8.8 Taxable Distributions From Traditional IRAs
If all of your tradional IRA contributions were deductible, any distribution from any of your traditional IRAs will be taxable unless you roll it over or redeposit it within 60 days (8.10). If you made both deductible and nondeductible contributions, withdrawals allocable to the deductible contributions are taxable and the balance is tax free (8.9).
Taxable distributions are also subject to these age-related restrictions:
- Distributions before age 59½ are subject to a 10% tax penalty, unless you are totally disabled, meet exceptions for paying medical costs, receive annual payments under an annuity-type schedule or you qualify for another exception (8.12).
- After you reach age 70½, you must start to receive annual distributions from your traditional IRA under a life-expectancy calculation. The required starting date is the April 1 of the year after the year in which you reach age 70½. For example, if you reach age 70½ during 2012, you must start taking IRA distributions no later than April 1, 2013. Failure to take the annual required minimum distribution could result in penalties (8.13).
How to report IRA distributions on your 2012 return.
All IRA distributions are reported to you and to the IRS on Form 1099-R (7.1). Form 1099-R must be attached to your return only if federal tax has been withheld. You can avoid withholding by instructing the payer not to withhold using Form W-4P or a substitute form (26.11).
If you have never made nondeductible contributions, your IRA withdrawals are fully taxable and should be reported on Line 15b of Form 1040 or Line 11b of Form 1040A. If you have made deductible and nondeductible contributions, complete Form 8606 to figure the nontaxable and taxable portions (8.9). Then you report the total IRA withdrawal on Line 15a of Form 1040 or Line 11a of Form 1040A and enter only the taxable portion on Line 15b or Line 11b, respectively.
If you have an individual retirement annuity, your investment in the contract is treated as zero so all payments are fully taxable. Distributions from an endowment policy due to death are taxed as ordinary income to the extent allocable to retirement savings; to the extent allocable to life insurance, they are considered insurance proceeds.
Proceeds from U.S. retirement bonds (which were issued by the Treasury before May 1982) are taxable in the year the bonds are redeemed. However, you must report the full proceeds in the year you reach age 70½ even if you do not redeem the bonds.
Conversion to Roth IRA.
A conversion of a traditional IRA to a Roth IRA is generally treated as a taxable distribution from the traditional IRA (8.21).
Distribution of IRA to charity: Exclusion for QCD not yet extended to 2012 when this book went to press.
At the time this book went to press, Congress had not extended to 2012 the law that since 2006 has allowed individuals age 70½ and older to annually exclude from income IRA distributions of up to $100,000 that are given to a qualifying charity in a trustee-to-trustee transfer. It is likely that the exclusion will be extended, and the following discusiion assumes that the exclusion will be allowed for 2012 transfers. However, check the e-Supplement at jklasser.com for an update.
If the exclusion is extended and in 2012, you had the trustee of your traditional IRA make a direct transfer from your account to charity, and you were at least age 70½ at the time of the distribution, up to $100,000 of the transfer is tax free. A qualifying transfer is referred to as a “QCD” (qualified charitable distribution). A QCD counts towards the required minimum distribution (8.13) that you must otherwise receive from your IRAs for the year. You cannot claim a charitable deduction for the amount of the QCD excluded from income.
The transfer must have been made directly by the IRA trustee to a qualifying charity that is eligible to receive tax-deductible donations; this excludes a “supporting organization” or donor advised fund. If your spouse was also at least age 70½ and directed the trustee of his or her IRA to make a qualifying direct transfer in 2012, and you file jointly, you can each claim the up-to-$100,000 exclusion.
Make sure that you get a timely written acknowledgment from the charity. You need the same type of acknowledgment that you would have to get to substantiate a donation exceeding $250 under the charitable contribution deduction rules (14.14).
If you made a QCD in 2012 and had made any nondeductible contributions to any of your traditional IRAs, the QCD is partly allocable to nondeductible IRA contributions and partly allocable to deductible contributions plus earnings. The transfer to charity is deemed to come first out of the otherwise taxable part of the distribution—that is, the deductible contributions plus earnings. The part of the distribution equal to the deductible contributions plus earnings is the excludable amount, up to the $100,000 limit. Any balance of the transfer is deemed to be a transfer of nondeductible contributions and is nontaxable. You must file Form 8606 (8.9) to report the distribution of nondeductible contributions; the allocable amount reduces your remaining basis in your IRAs.
On your 2012 return, the total transfer to charity must be reported on Line 15a, Form 1040 (IRA distributions), or Line 11a of Form 1040A. If any part is excludable, you should enter “QCD” next to Line 15b or Line 11b (taxable amount). If the entire transfer is a QCD, enter “0” on Line 15b or Line 11b. Any part of the distribution allocable to deductible contributions plus earnings that is not excludable is entered as taxable on Line 15b or Line 11b. Any part of the distribution allocable to nondeductible contributions reported on Form 8606 is not taxable and is not entered on Line 15b or Line 11b.
If you itemize deductions for 2012, the portion of the transfer allocable to nondeductible contributions, if any, can be claimed as a charitable contribution on Schedule A (14.1). No charitable deduction is allowed for the excludable portion (deductible contributions plus earnings).
Note: Since a QCD is not included in adjusted gross income, you may be able to preserve eligibility for the $25,000 loss allowance under the passive loss rules (10.2). The exclusion may also help limit the amount of Social Security benefits subject to tax (34.3).
Court Decision
Loan treated as distribution.
If you borrow from your IRA account or use it as security for a loan, you generally are considered to have received your entire interest. Borrowing will subject the account or the fair market value of the contract to tax at ordinary income rates as of the first day of the taxable year of the borrowing. Your IRA account loses its tax-exempt status. If you use the account or part of it as security for a loan, the portion that is pledged is treated as a distribution. However, under the rollover rules, a short-term loan may be made by withdrawing IRA funds and redepositing them in an IRA within 60 days, subject to the once-a-year rollover rule (8.10).
IRS seizure of IRA treated as distribution.
The Tax Court has held that an IRS levy of an IRA to cover back taxes is a taxable distribution to the account owner, even though the funds are transferred directly from the account to the IRS and not actually received by the owner. Where the owner is under age 59½, the 10% penalty for early withdrawals (8.12) does not apply to involuntary distributions attributable to an IRS levy.