IRS sent me a letter...I messed up by unwittingly taking money out of a Roth IRA and reporting it incorrectly

Question

I recently received a letter from the IRS based on my taxes for 2015. I believe I did not understand the proper workings of a Roth IRA. I was under the impression I could pull my money out and only report any distribution increases on my taxes. For instance assume I had $1000 bucks in my Roth IRA. Let's say I only gained 10 bucks on it giving me $1010. I previously thought a Roth IRA allowed me to withdraw my original $1000 without any penalty but if I were to withdraw any gains and not report it on my taxes that would be wrong.

In any event, I only had around $10000 on a new Roth IRA and at the time I ran into some financial issues. I wasn't smart and had not saved in an emergency fund at the time (I know this was rather stupid of me considering I was putting in 15% of my salary in my 401k and putting money into my Roth IRA). I don't need tips or a lesson on how this is important - lesson was learned at the time.

In any event in 2015 I had withdrew around $4750 of my own money (of which none of this had any gains) from my Roth IRA. I did not report this as income because I thought this was already taxed, already my money, and no gains.

So yesterday I got a letter from the IRS stating I owe $1950 back to them. Did I mess up? Was I supposed to report this as income? If I honestly messed up I will definitely pay it as I don't want to mess with the IRS and lesson learned. In other words if I can avoid this I'd like to but I am all for doing the right thing.

EDIT

Back in 2015 when I first started doing my taxes I did not pay attention to form 1099-R. I was an idiot and learned from my mistake. I just went to fidelity's site and downloaded my 1099R and here is what it gave me:

I believe I did not put this value on my form. I am confused now who I need to contact or how I should fix this. Should I contact Fidelity or the IRS?

Answer 1

There could be a few reasons for this, my first guess is that you didn't report the distribution on your return (indicated on line 15 of your 1040, pictured below), the IRS got a copy of the 1099-R, and assumes it's all taxable (or maybe the 1099-R indicates the full amount is taxable). If a 1099-R doesn't have an amount populated for 'taxable amount' it doesn't mean the distribution isn't taxable, and without any indication that it's not taxable the IRS assumes it is.

It's not taxable if it's a withdrawal of your contribution.

Here's a snippet from How to Calculate the Taxable Amount of an IRA Withdrawal:

Withdrawals from a Roth IRA
Since Roth IRA contributions are made on an after-tax basis, qualified withdrawals are completely tax-free. A "qualified" Roth withdrawal includes the following:

• A withdrawal of your original contributions at any time, for any reason.
• Any withdrawal from your account after you turn 59 1/2 years old and your account has been opened for five years or more.

If your 1099-R indicates a taxable amount, then you might need to contact the issuer to understand why. If it does not indicate a taxable amount and you failed to record the distribution on your return, you just need to file an amended return that shows the distribution on line 15a and shows no taxable amount on 15b along with a completed Form 8606.

You may not need additional documentation to support of your claim that it's not taxable, but if you do it would be any statement showing that your contributions over the years exceed your withdrawal.

What a 1040 with a non-taxable IRA withdrawal would show:

Note: There'd also be a completed Form 8606, the 1040 lines above just show if it was entered in.

The easiest path forward is probably to file an amended return using turbotax since you filed with them originally. I haven't dealt with an IRS letter in a few years, I can't recall if you need to contact them or simply file the amended return, but they're pretty good about including instructions so the letter probably indicates what you need to do. Don't delay in taking action, as the IRS can and will garnish wages if they are owed (or think they are owed) money.

Update: OP contacted IRS and they didn't even want an amended return, just the completed Form 8606, so it's worth calling the IRS first with these letters.

Answer 2

I just want to point out something that seems to be generally true:

If you are supposed to report something to the IRS, and you don't, the IRS will probably send you a letter assuming the maximum possible tax liability, and it's up to you to prove that scenario is incorrect.

In your case you obviously owe no tax, but since you didn't report it, the IRS simply assumed that you do owe tax until you prove otherwise. You're one form away from fixing the issue.

I have first hand experience that this is also true if you forget to report an HSA distribution. I received a letter considering my entire distribution as if it was for non eligible medical expenses. This made the amount taxable and had an additional 20% penalty to boot. Of course I have medical receipts for all of the distributions which makes them not taxable, and had I simply put the correct number on my return to begin with I wouldn't have had to fill out the additional form to correct my mistake.

Answer 3

The best thing you can do here is work with the IRS to the best of your ability. You can attempt to call them, attempt to go to one of their local branches in your area, or just hire an accountant to solve the problem. Just be mentally prepared to write a check.

You could attempt to figure this all our yourself, but then a lot of tax law is open to interpretation. This is why I would recommend seeking the IRS's help if you DIY. Once you have addressed the issue to the satisfaction of the IRS agent, this will no longer be a problem. Provided you have a good attitude (which you express in your question) and are honest, I have found them very easy to work with. You will be a refreshing change of pace to the actual tax cheats.

While I understand that you are not seeking advice on what got you your situation, I would like to offer some encouragement. Good for you for learning from, and addressing your mistakes. Doing this will serve you well in the future.

Answer 4

You need to fill out form 8606. It's not taxable, but you still need to report it

Answer 5

Yes sir, been there did that. Now a Roth account is considered income if you it pull out. It is your money and you have to report if you pull it out. FYI, open a savings account, and put it in that so if you need it this will not happen.