Distribution Due to Death of Plan Participant
When an individual taxpayer inherits a traditional IRA from anyone other than their spouse, the taxpayer cannot treat the inherited IRA in the same manner as they can treat an IRA that they own otherwise. Moreover, an IRA which is inherited is subject to several limitations on distributions that are based on if the deceased owner died on or after the date that was required to take minimum distributions from the IRA.
If the deceased owner had not yet started to take required distributions, the designated beneficiary typically may need to take a distribution of the inherited IRA by December 31 of the fifth year following the deceased owner’s date of death (or under certain circumstances the designated beneficiary has to commence a plan of distribution based on the beneficiary’s life expectancy within that five year time period). See: Publication 590-B – Distributions from Individual Retirement Arrangements (IRAs).
When a taxpayer receives a distribution from an inherited IRA, they should receive from the financial institution a 1099-R, with a Distribution Code of 4 in Box 7. This gross distribution is usually fully taxable to the beneficiary/taxpayer unless the deceased owner had made non-deductible contributions to the IRA. However, a distribution from an IRA to a beneficiary that has been made due to the Death of the original owner is not subject to the 10% early withdrawal penalty, regardless of the age of the beneficiary or the deceased owner.
To enter a distribution from an IRA that has been made as a result of the death of plan participant into Keystone Tax Solutions Pro that is reported on a Form 1099R – Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. with Code 4 in Box 7, from the Main Menu of the tax return (Form 1040) select:
- Federal Section
- Income Menu
- IRA/Pension Distributions (1099R / RRB, SSA)
- Add or Edit a 1099-R
- Enter the Payer EIN, Name and Address,
- Enter the Gross Distribution in Box 1 as it is shown on the 1099-R.
- The taxable amount in Box 2a should normally be the same as the amount from Box 1.
- The Distribution Code in Box 7 should be 4, and no further action is necessary upon exiting this menu. (When the Distribution Code is a 4, the 10% Additional Tax for Early Withdrawal does not apply, regardless of the age of the designated beneficiary.)
Distribution Due to Disability
When a taxpayer becomes disabled before they reach age 59-1/2, the taxpayer can receive a distribution from a traditional IRA or qualified pension plan and not be subject to the 10% additional early withdrawal penalty. In order to be considered disabled, the taxpayer has to be able to furnish proof that they cannot do any substantial gainful activity because of some physical or mental condition. This physical or mental condition must be determined by a physician to be something that the taxpayer will have for the rest of their life or for a long, continued and indefinite period. It cannot be condition that the taxpayer can reasonably be expected to recover from or a condition that is a physical handicap but does not prevent the individual from engaging in gainful activity.
A distribution from an IRA or a pension plan to a taxpayer that has been made due to their disability is fully taxable to the taxpayer unless the owner had made non-deductible contributions to the IRA or other non-deductible contributions to a pension plan. However, such a distribution is not subject to the 10% early withdrawal penalty, regardless of the age of the taxpayer.
A distribution that has been made to an individual as a result of their disability is reported to the taxpayer on a Form 1099-R – Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. To enter this distribution into Keystone Tax Solutions Pro, from the Main Menu of the tax return (Form 1040) select:
- Federal Section
- Income Menu
- IRA/Pension Distributions (1099R / RRB, SSA)
- Add or Edit a 1099-R
- Enter the Payer EIN, Name and Address.
- Enter the Gross Distribution in Box 1 as it is shown on the 1099-R.
- The taxable amount in Box 2a should normally be the same as the amount from Box 1.
- When entering the Distribution Code in Box 7,
- if the Code is a 3, the 10% Additional Tax for Early Withdrawal does not apply and no further action is necessary upon exiting this 1099-R menu;
- if the code is a 1 or 2, the program will prompt to select a Form 5329 Transfer Option. Because the distribution is from a pension plan or IRA, the transfer option should be “Transfer 1099-R Box 2a to Form 5329, Part I, Line 1”. The next question, “Does the Amount being Carried to Form 5329 Qualify for Any Penalty Exclusion?” should be answered YES if the taxpayer is claiming an exclusion from the 10% Additional Tax for Early Withdrawal due to Disability. Select exclusion #3, “Due to Total and Permanent Disability”, and enter the amount of the gross distribution that was reported in Box 2a that qualifies for an exclusion due to disability.
Keystone Tax Solutions Pro will transfer the amount to be excluded from the 10% Additional Tax for Early Withdrawal to Form 5329. In the 2019 Form 1040, the taxable amount of the gross distribution will transfer to Line 4b (IRA) or 4d (Pension).
NOTE: This is a guide on entering Form 1099-R issued for a distribution due to death or disability into the Keystone Tax Solutions Pro program. This is not intended as tax advice.
Additional Resources:
Publication 575 – Pension and Annuity Income
Publication 590-B -Distributions from Individual Retirement Plans