Premature Roth Distribution
I am trying help someone who took a Roth Distribution this year.
She only took out the amount she converted in 2009 – 18K
There are no contributions in the IRA, thus she is just taking the converted money and will be penalized 10% ($1800) – That seems logical.
I have an old verstion of TurboTax 2008 and wanted to plug the numbers with just that transaction to see all the tax forms generated. The amount due becomes [b]$1858[/b]. Why the extra penalty? Does it have to do with paying estimated taxes. I’m not sure I have an answer.
Thanks,
pko
Permalink Submitted by Alan Spross on Thu, 2010-08-19 23:55
pko,
It must be some kind of underpayment penalty. Is there any distribution date entered? Does it show 1,800 on line 4 of Form 5329? And -0- taxable amount on Form 8606?
Permalink Submitted by Anonymous (not verified) on Fri, 2010-08-20 00:19
No date, but I entered a 1099-R code “J”, taxes not determined
“Line 4 on 5329 shows $1800
Taxable amount on 8606 is 0 (line 25a)
1040 15b is 0 too
It just does not make sense to me that if someone payed all the taxes on the conversion in 2007 and took it out in 2008 that more than 10% penalty would apply. Especially, if that is the only transaction in 2008.
If it is estimated/quarterly taxes, why, when the taxed where payed on the money in the prior year? The only numbers on the 1040 that are not zero are the standard deduction entries. $58 is 3.2% of 18000??? The return does generate some payment vouchers for $450 each, also does not makes sense.
I am clueless…..
Thanks for the help, Alan
Permalink Submitted by Alan Spross on Fri, 2010-08-20 01:12
I think that the numbers pretty much confirm that underpayment penalties are the source of the extra $58. The average quarterly rate in 2008 was 6% for underpayment, and on a quarterly basis with $450, then 900, 1350 and 1800 applied @ 1.5% per quarter, it comes fairly close to $58. Also, the installment vouchers show 450 per quarter and that adds up to 1800. My impression is that tax software makes an effort to replicate what the IRS would charge, but in many cases people just pay the actual tax and let the IRS bill interest if they choose to. I think the $58 is TTax’s estimate of the underpayment penalty.
I am not exactly sure which year she took the distribution, but the interest rate for underpayment has dropped from 6% in 2008 to 4% in the more recent quarters.
Permalink Submitted by Anonymous (not verified) on Fri, 2010-08-20 15:35
Thanks Alan:
I guess it does not make sense to me that a good program (TT) would calculate such a tax. She will have taken 18K out in 2010. That money was all converted and the tax paid on the 2009 return. So I am amazed that they would tack on more than 10%.
pko
Permalink Submitted by Alan Spross on Fri, 2010-08-20 18:32
They are two totally separate penalties, and late payment of an early withdrawal penalty is no different than late payment of ordinary income taxes. Taxpayers run into this in a more costly manner when they bust a 72t plan and owe several years of retroactive early withdrawal penalties. The IRS makes a charge for each year based on the penalty due for that year for the length of time between the filing date for that year and the present, so these penalties could eventually equal an amount for an extra year’s worth of early withdrawal penalties.
But the IRS does not whether she took the distribution early in the year or late, and the underpayment penalty assumes she took it equally in each quarter. If she actually took the distribution late in the year, she could file the Sch AI of Form 2210, and the underpayment penalty would be reduced, but of course not the early withdrawal penalty.
I have no idea how accurate various tax programs are vrs the IRS rules, but it gets even more complicated if the IRS chooses to apply some of the other penalties related to underpayment in addition to just the basic penalty. They have been known to do that with Form 5329 tax items. There was a recent post where the taxpayer filed a stand alone 5329 per the instructions and the IRS thought that this was the initial return and levied a failure to file on time penalty on top of the underpayment penalty. So it is a tough call to determine what the IRS would do in your case if the person just paid the 1,800 and took their chances.