IRAs are tax-advantaged retirement accounts. They allow investors to hold most types of publicly traded securities as well as some alternative investments, like real estate. Unfortunately, however, certain kinds of collectibles, life insurance policies or debt-financed property cannot be held within an IRA.
Use code 4 when reporting distributions made to beneficiaries after the death of an IRA owner and distributions made from SIMPLE or SEP IRAs.
Code 1: Early distribution
Use code 1 when withdrawing funds from an IRA before the five year period has expired since your first payment. Also use this code for distributions from excess contributions and earnings.
Use code 7 when an IRA owner or participant aged 59 1/2 or over does not qualify for an exception from prohibited transactions, per IRS instructions for Box 7 on Form 1099-R. For more details.
Code 2: Early distribution exception applies
You may be eligible to avoid penalties on withdrawals made from an IRA to cover unreimbursed medical expenses that exceed 7.5% of adjusted gross income or for expenses associated with purchasing your first home, first-time homebuyer expenses and military reservists called to active duty for 180 days or longer.
Use code S to report distributions from a SIMPLE IRA during its first two years if no penalty tax exception applies.
Code 3: Disability
Use code 3 when reporting an early withdrawal penalty-exempt distribution due to disability as defined by many long-term disability (LTD) plans. This definition of disability may not apply.
An experienced CPA or EA can assist IRA owners in collecting the documentation necessary for filing disability exempt IRA accounts, such as a doctor’s statement certifying they are totally and permanently disabled.
Code 4: Death
Use Code 1 when taking an early distribution from a traditional or SIMPLE IRA without an exception being applicable; this also includes Roth IRA distributions.
Peter Lott, aged 48, withdrew $12,000 from his Roth IRA in 2021 in order to fund a trip through Europe. To which distribution code should your organization report this transaction on Form 1099-R?
Code 5: Prohibited transaction
An IRA presents several possible prohibited transactions, especially in self-directed situations. Simply stated, any time you or a disqualified person gain from investing in your IRA without following all required procedures is considered engaging in a prohibited transaction and should be avoided.
Example: If an IRA purchases property and you live there on fair market rent or for free, that would constitute an unlawful transaction.
Code 6: Exchange of life insurance
When investing IRA funds in collectibles such as artwork, rugs, stamps, coins, metals or alcohol beverages, your IRA becomes nonqualified and your transaction is considered prohibited by the IRS. Please refer to Form 1099-R instructions or their website for more details on this.
Use code J to report a distribution from a Roth IRA when its owner is under age 59 1/2 and neither Q nor T apply; additionally use this code when reporting modifications of series of substantially equal periodic payments.
Code 7: Normal distribution
Use code S for distributions made within two years of participation from a SIMPLE IRA if the employee/taxpayer is under age 59 1/2 and none of the early distribution penalty tax exceptions apply. It should not be combined with codes 3 or 4.
Enter code P for excess contributions plus earnings/excess deferrals that are taxable in 2019. Referring to Box 2a of the IRS instructions will assist with how this amount should be treated.
Code 8: Corrective distribution
Use code 8 for corrective distributions of excess deferrals and contributions, which will be taxed as income in the year of distribution.
Taxpayers can circumvent the 6% excise tax on excess contributions by making timely corrective distributions in the form of dollar-limited distributions, ordinary distributions or recharacterization. Cost of collectibles also counts as distributions in this instance.
Code 9: Recharacterization of an IRA contribution
Recharacterizing distributions from eligible retirement plans (for instance an employer-sponsored SEP IRA or SIMPLE IRA) by depositing them back into them or another eligible retirement account can be reported using code H.
When investing in collectibles, certain rules must be observed. For more information and compliance aids to meet those standards, refer to the IRS publication on this topic. It includes worksheets for helping to stay compliant.
Code 10: Pledge of an IRA
General, you are limited to rolling over an IRA or retirement plan distribution into another IRA once every 12 months; however, under certain circumstances this restriction may be waived by the IRS.
Include any collectible for which your IRA invested funds in 2021 on Line 1. Please refer to Form 1099-R for additional guidance.