Early Distribution of a Roth IRA - I say "Taxable", Software says "Not Taxable"

[doubleg10]

Filing status is MFJ

Client is 36 years old.

Opened the Roth IRA in December 2020 and his contributions from that time to December 31, 2023, were $4,405.

During 2024, he contributed $720 but withdrew $4,500.  The withdrawals were for paying down consumer debt therefore none of the exceptions were met. He received a 1099-R with Box 1 - $4,500 and Box 2 - $4,500.  Distribution code is J.  Federal tax withheld was $450.

I answered "No" to "Opened a Roth IRA before 2020".  I inputted his cumulative regular Roth IRA contributions as $4,405 (basis).  According to my Gregorian calendar calculations, he had the Roth IRA open for 37 months (prior to January 1, 2024) and 44 months before the withdrawal.  These are well short of the required 60 months.

All Gregorian and Julian calendar aficionados are welcome to reply as well as those tax experts that are a lot smarter than me.

Enjoy the day/evening!

[rbynaker]

Contributions come out first.

$4,405 + $720 = $5,125 contribution basis - $4,500 = $625 remaining basis.  Nothing is taxable.

[doubleg10]

Thank you for the answer but how does one get around the less than 5-year requirement?  Even though there is remaining basis is positive, the methodology results in he didn't take out any earnings.  Your answer leads me to believe that if one still has basis (even before the 5-year requirement is met) that the tax code comes back with "non-taxable".

I appreciate the dialogue.

[rbynaker]

There's a flowchart in Pub 590B (2024 discussion starts on page 33, chart on page 34).  It's not a qualified distribution but it doesn't matter since you don't run out of basis.  From the flowchart (emphasis mine):

The distribution from the Roth IRA
isn’t a qualified distribution. The
portion of the distribution allocable
to earnings may be subject to tax
and it may be subject to the 10%
additional tax.

Ordering rules start at the bottom of page 35.

[qbteachmt]

Just for future reference: "he had the Roth IRA open for 37 months (prior to January 1, 2024) and 44 months before the withdrawal. These are well short of the required 60 months."

The 5-year rules are by Tax Year. That's why you can put a contribution in now, April 2025, and apply it as your 2024 contribution, and it counts as if this is Jan 1, 2024.

"Since the 5-year rule starts the clock on January 1 of the tax year of your first contribution, this may, in practice, help you meet the aging requirement sooner. For example, if you contribute to a Roth IRA in April 2025 for the 2024 tax year, you may meet the 5-year rule in a bit under 4 years."

"The 5-year rule for Roth IRAs means that at least 5 years must elapse between the beginning of the tax year of your first contribution to a Roth account and withdrawal of earnings."

From: https://www.fidelity.com/learning-center/personal-finance/retirement/roth-ira-5-year-rule

There are ordering rules for what comes out in sequence, so Basis wasn't totally removed.

Then, there are 5-year aging rules for each conversion. If there are both taxable and non-taxable conversions, the taxable conversions are considered to have been withdrawn first.

Earnings are last.

[doubleg10]

Thank you very much for pointing me to the Pub 590B and the flowchart.

"Give a man a fish and you feed him for a day. Teach him to fish and you feed him for a lifetime"

Thank you for the education.  It is much appreciated.

[doubleg10]

Thank you, qbteachmt, for your response and further education.  I did not know about the "clock starting" point.

This stuff is good and the community is good!