An individual retirement account is a good way to save and invest for retirement. However, the tax advantages of IRA accounts also come with some tricky tax requirements. Like all tax matters, IRA transactions must be reported to the Internal Revenue Service when you file your income taxes. Forgetting to include material information on your tax returns can cause big problems. The quicker any errors are remedied, the better.
IRA Tax Basics
All money inside of an IRA grows tax-deferred. That means that while the funds are inside of the IRA account no taxes need to be paid on dividends, interest or capital gains. However, when money is withdrawn from an IRA it counts as income and is taxed accordingly. Furthermore, withdrawals made before age 59 1/2 may be considered early withdrawals and subject to a 10-percent tax penalty.
Reporting IRA Withdrawals
The financial institution that holds your IRA account is called the custodian. Every IRA custodian must report any withdrawals from an IRA to both the IRS and the account holder on Form 1099-R each year. The IRS computers attempt to match up what is reported by the IRA custodian with what is reported on the taxpayer's income tax filings. Inconsistencies in the amounts reported may trigger an audit or other review of your taxes.
Failure to Report Income
IRA withdrawals are considered taxable income. Failing to report an IRA withdrawal is a failure to report income. The difficulty is that many computations on various tax forms depend upon the number reported as income. In the case of forgetting to include IRA withdrawals, these computations may be incorrect throughout the tax filing.
Filing an Amended Return
Forms 1099-R reporting IRA withdrawals are sent directly to the IRS in addition to the taxpayer. This makes the likelihood of the error being flagged high. Higher income means higher taxes and the IRS may charge penalties and interest on the unpaid amount. Therefore, the taxpayer should file an amended tax return as soon as possible to avoid accumulating additional interest. To file an amended return use IRS Form 1040X. You will also have to attach any schedules that change due to the amended return. Be sure to include payment for any additional taxes due.
State Income Taxes
Many states base their income taxes on figures calculated on the Federal tax return. If your state uses numbers from your Form 1040 then you may also need to file amended return for your state taxes. Each state has a different procedure for doing so. You'll need to check directly with the agency responsible for collecting income taxes in your state.