An individual reports the majority of his/her traditional IRA and Roth IRA activity on his/her federal income tax return, generally IRS Form 1040, U.S. Individual Income Tax Return. In addition, the following IRS forms are potential attachments to an individual’s tax return that complement the tax return by determining an IRA-related income amount, additional tax, or tax credit:
- IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts
- IRS Form 8606, Nondeductible IRAs
- IRS Form 8880, Credit for Qualified Retirement Savings Contributions
- IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs
IRS Form 5329
Form 5329 is a multipurpose, eight-part individual income tax form. Its primary purpose is to report additional taxes an individual may owe on certain transactions with qualified retirement plans, IRAs, modified endowment contracts, Coverdell Education Savings Accounts (CESAs, also referred to as Coverdell ESAs), Qualified Tuition Programs (QTPs), Archer Medical Savings Accounts (MSAs), and Health Savings Accounts (HSAs).
An individual files Form 5329 to report:
- A 10 percent penalty tax on an early withdrawal (prior to age 59½) from a traditional IRA, a Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) IRA, or a Roth IRA (Part I of Form 5329)
- A 10 percent additional tax on any taxable distribution from a CESA or QTP that was not used for qualified education expenses (Part II of Form 5329)
- A 6 percent penalty tax on any uncorrected excess contributions to an IRA, CESA, Archer MSA, or HSA (Parts III through VII of Form 5329)
- A 50 percent penalty tax on any failure to satisfy a required minimum distribution from a qualified retirement plan or IRA (Part VIII of Form 5329)
Though unlikely to occur, a taxpayer might file Form 5329 for an early distribution from a traditional IRA that his/her IRA custodian/trustee did not report using IRS Code 1—early distribution, no known exception—in Box 7 of Form 1099-R.
Click here to see Form 5329.
If distribution Code 1 is correctly shown in Box 7 of Form 1099-R for a distribution subject to the additional 10 percent tax, it is not necessary for the taxpayer to file Form 5329 for his/her traditional IRA. Instead, he/she can report the penalty tax on Line 59 of Form 1040.
Example: Greg, age 56, took a distribution from his traditional IRA to purchase a new motorcycle. Greg’s IRA custodian generates a Form 1099-R with distribution Code 1 in Box 7. It is not necessary for Greg to file Form 5329, as he will report the 10 percent penalty tax directly on his Form 1040.
In some cases, an individual files Form 5329 to avoid an additional tax.If distribution Code 1 is shown in Box 7 of Form 1099-R, but the distribution is not subject to the 10 percent penalty tax, a taxpayer must file Form 5329 to indicate an exception to the penalty tax applies. (See Line 2, Part I of Form 5329.) The instructions for Form 5329 provide nine possible IRA-related exception codes, including codes for reaching age 59½, first-time homebuying, and receiving substantially equal periodic payments.
Example: Fran, age 40, took $10,000 from her traditional IRA to use as a down payment for her first home. Fran’s IRA custodian is not responsible for determining whether the distribution is exempt from the 10 percent penalty tax. Therefore, it generates a Form 1099-R with IRS Code 1 in Box 7. If Fran meets the first-time homebuyer eligibility criteria, making the distribution exempt from the 10 percent penalty tax, she must file Form 5329, entering Exception Code 09 to avoid the penalty tax.
IRS Form 8606
IRS Form 8606 is a three-part, multipurpose individual income tax form. An individual completes Part I to:
- Report his/her nondeductible contributions to a traditional IRA
- Determine the taxable portion of any traditional IRA or SIMPLE IRA distributions if he/she has a nontaxable basis in his/her traditional IRAs
- Determine the nontaxable portion of any partial conversion of a traditional IRA to a Roth IRA if he/she has a nontaxable basis
A nontaxable basis in a traditional IRA results from nondeductible regular contributions and rollover contributions of nontaxable assets from qualified employer plans.
An IRA owner uses Part II of Form 8606 to report any complete or partial conversion of traditional IRA assets to a Roth IRA, even if he/she must also complete Part I because of a nontaxable basis. A Roth IRA owner uses Part III of Form 8606 to report any Roth IRA distributions that he/she did not roll over or recharacterize, or if there was a return of any regular contributions.
Click here to see IRS Form 8606.
IRS Form 8880
Internal Revenue Code (IRC) Section 25B provides a nonrefundable tax credit for an eligible individual who makes a regular traditional IRA or Roth IRA contribution or defers a portion of his/her salary to a qualified employer plan. An individual or married couple files IRS Form 8880 to take advantage of the credit, which is only available through 2006.
An individual bases the credit calculation on a percentage of his/her regular IRA contribution and/or salary deferral up to $2,000 each year. The credit ranges from 10 percent to 50 percent of the IRA contributions and/or salary deferrals depending on an individual’s adjusted gross income.
As a nonrefundable credit, it is only available to the extent of an individual’s income tax. In other words, if an individual determines that he is entitled to a $1,000 credit but only owes a tax of $500, the credit will zero out his tax, but the remaining $500 of credit is lost.
Furthermore, the credit is not available to any full-time student, any individual claimed as a dependent on another person’s federal income tax return, or to any individual with adjusted gross income over $25,000 ($37,500 for an individual filing as a head of household and $50,000 for a married couple filing a joint return).
Click here to see IRS Form 8880.
IRS Form 8881
IRC Section 25A provides a tax credit to small employers for certain costs associated with starting certain retirement plans. An eligible employer can claim the credit of up to $500 for each of the first three years of a retirement plan by filing IRS Form 8881 each year. An eligible employer can be either an incorporated or unincorporated business (a sole proprietor or partnership).
To be eligible, an employer must have had no more than 100 employees during the tax year preceding its first credit year, who each received at least $5,000 of compensation during that tax year. In addition, a business must also have at least one employee who is not a highly compensated employee. A sole proprietor is always a highly compensated employee by definition as 100 percent owner of a business.
Eligible plans include plans qualified under IRC Section 401(a)–including 401(k) plans–simplified employee pension (SEP) plans, and SIMPLE IRA plans. Eligible expenses include those incurred in establishing or administering an eligible plan, and the cost of educating employees with regard to the plan.
Click here to see IRS form 8881.
IRS Form 1040
IRS Form 1040 is the most important form an IRA owner must file. Here he/she summarizes most of the IRA contribution and distribution activity for the tax year. Each of the other forms discussed in this article generally has a direct connection to a line item on an individual’s federal income tax return.
The IRS provides work sheets in its instructions to the tax returns and in Publication 590, Individual Retirement Arrangements (IRAs), that may help an individual determine his/her allowable traditional IRA deduction for entry on Line 25, Form 1040, or his/her allowable Roth IRA contribution, which is not deductible and not reported by the taxpayer.
A taxpayer uses Form 1040, Line 15, to report IRA distributions. If he/she has a nontaxable basis in any traditional IRAs or is taking a nonqualified distribution from a Roth IRA, he/she must complete Form 8606 to determine the taxable portion to enter on Line 15b.
An individual reports rollover contributions of his/her traditional IRA and SIMPLE IRA distributions and rollover contributions of distributions from certain qualified employer plans on his/her federal income tax return. Some taxpayers mistakenly think that they do not have to report a rollover contribution because it is not taxable. This is especially true of direct rollovers from an employer’s plan to a traditional IRA.
An individual reports any rollovers of traditional IRA distributions by showing the total traditional IRA distributions during the tax year on Line 15a, Form 1040, and the taxable portion he/she did not roll over on line 15b, writing “rollover” next to Line 15b.
Example: In 2004, George took a $55,000 distribution from his traditional IRA at ABC Bank. Within 60 calendar days, he rolled $50,000 into another traditional IRA at DEF Credit Union. He reports this on his 2004 Form 1040 by showing his total distribution of $55,000 on Line 15a and $5,000 on Line 15b, the taxable amount not rolled over, writing “rollover” next to Line 15b.
Rollovers of qualified employer plan distributions are subject to the same type of reporting. For these rollovers, a taxpayer uses Line 16a to show the total plan distributions received and 16b to show the taxable portion that he/she did not roll over, writing “rollover” next to Line 16b.
A self-employed individual also uses Form 1040 to report his/her personal SEP plan contributions to a traditional IRA or his/her personal SIMPLE IRA plan contributions as an adjustment to gross income on Line 32. An individual reports any rollovers of distributions from these IRA types on Lines 15a and 15b.
Click here to see IRS Form 1040.
Conclusion
An IRA owner’s annual reporting responsibilities vary depending on the type of IRA he/she has and the contribution/distribution activity during the year. This article was an introduction to an IRA owner’s reporting responsibilities, briefly describing the purpose and use of the various report forms.
For more information, the IRS provides completion instructions for each of the forms discussed here. IRS Publication 590 is also a good source of IRA reporting information. All are available here (go to Research Links) and on the IRS web site, www.irs.gov.
An employee’s basic understanding of when and why an IRA owner files these IRS forms may be appropriate to a financial organization’s customer service policy that provides information and not tax advice. For best results and to ensure compliance, an IRA owner should seek the guidance of a tax or legal professional.
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