Clarifying Form 1099-R would help the Internal Revenue Service identify more taxpayers who are underreporting their retirement income, according to a new report.

J. Russell George

The report, from the Treasury Inspector General for Tax Administration, noted that in a tax gap study for tax year 2001, the IRS estimated that as much as $4.2 billion could be attributed to underreported retirement income. Given the magnitude of underreporting, even small improvements in the IRS’s examination of tax returns with retirement income could increase taxpayer compliance and generate substantial revenue to the federal government to reduce the tax gap between taxes owed and money actually collected.

TIGTA conducted its review to determine whether the IRS has effective controls and processes in place to ensure that taxpayers and retirement income providers are correctly computing and reporting the taxable portion of retirement income.

TIGTA looked at the IRS’s Automated Underreporter Program, a compliance program, and found that it is effectively determining the proper reporting of retirement income when Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., discloses the taxable amount of the retirement distribution. For example, for tax year 2007, AUR Program examiners made tax assessments totaling approximately $607.5 million on 217,811 tax returns. However, it found that additional tax form information, if available, would improve compliance even more.

TIGTA recommended that the commissioner of the IRS’s Wage and Investment Division revise the Form 1099-R to clarify the meaning of the “taxable amount not determined” box in order to reduce taxpayer confusion and include the dates needed to identify retirement savings program distributions and transfers not rolled over within 60 days as required. The IRS should also establish procedures to transcribe additional lines from various tax forms, suggested the report.

“Our report found that correctly reporting taxable amounts of retirement distributions on Form 1099-R can be confusing for taxpayers,” said TIGTA Inspector General J. Russell George in a statement. “By implementing TIGTA’s recommendation to clarify the form, the IRS can reduce taxpayer confusion and improve compliance.”

The IRS substantially agreed with TIGTA’s recommendations and plans to revise the instructions to Form 1099-R to clarify taxpayer responsibilities and the amounts to report. The IRS also intends to consider the feasibility and benefits of including the dates of distributions and their respective contributions to identify distributions not rolled over within 60 days. However, TIGTA maintains that this information would be useful to the AUR Program when taxpayers do not utilize direct transfers between financial institutions.

The IRS plans to conduct its own study to determine the benefit of transcribing additional lines from tax forms. TIGTA maintains that the cost to transcribe the forms would be nominal and would not increase taxpayer burden.

The IRS also had other objections. “We will explore your recommendations, but based on our experience from working with retirement professionals and financial institutions, we question whether required reporting of distribution and rollover contribution dates will lead to significant improvements in the deterrence or detection of unreported retirement income,” wrote Richard Byrd, Jr., the commissioner of the IRS’s Wage and Investment Division. “As noted in the report, an individual receiving certain types of distributions from retirement plans or Individual Retirement Accounts (IRA) may have the option of transferring the distribution amount to another qualified plan or IRA. When individuals receive rollover-eligible distributions from the retirement plan or IRA, rather than having the funds transferred directly between the plan administrators and/or trustees, they must deposit the funds into a qualified plan or IRA within 60 days from the distribution date. Failure to deposit the funds can subject the distribution to taxation as regular income and an additional ten percent tax.”