distributions From Retirement Plans Other Than IRAs
Public Safety Officer exclusion
A retired public safety officer may exclude up to $3,000 from taxable income distributions made from an eligible retirement plan used to pay the premiums for accident insurance, health insurance, or long-term care insurance. There is also an exception for retired public safety officers. The premiums can be for coverage for the taxpayer, spouse, or dependents, but note that the distributions must be made directly from the plan to the insurance provider.
An eligible public safety officer includes:
- a law enforcement officer
- member of a rescue squad or ambulance crew
To enter Form 1099-R in TaxSlayer Pro, from the Main Menu of the tax return (Form 1040) select:
- IRA, Pension Distributions (1099R, RRB-1099-R) - Select New, and if prompted indicate whether the payee is the taxpayer or spouse.
- Enter the payer EIN, name and address.
- Enter the Gross Distribution in Form 1099-R Box 1.
- The taxable amount in Box 2a should normally be the same as the amount from Box 1.
- When entering the Distribution Code in Box 7, if the Code is a 3, the 10% Additional Tax for Early Withdrawal does not apply and no further action is necessary upon exiting this 1099-R menu. However, when the Distribution Code in Box 7 is a 1 or 2, the program will prompt you to select which part of Form 5329 the distribution should transfer to. Because the distribution is from a pension plan or IRA, select "Transfer 1099-R Box 2a to Form 5329, Part I, Line 1".
- Does the Amount being Carried to Form 5329 Qualify for Any Penalty Exclusion? - If the taxpayer is claiming an exclusion from the 10% penalty, this question should be answered YES. Select the appropriate exclusion, then enter the amount reported in Box 2a that qualifies for an exclusion.
Note: This is a guide on entering an early distribution reported on Form 1099-R when claiming an exclusion to the early distribution penalty. This is not intended as tax advice.
IRS: Instructions for Forms 1099-R and 5498
IRS: Publication 575 - Pension and Annuity Income
IRS: Publication 590-B, Distributions from Individual Retirement Plans
IRS: Instructions for Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts