VITA: 01

1. VITA: 01/16/09Lesson 11: Retirement Income Winter 2010 Kristina Shroyer

2. Lesson 11: Retirement Income Blank Forms for this Lesson As we go through this lesson you'll want to use some of the blank forms in Publication 4491-W for reference (blank forms start on Page 215) Form 1040 (page 215) Form 1099-R (page 50)

3. Lesson 11: Retirement Income Introduction In this lesson we're going to talk about retirement income that gets reported on lines 15 and 16 of Form 1040 (Social Security and Railroad retirement benefits will be covered in another lesson) What is Retirement Income? Any benefits from annuities, retirement or profit sharing plans, insurance benefits, IRAs etc. Retirement income may be fully or partially taxable How is Retirement Income Reported? Retirement income is reported on Form 1099-R - let's take a look at one Line 1 is the Gross Retirement Distribution Line 2a is the Taxable Amount If the taxable amount is reported here you will see reporting retirement income on the Form 1040 is very easy – this is an intermediate level topic Line 2a may not be filled out and box 2b "Taxable Amount not Determined" may be checked If this is the case you will have to calculate the taxable amount making the reporting more difficult, as a result this is an advanced level topic

4. Lesson 11: Retirement Income How to report Retirement Income if the taxable portion IS calculated The taxable portion of the retirement distribution is calculated if the payer reported an amount on line 2a of Form 1099 R Step 1: If the distribution is an IRA the box next to #7 will be checked Use line 15a (or 11a on Form 1040A) to report the gross distribution from Box 1 of Form 1099-R Use line 15b (or 11b on Form 1040A) to report the taxable amount of the distribution from Box 2a of Form 1099-R If the distribution is NOT an IRA (the box is not checked) Use line 16a (or 12a on Form 1040A) to report the gross distribution from Box 1 of Form 1099-R Use line 16b (or 12b on Form 1040A) to report the taxable amount of the distribution from Box 2a of Form 1099-R Step 2: If there is an amount in Box 4 of Form 1099-R (Federal Income Tax Withheld) it should be reported in the Payments Section of the Form 1040 (line 61) Also make sure any amount in Box 10 of Form 1099-R (State Tax Withheld) is also reported properly Note: Box 7 of Form 1099-R identifies what type of distribution the taxpayer has received (we'll talk more about this later) Right now we're talking about "normal" distributions, which result in a "7" in Box 7 A normal distribution is taken after the taxpayer turns 59 ½

5. Lesson 11: Retirement Income How to report Retirement Income if the taxable portion IS NOT calculated If the payer did not report an amount on line 2a of Form 1099 R (box 2b will normally be checked) you will need to calculate the taxable portion of the IRA, Pension, or Annuity (this is an Advanced Topic – it's one you will probably have to look up when it comes up) Contributions vs. Distributions Contributions are the amounts deposited into a retirement account and Distributions are the amounts withdrawn from a retirement account The benefit is the income (dividends/interest/gains) allows the retirement account to grow tax free until benefits are distributed (withdrawn) and reported on Form 1099-R General Information about Retirement Plan Distributions Retirement plans are funded by either before-tax contributions or after-tax contributions Before-tax Contributions Means the taxpayer did not pay taxes on the money at the time they contributed it to the retirement plan Before Tax Contributions to a retirement plan are fully taxable when distributed (paid out) to the taxpayer After-tax Contributions Means tax had already been paid on the money at the time the taxpayer contributed to the retirement plan After-tax contributions are partially taxable when distributed (paid out) to the taxpayer, generally only the earnings on after-tax contributions are taxable when distributed (paid out) There is a chart in your book on page 11-3 that summarizes this Read Example at bottom of page 11-3

6. Lesson 11: Retirement Income How to figure out the taxable portion of IRA distributions (income) Remember IRA distributions are reported on Form 1099-R with box 7 checked There are two types of IRAs that are within the scope of VITA Traditional IRAs Distributions from traditional IRAs are generally taxable because contributions are generally before tax contributions (deposits) Under most circumstances contributions made to traditional IRAs are subtracted from income on the tax return on line 32 (you'll learn about this in detail in Lesson 17) There are certain qualifications a taxpayer must meet for a Traditional IRA contribution to be non-taxable that you will learn in Chapter 17) The exception is when a taxpayer fills out a Form 8606 at the time they make a traditional IRA contribution to indicate that was made with after tax money – they would do this if they made an IRA contribution that didn't qualify to be reported on line 32 and subtracted from tax Any distributions a taxpayer received from a traditional IRA they made non deductible contributions to (reported on form 8606) is out of the scope of VITA and the taxpayer should be referred to a professional tax preparer Read Example on Page 11-4 If a taxpayer's distribution is from a traditional IRA and the taxable part is not determined ask them if the contributions to the traditional IRA were deducted from income in the year they were made If the answer is yes the distribution is 100% taxable and use lines 15a and 15b to report it (or lines 11a and 11b on Form 1040A)

7. Lesson 11: Retirement Income How to figure out the taxable portion of IRA distributions (income) Remember IRA distributions are reported on Form 1099-R with box 7 checked There are two types of IRAs that are within the scope of VITA Roth IRAs Contributions to Roth IRAs are made with after-tax contributions and may be excluded from income if all the following requirements are met: The distribution is made after the 5 year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for the taxpayer AND The distribution is: Made on or after age 59 ½ - OR – Made because the taxpayer was disabled (see tip page 11-5) – OR- Made to a beneficiary or estate – OR- Used to pay certain qualified homebuyer amounts (up to a $10,000 limit for the taxpayer's lifetime) IF the two above requirements are not met the Roth IRA could be partially taxable and subject to a 10% penalty – this is out of scope for VITA and should be referred to a professional tax preparer If the above two requirements are met the Roth IRA distribution is not taxable and does not need reported on the tax return Let's read the exercises at the bottom of page 11-5

8. Lesson 11: Retirement Income How to report IRA Distributions once you've figured out the taxable portion Remember IRA distributions are reported on Form 1099-R with box 7 checked If the taxpayer's IRA distribution is from a traditional IRA and all contributions were deducted from income in the year they were made the distribution is fully taxable Use line 15a (or 11a on Form 1040A) to report the gross distribution from Box 1 of Form 1099-R Use line 15b (or 11b on Form 1040A) to report the taxable amount of the distribution from Box 2a of Form 1099-R If the taxpayer's traditional IRA contributions were NOT all deducted from income in the year they were made (taxpayer should have filled out form 8606) out of VITA scope, refer to professional tax preparer If the taxpayer's IRA distribution is from a ROTH IRA and all requirements specified are met it is not reported on the tax return If all requirements are not met the ROTH IRA distribution could be partially taxable and the taxpayer should be referred to a professional tax preparer

9. Lesson 11: Retirement Income How are rollovers handled? A rollover occurs when a taxpayer gets a distribution from one retirement account (IRA or pension) and transfers that distribution (rolls it over) into another retirement account (IRA or pension) within 60 days of the original distribution When a rollover occurs a 1099-R will be issued to the taxpayer If it was a direct rollover (from one financial institution directly to another) box 7 will have code G in it (this is the easiest) On the back of Form 1099-R (or at the bottom) there is a list telling you what the codes in Box 7 mean – it's in the "Instructions" – let's take a look If it was not a direct rollover it is up to the taxpayer to have the amount re-deposited into the rollover account within the 60 days (they should give you some sort of documentation) To report the rollover (if it is an IRA) report the gross amount on line 15a (11a on form 1040A) and enter $0 on line 15b (11b on form 1040A) and write the word "Rollover" next to line 15b or 11b

10. Lesson 11: Retirement Income What if the distribution is used for Charitable Purposes? This is called a QCD (Qualified Charitable Contribution) and occurs when a taxpayer has a distribution taken from their IRA made to an organization eligible to receive tax deductible contributions This normally makes any part of the distribution that would have been taxable to the taxpayer, non-taxable Box 7 has no distribution code that identifies a QCD Requirements for QCD (from page 11-7): Taxpayer must be 70 ½ or older at time of distribution Distribution must be from a TRADITIONAL IRA (no other types qualify) Amount cannot be more than $100,000 (each spouse on a joint return gets $100,000) Amount cannot be included on Schedule A (Itemized Deductions) with other charitable contribution deductions (this would be double reporting the deduction) Taxpayers should have written acknowledgement from the recipient stating the following: (from page 11-7): Organization's Name The amount The date A statement indicating there was no personal benefit to the taxpayer This is in the scope of VITA ONLY if this QCD Distribution is a result of pre-tax contributions (so if not QCD would have been fully taxable) How QCD's are reported: Total Distribution goes on line 15a Taxable amount of the distribution goes on line 15b with the word "QCD" next to the amount on line 15b to indicate it was partially or fully non taxable because it met QCD requirements

11. Lesson 11: Retirement Income How to figure out the taxable portion of pensions and annuities? (if box 2a not filled so you must calculate) Box 7 is not checked in this case on Form 1099R indicating this is not an IRA but instead a pension or annuity Fully Taxable Pensions and Annuities Generally Pension and Annuity Income is fully taxable if ALL of the following are true: Taxpayers did not pay any part of the cost of their annuity or pension Employers did not withhold part of the cost of the annuity or pension from the employee's pay Employers withhold part of the cost from the taxpayer's BEFORE-TAX pay while they worked The above situations are basically saying the pension or annuity distribution is a result of contributions the taxpayer has not yet paid tax on and earnings See Example on 11-8

12. Lesson 11: Retirement Income How to figure out the taxable portion of pensions and annuities? (if box 2a not filled so you must calculate) Box 7 is not checked in this case on Form 1099R indicating this is not an IRA but instead a pension or annuity and taxable amount is not determined Partially Taxable Pensions and Annuities There are two methods used to figure the taxable portion of each pension or annuity payment General Rule Simplified Method Retirees must use the Simplified Method for annuity payments from a qualified plan unless an exception applies If a taxpayer tells you they have been using the General Rule to figure out the taxable portion in the past this is out of scope of VITA and they should be referred to a professional tax preparer Using the Simplified Method The Simplified Method Worksheet (in the Form 1040 (page 26) or Form 1040 A Instructions) calculates the taxpayer's cost basis for each monthly payment The number of payments is based on the taxpayer's age on the annuity start date Monthly Tax Free Portion = Taxpayer's cost basis/Number of Monthly Payments Taxwise has a screen to calculate this for you this is the information you need: The cost of the plan (box 9b of Form 1099-R) The taxpayer's age on the date the annuity began The total tax free amounts from previous years available from the taxpayer's prior year worksheet Basically this is saying if this is not the first year they've used the simplified method they need LAST year's worksheet (either the paper sheet or the one from the tax software) If the taxpayer has more than one 1099-R with a pension or annuity that is not fully taxable and has the taxable amount not determined you must calculate each one separately Meaning you will fill out a separate worksheet for each annuity or pension with "taxable amount not determined" that qualifies for the simplified method

13. Lesson 11: Retirement Income Disability Pension Income If a taxpayer retires on disability, disability payments are generally taxed as wages (and reported on Form W-2) until the taxpayer reaches the minimum retirement age (which is set by the employer) Note: if disability pay is treated as wages it may affect the earned income credit If the taxpayer has not reached the minimum retirement age, the disability payments will be reported on W-2 and therefore go on line 7 of Form 1040 Once the taxpayer reaches the minimum retirement age disability payments are reported on Form 1099-R and treated like other pension income to determine taxability Retired Public Safety Officers Eligible officers can elect to exclude from income up to $3000 made from a government retirement plan to the provider of accident, health or long term disability insurance See Publication 575 (Insurance Premiums for Retired Public Safety Officers)

14. Lesson 11: Retirement Income Lump Sum Distributions A lump sum distribution is a distribution or payment within one year of an employee's entire balance from all pensions, profit sharing plans, or stock bonuses that an employer maintains. (see page 11-10) Distributions from IRAs or tax sheltered annuities do not qualify as lump sum distributions To qualify as a lump sum distribution the payment must have been made for one of the following reasons (from page 11-10): Because the plan participant died After the participant reached 59 ½ Because the participant (not self employed) separated from service with the employer After the participant, if self employed became permanently and totally disabled The reason you need to recognize a lump sum distribution is they qualify for special tax treatment A lump sum distribution will be reported on Form 1099-R and will have distribution code A in Box 7 If you have a taxpayer with a lump sum distribution it is outside the scope of VITA and should be referred to a professional tax preparer

15. Lesson 11: Retirement Income Premature (Early) Distributions An early distribution is withdrawal made from a retirement plan for purposes other than retirement by a taxpayer who is under at 59 ½ If there is no exception, early distributions are subject to a 10% additional tax, the additional tax applies to the taxable portion of the distribution payment If the distribution code in Box 7 of the 1099-R is a 1 that means the distribution was an early distribution with no known exception and is subject to the 10% additional tax The 10% tax is reported on line 58 of Form 1040 and Form 5329 is not required, write "No" next to the amount to indicate Form 5329 is not required If the taxpayer meets an exception but the 1099-R was still prepared with a 1 in Box 7 the taxpayer should be referred to a professional tax preparer If the distribution code in Box 7 of the 1099-R us a 2,3, or 4 the taxpayer has met an exception and does not have to pay the additional 10% tax – a Form 5329 is required to show which exception was met – fill out Part I only 2—Early distribution, exception applies (under age 59½). 3—Disability. 4—Death. I'm assuming they talk more about the additional tax in the "other taxes" chapter of the book and in the adjustments section Let's take a quick look at Form 5329

16. Lesson 11: Retirement Income Minimum Distributions Taxpayers are required to start taking RMDs (Required Minimum Distributions) from their retirement accounts by a specified date The specified date is the year in which the taxpayer either reached age 70 ½ or retired whichever is later These rules do not apply for Roth IRAs After the year the taxpayer is required to start taking an RMD they must receive the minimum distribution by December 31 of that year If a taxpayer does not receive an RMD an additional tax may apply Temporary Waiver of minimum distributions for 2009 For 2009 taxpayers are not required to take an RMD from their IRA or defined contribution plans This applies to participants, beneficiaries and to taxpayers who turned 70 ½ in 2009 and delayed their RMD until 04/01/10 The waiver does not apply to 2008 RMDs This is something that a taxpayer might have questions about if you are helping an elderly taxpayer You can look up the details here if the questions come up Withdrawal of Excess IRA contributions is covered in detail in Chapter 17

17. Lesson 11: Retirement Income Requesting Retirement Income Withholding If a taxpayer owes $1000 or more on their return and most of their income is Form 1099-R income they may want to request that Federal Income tax be withheld from their Retirement Distributions They can make this request with a Form W-4P and then send this form to their payer, Form W-4V can be used to request withholding from Social Security Benefits and sent to the Social Security Administration