1099-R Coding Error

L1: 1099-R Coding ErrorI have a SEPP running now that was started on 3/15/2005. I did not notice that my form 1099-R for 2005 was coded in box 7 as a “1”, which means that no known exception to the 10% early withdrawal penalty applies. This box should be coded as a “2” since I am taking early distributions under the 72(t) exception. I filled out and signed a form from my custodian to this effect and they are sending me regular equal payments from this account.
I contacted my IRA custodian and requested a corrected 1099-R for tax year 2006 but they refused to issue one. They claim that the tax law language changed in 2005 and that the coding of “1” is correct. I do not agree with this assertion.
I then filed an amended tax return for year 2005 that included a completed form 5329 and a letter of explanation for the amended filing. After considering my information, the IRS responded with a letter that said the amended return did not change the amount of tax that was due and that I should request a correctly coded 1099-R from my IRA custodian for tax year 2006 (and presumably each following year of my SEPP as well).
If the IRS agreed with the custodian”s interpretation of the tax law concerning 1099-R coding, they would have suggested that I simply include a completed form 5329 for each of the tax years remaining under my SEPP. Since they did suggest that I get a corrected form 1099-R from my custodian, it is clear that the IRS does not agree with the custodian”s interpretation of the form 1099-R coding requirements.
The custodian seems to be saying that by claiming the 72(t) exception to the 10% early withdrawal penalty, theycould somehow be held responsible for any errors made by the tax payer in setting up and handling the SEPP. I have read the rules on SEPP accounts pretty thoroughly and I cannot find any reference whatever that supports this contention.
Can anyone clarify this situation?
Ed
2007-03-18 16:27, By: Ed_B, IP: [67.170.159.37]

L2: 1099-R Coding ErrorAs you apparently realize, this 1099R coding issue is a major headache and getting worse every year. Back in 2005, the IRS issued 1099R instructions that eliminated the exception coding (# 02) for SEPP plans, then later in the year realized their error and issued a correcting bulletin. However, by that time custodians had corrected their systems and began coding all the plans as a “1”. Even though later editions of the 1099R instructionsallow the exception coding once again, most custodians apparently see the exception coding as something that can get them into trouble if they mis diagnose the accuracy of a taxpayer”s calculations. No one has posted a specific case that resulted in any dire consequences for any custodian that I have heard of, so I suspect there is some collusion afoot in using the original IRS error as an excuse to bail out of business of underwriting valid SEPP plans. Not a very service oriented position. Even Vanguard is one of these and I think Fidelity also. All any of these custodian need to do is to look at the current version of the 1099R instuctions and they will see that the IRS exception coding is alive and well, if they wanted to.
As a result, most 1099Rs are now coded “1” and taxpayers report the exception on Form 5329 (code 02).That”s really all that should be necessary, and the IRS is accepting these unless they want to audit a specific taxpayer”s calculations. You have already done more than you should have needed to. The 5329 can be filed “stand alone” without a 1040X in most cases. Just tell the IRS your custodian and almost all custodians no longer issue the exception coding because of the original IRS instuctions in 2005. Tell them your plan is sound and offer to send them your calculations if they wish.
Note: Charles Schwab still offers the 02 code, as I understand.
2007-03-18 21:43, By: Alan S., IP: [24.116.66.98]

L2: 1099-R Coding ErrorEd,
Alan sums it up correctly as always. For more participant feedback on this topic, see my posting from 1/25/07 (currently page 6). KEN2007-03-19 04:55, By: Ken, IP: [129.44.180.5]

L2: 1099-R Coding ErrorEd,
One more thing.. In addition to my Schwab IRA where I am doing my 72(t), I have another IRAat Vanguard. I just looked up on their site (using search for SEPP) and found their paperwork with worksheet that helps you figure out the SEPP payment. I alsofound this disclaimer on that page, which I will post below aboutthe 1099 code “2”. The custodiansthat no longer offer the code “2” probably all have this warningsomewhere in their paperwork and online details, and they may assume that you use their worksheets to figure out the withdrawal, so you will know that the code will not be a “2”.I never did it that way when I set up mine at Schwab, and you probably didn”tdo that as well. Thereseem to be veryfew that offer it anymore. IF you had used computer tax software last year, it shd have warned you on that code “1”. IF not, Ican see how it was new, just like mine was this year. I just knew to look for the code “2” from reading postings on this site, and was happy when I popped up the online 1099-R before the hard copy showed up in the mail, which iswhen I posted that Jan 25th message. KEN
How to claim your exception to the 10% penalty
Vanguard will report your distributions to the IRS on Form 1099-R, but the form
will not indicate whether your distribution qualified for an exception to the 10%
penalty rule. You must claim the exception yourself by filing IRS Form 5329, Additional Taxes
on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with your
tax return.To obtain Form 5329 and its instructions, call the IRS at 800-TAX-FORM
or download them at www.irs.gov. 2007-03-19 09:09, By: Ken, IP: [151.199.54.57]

L2: 1099-R Coding ErrorA question and a comment.
1st, Ed; is the IRS still trying to collect the 10% surtax for 2005 or is that matter now closed?
2nd, all of the trustee/custodians out there usually have a whole floor of lawyers devoted to compliance matters of which 1099R coding is just one. As a result, the trustees fully understand the rules and by far and large are refusing to code SEPP plans with a “2” for one very simple reason: they think or are concerned that coding a 1099R with a “2” imposes or implies a duty on their part. Furthermore if there is a duty, they don”t know what that duty is and furthermore do not want to expend organizational efforts to perform that duty. I am not pro-trustee but in a fashion I also understand their dilemma.
This will not get itself resolved until one of two events transpires: one, the IRS issues a ruling or procedure on this issue outlining what a trustee is supposed to do in order to code the 1099R as a “2”; two, some one steps up to the plate and files a breach of fiduciary trust case against a trustee where this issue is a central issue to the case.
TheBadger
wjstecker@wispertel.net
2007-03-19 17:13, By: TheBadger, IP: [72.42.67.236]

L2: 1099-R Coding ErrorHello, All:
Thanks much for the replies on the 1099R coding issue. This whole thing has been bothering me a lot lately and it is comforting to get some straight info on it. This web site tends to provide that! 🙂
Alan – Yes, I knew that there was some problem with most custodians and their 1099R coding. What was getting to me was the fact that I could not find anything in the tax law that supports their position. Thanks a lot for clarifying the on / off nature of the IRS rules on this topic. I did not know that this had occurred but knowing it now does make this issue more clear.
Yes, you are correct that Vanguard is one of the custodians that does not code box 7 correctly. I expected better of them and am disappointed that they chose to provide a lower level of service as opposed to the higher level that I have come to expect from them. I am just glad that the IRS did not see this as an opportunity to drop the hammer on an unsuspecting tax payer and roil the SEPP waters.
As to my plan, I believe that I did a good job with it and am in compliance with all IRS rules on it. I have a 3-ring binder that is filled with documentation on my plan setup and operation. I am confident that I can fully explain my plan to the IRS, if necesary, and that it will pass muster. I used the SEPP brochure on the Vanguard web site to do the amortization calc and then double checked the result via the 72t web site calculator. The SEPP payments from both of these argeed to within about $0.50 per year, which I took as complete agreement with the tiny difference due to rounding / number of digits used in the calc.
Kudos to Charles Schwab on their continuing to use the proper 1099R coding. Anyone looking at setting up a new SEPP could do worse than to pick Schwab as their custodian. I will stick with Vanguard for now, as I don”t want to complicate my situation any more than necessary.
Ken – I looked up your post from 1/25/07 and agree that it is good that you are getting a code of 2 on your 1099R from Schwab. Hopefully, they will continue to code your 1099R correctly.
As to Vanguard and their disclaimer, they did not have this in effect when I set up my SEPP in Feb. 2005. In fact, their SEPP form specifically included a box that could be checked that says “code 2 – 72t exception applies”, or something similar to that. I checked that box, for all the good it did.
Yes, computer tax software would have caught this error early on and would have kicked out a completed form 5329. A good friend of mine uses TT for this and that is what it did for him. My wife and I do our taxes together. We used to use the Tax Cut software but wife did not like that and prefers to do it by hand. I prefer computer myself but go with her on this to preserve family peace.
TheBadger – The matter seems to be closed. I took their comment to mean that no additional 10% tax was due. They did not include any kind of a request for payment. I”ve only dealt with the IRS a few times but whenever I owed them money, they were not shy about asking for it. I prefer to pay what I owe on time and lurk below their radar… no news is good news being the operative term.
I also understand their reasoning… I just don”t agree with it. Unless there is some language out there in the tax code that I do not know about (which is entirely possible), they seem to be “whistling past the graveyard” on this one. Their actions on this remind me a lot of Sgt. Schultz in the old Hogan”s Heros TV show… (paraphrased a bit) We don”t know and we don”t want to know” (about proper 1099R coding). My thought is that youare correct and they DO know what the proper coding should be; they just see this as an opportunity to avoid any possible liability and they are taking it. I suppose that the IRS could come down on this and issue instructions that require proper coding and define a code of 2 as proper whenever a tax payer claims the 72t exception… and not when the custodian guarantees that the SEPP was done correctly. SEPP viability should be an issue that is strictly between the IRS and the tax payer, IMHO, and not between the IRS and the custodian. Custodial bookeeping errors excluded, of course.
Ed2007-03-20 11:15, By: Ed_B, IP: [67.170.159.37]