Roth IRAs are designed to tax all contributions in the year of contribution, with earnings not taxed when distributed after age 59-1/2. If the taxpayer elects to take a distribution prior to reaching minimum retirement age and before the Roth IRA has been in place for a full 5 years, then a portion of the distribution will be taxable and also may be subject to the 10% penalty.
When is a Roth IRA Distribution taxable?
Current legislation requires that a Roth IRA be in place for a full 5 years prior to any withdrawal. Distributions from a Roth IRA that include earnings may be taxable if the taxpayer is under the age of 59-1/2 or has not met the 5-year rule.
If IRS withdrawal requirements are not met, earnings withdrawn will be included in income and taxed. Taxpayers under the age of 59-1/2 will also be subject to a 10% penalty on earnings withdrawn unless they meet qualified exceptions.
Taxpayers who meet the age 59-1/2 requirement will be subject to income tax on the earnings of early withdrawals (due to not meeting the 5-year rule) but aren't subject to the 10% early withdrawal penalty.
The preparer needs to enter the Form 1099-R, and ProWeb will calculate the taxable portion, if any, along with penalty, if any. If an early withdrawal has a qualifying exception, the 10% early penalty will not be assessed.
For a complete list of exceptions, refer to IRS Exceptions to Tax on Early Distributions.
Note: This is a general discussion of IRS regulations regarding the taxability of a Roth distribution. It is not intended as tax advice.