Form 1099-R distribution codes

L1: Form 1099-R distribution codesA fiduciary is showing a distribution code of 1 (Early distribution, no known exception) for all IRA distributions made prior to the time the taxpayer has reached age 59 1/2, even if the distribution is being made pursuant to 72(t). The fiduciary has indicated that they are doing this due to some published IRS guidance; however, I cannot find anything that would indicate that the fiduciary is required to use this code in cases where they know that 72(t) applies. My guess is that they are taking the easy way out, and putting the burden on the taxpayer to file the Form 5329 and input code 2 on line 2. Any thoughts?2006-10-30 12:37, By: fbotax, IP: [8.10.242.123]
L2: Form 1099-R distribution codesYou may very well be correct – the Company that I represent made that decision last year and as we go forward my best bet is that more Trustees/Custodians will make the same decision.
We thought about having the owner signone ofour forms on an annual basis, but decided that by the time that we did that, we may as well use a code of ”1” and let the owner file a form 5329. It”s the Trustee/Custodian that bears the responsibility of completing the 1099 accurately – a code of ”1” is 100% accurate because there is a form 5329.
Just my thoughts.

2006-10-30 12:45, By: Gfw, IP: [172.16.1.70]

L2: Form 1099-R distribution codesHello fbotax:
I think; therefore it is just my opinion, that you are 100% correct. I admittedly do not read every piece of paper the IRS publishes; but, I have yet to find any document that hints at, much less defines, what steps/procedures/due diligence a trustee should take in order to put a “2” in the reason code. As a result, a trustee, without guidance, will not surpisingly take the course of least resistance coupled with protecting the trustee”s interests first.
TheBadger
wjstecker@wispertel.net

2006-10-30 13:00, By: TheBadger, IP: [72.42.66.32]

L2: Form 1099-R distribution codesI”m not saying this is a hard and fast rule, but if I were choosing a company to manage my accounts, that fact that they won”t accept responsibility for properly coding my 1099-R might be a factor in my selection. It”s certainly a benefit to the trustee to do it this way, but when trying to lure money into their accounts, I wonder how many trustees would be honest enough to disclose “We want you to know we really care about you when we are trying to get your money, but when it comes time to reporting distirbutions we are going to take the easy way out – be advised that you”re on your own then.”2006-10-30 13:07, By: SPECTEC, IP: [206.113.214.147]

L2: Form 1099-R distribution codesActually, they will all tell you is you ask. We used to use a code of ”2” if all assets were in a single account, there was no recalculation and all assumptions were perfectly in line with 89-25.
However, with the advent of 2002-62 and the probability that most all previous PLR”s were ”no more” so to speak and that fact that the IRStemporarily did away with the code of ”2” for SEPPs, it just madesense that the owner justify the exemption – that”s what the IRS appears to want.
Tell a Trustee/Custodian that you won”t use them if they won”t give you a code of ”2” and my guess is that many willtell you who will give you the ”2” code.
Remember, the code of ”2”really means absolutely nothing – the end result is that it is still between you and the IRS – keep good records and know what you are doing and the ”2” code means nothing.
2006-10-30 13:17, By: Gfw, IP: [172.16.1.70]

L2: Form 1099-R distribution codesI agree with SPECTEC. It”s about time IRA custodians that want to accumulate retirement assets step up to the plate and establish standards under which they will provide the 2 code. They would be free to limit the standards to their comfort level, and I cannot blame a custodian for refusing the 2 code for some of the exotic high expense investment strategies that test some of the 72t standards. But a plain vanilla 72t plan with no recalc and a SEPP universe limited to the specfic custodian should fall within that comfort level.
My impression is that the IRS is largely responsible for this evolving IRA custodian attitude. In 2004, the 1099R instructions implausibly OMITTED 72t plans from the list of code 2 exceptions. I understand that their error was discovered and they sent out a midterm clarification notice, but that notice may have been widely overlooked. The error was corrected in the 2005 Inst for 1099R, but by that time the custodians had the excuse many probably wanted, ie to stop providing the exception coding. Perhaps some custodians were fined or warned by the IRS as well, and that would have added to their hesitancy. In the final analysis, coding a legit 72t distribution as “early” is not taxpayer friendly, causes the IRS to inquire more frequently and adds unnecessary expense and inconvenience to the entire process. The 5329 does not have the same credibility with the IRS that a code 2 does.
Taxpayers should interrogate potential IRA custodians and consider avoiding those that will unconditionally refuse to provide the exception coding. If they start losing assets, perhaps a more accomodative attitude will emerge!
2006-10-30 13:32, By: Alan S., IP: [24.116.66.98]

L2: Form 1099-R distribution codesWell said, Alan.
If trustees are willing to accept client”s investments in order to generate fee & commision income, they should be as willing to properly code the 1099-R forms – that”s part of the job they are getting paid to do. My question would be is it possible that they are as cavalier about investing my funds as they are about their reporting duties, and if so how can I trust them to do the best job for me?
And the previous statement that the code means “absolutely nothing” is just simply wrong. At the very least, the addition of a 5329 to a tax return increases the DIF score and moves it further up the audit list.How much further nobody knows because it”s a cloesly-guarded secret, but my guess is thatit is a significant increase in the audit risk. I believe trustees who shirk this responsibility should be required to at least notify the taxpayer that their inaction is likely to increase the chances of their customer”s being audited by the IRS, because that is an undeniablefact.2006-10-30 17:11, By: SPECTEC, IP: [206.113.214.171]

L2: Form 1099-R distribution codesI would imagine that the investment diligence would generally be better than the breadth of consumer friendly administrative options. Some firms no doubt view 72t plans as a necessary evil, an expense, and typify a client whose assets generally will be reduced at a much faster rate than RMDs. Sloppy investment results in comparison willcost them assets from all sources. 72t distributions probably only represent small single digit %s of most firms assets.
I think Gordon meant to indicate that if there is an inquiry, it does not matter what the IRA custodian shows as a code. However, I do agree getting the code provides some “insurance” against such inquiries in the first place, although an IRA custodian should ONLY be using the 2 code for 72t, annuity payouts or IRS levies. So most of the time that they see a “2” they probably know the reason is a 72t.2006-10-30 18:19, By: Alan S., IP: [24.116.66.98]

L2: Form 1099-R distribution codesSPECTEC and Alan S:
I thoroughly enjoyed your exchange concerning 1099-R coding. I share your views. I will certainly be paying attention to how a custodian codes 1099”s when selecting same. As a fee generating customer, I am paying for service. If a custodian arbitrarily decides it will not correctly code this document, I am not being well served. So..this leads to..who (and who does not) correctly code form 1099-R?
Alan: (reference a question you asked “pete” in the next post) Vanguard apparently does not provide code 2 on 1099-R”s for SEPP plans. Go to page 14 of this link: http://www.vanguard.com/pdf/bspp.pdf
Gfw: Thank you for providing and maintaining this forum.2006-10-31 06:29, By: DME, IP: [209.112.195.29]

L2: Form 1099-R distribution codesI”m going to take a different approach to this discussion and play “devil”s advocate” for the custodian. I am an advisor and use several different custodians. Let”s start by restating GFW”s last sentence:
It”s the Trustee/Custodian that bears the responsibility of completing the 1099 accurately – a code of ”1” is 100% accurate because there is a form 5329.
If the Trustee/Custodian doesn”t code properly then they are in trouble with the IRS. How can they be sure their coding is correct when they issue a Code 2? The only way I know, and it”s the same story with all custodians I have talked with, is to only pass judgement on the funds held by an individual custodian. Some also take the position that only one account can be used for 72(t) … as they read the IRS Code. I”ll not pass judgement on this stance.
Many times on this board we have talked about having several different accounts at different custodians and all accounts encompass one SEPP universe. The IRS allows the taxpayer to withdraw from all, a few or just one IRA to satisfy72(t) or RMD distributions. But from the custodian”s point of view, how can they be assured that distribution amounts are correct so they can issue a Code 2? Let”s assume you have 3 IRA”s comprising your SEPP universe but they areat 3 different custodians. Assumethat IRA “A” is used only for growth and you are not taking any distributions;IRA “B” is used for withdrawals based on the full value in IRA “A” and 1/2 the value in IRA “B”; and IRA “C” is used for withdrawals based on 1/2 ofthe value in IRA “B” and the full value of IRA “C.” You inform each custodian that the IRA they hold is part of a 72(t) distribution plan and you expect them to issue a Code 2. How are you going to document to each custodian that you are taking the correct amount of distribution to satisfy your annual distribution amount? If I were a custodian I certainly wouldn”t rely on the verbal assurance from the client when the potential penalties to the custodian are so great. I believe this is the logic they use when they say they will only report based on assets held and distributions made by them.
Picking a custodian based on their willingness to issue a Code 2 on the 1099-R is a bit short-sighted. There are so many more critical issues to be concerned about. For example, can the custodian accuratly account for transactions within the account like transfers in / outand monthly distributions? Are they going to be sure to make the required distriubtions on time and within the same calendar year so your are not short or long on amounts? Can they hold the assets you want and make trades accurately and efficiently? The taxpayer can deal with getting a Code 1 and accurately reporting the exception on Form 5329 without having to deal with more important issues of managing the assets for best investment growth.
OK. I know some of you will disagree with me on this, but I really believe trying to “punish the custodian” by transferring assets if they don”t issue you a Code 2 for a really complicated structure of your SEPP Plan is trying to fight the wrong battle. Each time you make a transfer from one custodian to another, you open yourself up for goof that can cost you. Remember, you sign your tax return, not the custodian.
Jim2006-10-31 10:19, By: Jim, IP: [70.184.2.72]

L2: Form 1099-R distribution codesFYI: I would be careful in shopping around for a custodian that will provide (or say they will provide) specific coding on the 1099-R. Notwithstanding all the points made earlier, it just doesn”t make my list for critical features that need to be considered in selecting a custodian / trustee.
After you get all the funds transferred and periodic payments set up, they will probably change their procedures and start coding all distributions as ” 1 ” if you are not 59 1/2.

2006-10-31 16:04, By: gary t, IP: [24.145.246.83]

L2: Form 1099-R distribution codesAs a 72(t) semi-retiree, I totally agree with Jim”s commentary. His description is an excellent generic representation of the way I set up my own SEPP universe. I completely understand why the custodians would not use a code 2. I personally did not want a single custodian for my retirement compensation vehicles. I must say, however, I do not look forward to correspondence with the IRS on the topic even though I have followed all advice regarding documentation.I hope my small distribution will fly under its radar. Getting lost in the bureaucracy reminds me of the folk pop song about getting lost on the MTA.2006-11-01 09:29, By: squeaky, IP: [69.227.208.32]

L2: Form 1099-R distribution codessqueaky:
Speaking of folk songs, sometimes getting into a correspondence blizzard with the IRS is more closely aligned with being a character in Arlo Guthrie”s “Alice”s Resturant”. 2006-11-01 09:35, By: spectec, IP: [206.113.214.147]

L2: Form 1099-R distribution codesJust to add a little perspective…
In 2004, the 1099-R instructions were issued in May and removed all language about 72(t) distributions and IRS reason code 2. The IRS stated they wanted to place the burden on the client to file the 5329 and claim the exemption to the penalty. In October, the IRS issued updated instructions to this form that again included the language for code 2.
The firm I represent also quit using code 2 in 2004 because of this and the difficulty in verifying that the distributions were valid and compliant. In 2006, we put a new process in place to verify calculations and monitor the distributions, and we have gone back to using code 2.
The IRS however has actively pursued accounts that had a code 1 and filed the 5329. We have seen several hundred accounts that have received a bill for payment of the penalty, even though they did file the 5329. In numerous conversations with the IRS, we have found that the IRS doesn”t necessarily recognize the 5329, and they actually have a system that if they see a code 1 and no penalty payment, their computers will systematically generate an inquiry on the return.
I have also seen many audits that state the 5329 is not acceptable, and the custodian MUST issue a corrected 1099-R using code 2. Obviously, this is contrary to the IRS rules and instructions for the 1099-R and 5329. Long story short, if the custodian does not use code 2, it is a huge red flag and may well trigger an inquiry into the return.2006-11-06 14:58, By: jrog74, IP: [167.80.244.204]

L2: Form 1099-R distribution codesThat is very helpful information.
Looks as though a Code 1 accompanied by a correcting 5329 runs the DIF score up to the max and guarantees at least an inquiry with a bill for the amount the IRS assumes is owed, if not a full-blown audit. So much for the “it doesn”t really make any difference” excuse.
While I can understand the reluctance of the trustees to get in the middle of this, and nobody ever accused the IRS of consistency, I still would expect the trustee to issue a properly coded 1099 or I”d be looking for another trustee – especially if I were using the life expectancy method. After all, no financial advisor ever has any difficulty calculating the premium they need to collect when trying to sell their client an insurance policy or how much they arewilling to pay an annuitant, and those types of contracts are at least as or much more complicated to calculate than an SEPP distribution.2006-11-06 15:23, By: spectec, IP: [206.113.214.147]

L2: Form 1099-R distribution codesspectec – the problem isn”t the calculation – that part is really easy, even on an annual basis.
The problem iswith the verification after the first year that the plan is still intact and meets the requirements of 72(t). The IRS (as pointed out by Bill above) has never really given instructions on what constitutes verification to use a code of ”2” for a SEPP – if they did, perhaps more would issue the code.
Even the verification is relatively easy if the SEPP plan consists of onlyone account with just one trustee/custodian as long as there is no annual recalculation being used. The type of plan I just described may even get a code of ”2”. The problem is if there is recalculation, assets in a second account, etc. itmay be impossible properly attach a code of ”2” since only a part of the funds are being monitored/verified. A code of 1′, contrary to your thoughts, is always acceptable.
However, if your biggest criteria is a code of 2′ then merely call the trustee/custodian that you plan on using and verify how they code a 1099 for a SEPP and what their requirements are for the 2′ now and what events would cause them to stop using a 2′ in the future. Once the funds are there you will probably want to leave them there for the duration of the SEPP since a transfer to another Trustee/Custodian will probably result in a code of 1′ in the year of the transfer by both the new and old custodians.
The previous post mentioned letters because of a code of ”1” – next year it could just as easily be letters just because it was a code of ”2”. It all still comes down to you having the proper documentation. If there is an audit, it will make no difference what the code on the 1099 is, they will still want to see your documentation for your SEPP plan.
I have also seen SEPP plans coded with ”1” that have used a 5329 for years without a problem or an audit.2006-11-06 16:27, By: Gfw, IP: [172.16.1.71]

L2: Form 1099-R distribution codesFidelity told me that they will only code a 2 if they calculate the amount. They only use the single life expectancy table for the MRD method. I”ve been using the joint life expectancy table so their calculation would be wrong. The previous seven years they had been coding a 2. I emailed them and said I would move my account but that didn”t scare them. The following was in an email that they sent me:”The IRS has indicated that unless we are
able to ensure that one of the three approved calculation methods for a
SEPP distribution is used that we should use a code one on the 1099R
Tax Form”Mike2006-11-07 11:21, By: daddy0, IP: [69.120.56.189]

L2: Form 1099-R distribution codesSpoke with a Fidelity retirement specialist today. He says that starting with the 2007 tax year (meaning the 1099 that you will get in Jan of 2008) all SEPPs will be coded with a 1. He says a letter is being sent out this week about this. Seems odd that they would send a letter a year in advance. He says Fidelity doesn”t have the resources to verify that the IRA withdrawals comply with the 72t rules. He says besides the calculation they would have to ensure that no additional withdrawals had been made during the year or any contributions had been made to the account. Maybe if enough people complain they”ll change their minds.Has anyone on this froum been audited because their 1099 was coded with a 1?. Any problems from the audit?Mike2006-11-08 10:59, By: daddy0, IP: [69.120.56.189]