Purpose of Form 1099-R
Your financial institution will mail Form 1099-R to you and the IRS, typically in late January of the year following your distribution. The total amount of the distribution is reported in box 1. A taxable amount may be reported in box 2, although it's not required. Federal income tax withholding, if any, is reported in box 4. Of particular importance is the distribution code shown in box 7.
A Form 1099-R for an inherited retirement account will usually report a “4,” a “T” or a “Q” in box 7. If a “4” appears, it means you have taken a distribution from a tax-deferred retirement account and you are exempt from the early distribution penalty because the distributions were made pursuant to the death of the original account holder. Codes “Q” and “T” denote a distribution from a Roth account. The former means that the five-year holding period to take qualified distributions has been satisfied, so the amount is a qualified distribution; the latter informs the IRS that the holding period has not been met, but the distribution is exempt from the early withdrawal penalty because it was paid to a beneficiary. If your 1099-R has a different code in box 7, such as “1,” the issuing institution is not recognizing that you are receiving payments as a beneficiary of the decedent. In this case, you must file Form 5329 with your tax return and enter code "04" on line 2 to notify the IRS that the distribution is exempt from the early withdrawal penalty.
Unfortunately, all of the information necessary to determine the taxable portion of the distribution may not be included on the 1099-R form. If you have a Roth account with code Q, none of the distribution is taxable because it is a qualified distribution from a Roth IRA. If you do not have a code Q, you need to know the basis of the inherited retirement account. The “basis” is the amount of after-tax contributions to the account. If no after-tax contributions were made, the entire distribution is taxable, but determining the amount depends on the type of plan. If a code T is reported, it denotes a Roth IRA distribution and that the initial contributions withdrawn are tax-free; distributed earnings, however, are taxable. So, if you've inherited a Roth IRA with a value of $25,000, a basis of $15,000 and you withdraw $10,000, none of the distribution is taxable and your basis decreases to $5,000. If a “4” or a “1” appears in box 7, it means the distribution is from a tax-deferred account. If you have no basis, the entire amount is taxable. If the account does have a basis, it must be prorated based on the size of the distribution relative to the account value. For example, if you have a $10,000 basis in an account worth $40,000 at the time of the distribution, 25 percent of the distribution would be tax-free.
Reporting 1099-R Information on Taxes
Regardless of whether your distributions from an inherited retirement account are taxable or not, you still have to report the money on your income tax return, and you will be required to file either Form 1040 or Form 1040A. IRA distributions are reported as nontaxable or taxable on line 15a and 15b of Form 1040 or on line 11a and 11b of Form 1040A. For other pension distributions, such as from 401(k) and 403(b) plans, the nontaxable portion is reported on line 16a and the taxable portion on line 16b.