Ask Me Help Desk - IRS objecting to the way TurboTax reported my IRA rollover to Roth

Hello. In my 2010 taxes I reported that I rolled over $41K to Roth from within my 401k account. TurboTax gave me the option to pay the taxable amount of $11.5K in 2010 or defer and pay half in 2011 and half in 2012. I chose to defer and made the first payment with my 2011 taxes. This week I received a letter from the IRS saying that "form 8606 attached to your 2010 tax return was not fully completed and can not be accepted". TurboTax filled out this form. Any suggestions on how to resolve?

BTW, the IRS is suggesting that the $11.5K be treated as additional taxable income in 2010 and that I therefore owe about $5K in back taxes. I don't think the $11.5K is taxable income, it is actual tax due. So I am planning to pay the full $11.5K to the IRS as zero in 2010, half with 2011 taxes, and half with 2012 taxes.

I think the problem is that you can't roll directly from a 401(k) plan to a Roth IRA and differ the taxes to 2011 and 2012. You can use the differal option only for conversions from a traditional, SEP, or Simple IRA to a Roth IRA. So what you should have done is (a) roll your old 401(k) to a traditional rollover IRA, then (b) converted that IRA to a Roth IRA. Not sure how you filled out Form 8606, but if you put the 401(k) distribution amount on line 7 or 8 that would be wrong.

Edit: regarding the amount of taxable income it should indeeed be $41K as you suggest. You should have received a 1099-R from the 401(k) plan admimistartor showing that amount as a taxable distribution - did you?

Thanks ebaines. In my case the 401k is at Fidelity and TurboTax directly links to them to inport all transaction data and fill in the tax forms -- so I never entered anything myself. Fidelity did create a 1099-R saying that I had $11.5K taxable income from the rollover. TurboTax entered this amount on line 23 of form 8606 in my 2010 taxes. Lines 7 & 8 are blank. TurboTax then lists half of this tax obligation on line 25a as being due with my 2011 taxes and half on line 25b as bing due with my 2012 taxes. Thanks for your help and guidance!

OK - it took me a while to find a copy of the 2010 form 8606, but finally did (se below).

I think TurboTax is correct, with one minor nit - and that is that the rollover should have been listed on line 21 as well as line 23 (assuming the 401(k) is funded solely with pre-tax money). I also am confused by the amount - Fidelity said you rolled $11.5K over, not $41K. So that's why the IRS says $11.5K is the taxable income. Do you have any idea why Fidelity said $11.5K is the amount of taxable distribution, and not the $41K you originally mentioned? Could it be that your 401(k) had a large amount of after-tax money in it (which would be unusual). I would point out that your assumption that $11.5K is the tax due on a $41K rollover is incorrect - there is no way that Fidelity knows what your tax rate is. However - that number is awfully close to 20% of $41K, which causes me to ask -- please confirm that Fidelity did a direct rollover from your 401(k) to the Roth IRA, as opposed to sending you a check. If they sent you a check they would have withheld about $10.5K for taxes - please confirm that this is NOT what happened. For clarity - please list all entries on the 1099-R that Fidelity sent you, especially entries in boxes 1, 2a, 2b, 4, and distribution code in box 7.

Thanks again ebines!

The 1099-R from Fidelity listed
Box 1 (gross dist): $41,556
Box 2a (taxable amt): $11,425
Box 2b: nothing checked
Box 4 (tax withheld): $0
Box 5 (empl contribution/Roth contribution or insur prem): $30,131
Box 7: G

When imported into 2010 TurboTax on form 8606 it looks like this:
Line 21 (amt rolled over): $41,556
Line 22 (basis): $30,131
Line 23 (taxable amount): $11,425
Line 24 (amount subject to tax in 2010): $0
Line 25a (amount subject to tax in 2011): $5713
Line 25b (amount subject to tax in 2012): $5712

My 2011 taxes then include $5713 on 1040 line 16b (taxable amt from pensions & annuities)
So I mis-spoke before. I did not pay $5713 in my 2011 taxes, I just paid tax on $5713.

It seems to me that everything above was done correctly.

The letter I received from the IRS is confusing to me, but as I re-read every page I found this additional description of what they want:

"We need more information for the distribution shown in this notice. We need to know if the income is a pension or an annuity, an IRA or lump sum rollover, or an employee savings plan.

If the income is from a pension/annuity or an employee savings plan and you are recovering your contributions using general rule or the simplified general rule, please send us a signed statement with the date of your first pension payment, the amount you receive monthly, and total amount you contribute.

If the income is an IRA or lump sum and was rolled over, please send us form 5498, IRA Contribution Information or similar documentation.

If the income is from an employee savings plan, please send us a copy of the document showing the total distribution amount you received for 2010 and the nontaxable amount of the distribution."

I conclude from this that maybe everything is fine and I just need to send the IRS form 5498 explaining it to them. However, I don't have form 5498. TurboTax says my IRA trustee should have sent it "just for my records", but Fidelity did not. On the Fidelity web site I can view and reprint my 2010 tax forms, but the only one they have for this account is form 1099-R. I think my choices now are to try to get Fidelity to send me a 5498 or just write a memo telling the IRS this was a Roth rollover.

Thanks for your help so far! Your questions have caused me to look harder and understand the situation much better.

Quote:

Originally Posted by bzsjrx

It seems to me that everything above was done correctly.

I agree. I think the IRS is asking for further detail because of the after-tax basis that was claimed in your 401(k). It appears you have a significant amount of after-tax money in the account, which is not unheard of but is a bit unusual for a 401(k) plan. Hence the IRS is asking for documentation.

Quote:

Originally Posted by bzsjrx

I conclude from this that maybe everything is fine and I just need to send the IRS form 5498 explaining it to them. However, I don't have form 5498. TurboTax says my IRA trustee should have sent it "just for my records", but Fidelity did not. On the Fidelity web site I can view and reprint my 2010 tax forms, but the only one they have for this account is form 1099-R. I think my choices now are to try to get Fidelity to send me a 5498 or just write a memo telling the IRS this was a Roth rollover.

No - Form 5498 is only used to document contributions for IRA accounts. There is no equivalent Form 5498 for 401(k)'s. I suggest that you look through your records for an account statement that documents the rather large amount of after-tax money included in the distribution, or ask Fidelity how they calculated that only $11,425 is taxable. For example, did you originally roll money into the 401(k) from an outside source? Or perhaps the 401(k) is actually a Roth 401(k)? Let us know what you find out - good luck!