Combat Zone Tax Exempt Contributions – 1099-R Problems

Submitted by George Typhair on Tue, 2016-04-19 16:07

I am a 48 year old retired Army Officer that contributed to the TSP (Thrift Savings Plan) throughout my career. I made significant contributions during three combat tours (Afghanistan and Iraq) which built up my tax-exempt contributions. Upon retirement I rolled over all of my TSP contributions into two Traditional IRAs. One for the tax-deferred contribution portion of my TSP and one for the tax-exempt contributions, fully understanding that I would have to pay taxes on my earning for the tax-exempt contributions. This rollover occurred in 2014.

I made no further contributions in 2015, but withdrew all tax-exempt monies except $100 (and the earnings) from the IRA in 2015. I received a 1099-R with the following annotations: Block 1 Gross distributions: $30,228; Block 2a. Taxable amount: $30,228; and Block 2b (selected): Taxable amount not determined.

While filing my 2015 tax return using H&R Block Basic online, and entering this information, I was initially being taxed on the full amount of the tax-exempt contributions. After entering information on IRS Form 8606, and failing to annotate in Line 6 the total remaining balance in my combined IRAs as of 31 Dec 2015, I was no longer being taxed on the distribution. However, when running a check at the end of the online filing process an error was detected. I was directed to add the balance to line 6 on Form 8606 and when the return was recalculated it reflected that I owed over $7K. I have called my financial institution holding the IRAs, H&R Block, the IRS, TSP, and all have been unable to assist me in this area.

The instructions for IRS Form 8606 are confusing and it is unclear if I actually need to enter an amount. If it is required, I am unsure how to correct the issue. Any assistance in this area is greatly appreciated.



Submitted by Alan - IRA critic on Tue, 2016-04-19 18:42

  • The problem here is the so called “cream in the coffee” principle for TIRA accounts. Once you add basis to any of your owned T IRA accounts, the basis (cream) cannot be separated from the coffee (pre tax) amounts. That results in all distributions being pro rated between IRA basis per Form 8606 and total year end value of the account(s) plus your distribution. When you report a distribution Form 8606 calculates the taxable amount and overrides the amount in Box 2a of the 1099R. Line 6 of Form 8606 must contain the total value of all your TIRA accounts on 12/31/2015. Therefore, the error detection process was correct.
  • If you had basis in your TIRAs before this rollover, that amount goes on line 2 of the 8606. In addition, the after tax amount you rolled over from the TSP is added to the line 2 amount. Sounds like you did this, but did not enter the total year end value of both IRA accounts on line 6. This would result in much more of the 30k distribution being taxable. Unfortunately, there is no fix or correction available for this. The completed 8606 will show on line 14 how much basis you have left in your TIRAs for 2016 and beyond. Of course, your tax bill is increased for 2015, but you still have basis left in your TIRA that you did not use due to the pro rating. There will be no double taxation of the same amounts, just a higher tax bill for 2015 and a lower tax bill thereafter because some of your basis is saved for the future.
  • I think the TSP may accept rollovers from IRA accounts after separation, but am not positive. If you were to roll the pre tax balance of your IRAs back into the TSP this year, you could withdraw the IRA basis that remains tax free or you could convert it to a Roth IRA tax free. Then in 2017 you could roll the TSP balance back out. This would allow you to take the rest of your IRA basis out tax free without any pre tax amounts since all the pre tax amounts were in the TSP at the end of the year. You may want to look into that if you have enough basis left in your TIRA to be worth doing this.
  • Unfortunately, you did not get good advice when you did the 2014 rollover. You could have had the pre tax amount only rolled into the TIRA and the after tax basis sent to you personally as a separate check, and that would have avoid commingling both in your TIRA.

Add new comment

Log in or register to post comments