When the company who generates a taxable event doesn’t know it

Most people who have a job pay the “FICA” or Social Security tax. This tax is 6.2% of income paid by the employee as withholding from each paycheck, and another 6.2% of income paid by the employer. But of course, this system that’s supposedly good enough for the rest of us doesn’t apply to government employees. No, they have their own program. For part-time government employees in Massachusetts, there’s a 7.5% compulsory contribution to the Massachusetts SMART Plan instead of a payment into Social Security. It’s a 457 plan, which is somewhat like a 401(k) or 403(b). Although, unlike those, there was no choice as to how to invest the money. The fund that it gets invested in is called “The Income Fund”, which is a fund that isn’t supposed to lose value, but that I can’t easily find many details on.

So, while Jessi was working part-time as a substitute teacher in 2006 and 2007, she had contributed about $300 into this fund. However, the monthly fees being deducted for maintaining the account were more than The Income Fund was growing on $300 of principal. So, rather than waiting for it to whittle away to nothing, in 2008 we thought that it would be smart to transfer the money to a Roth IRA at Vanguard that we had already established for her. This is the advantage of a system like this over Social Security, is that you can transfer the money out, at least once you leave employment. Now, the 457 plan is pre-tax money that grows tax-deferred, and a Roth IRA is after-tax money that grows tax-free, so basically this transfer means that (1) we pay taxes on the $300 now and never need to pay taxes on what it grows into (good as with all the deductions we have, we’re paying little in Federal Income Tax in 2008, and I expect tax rates to go up in the future), and (2) we can invest the money as we wish. So, we eventually (over several months) managed to get all the paperwork filled out for them to transfer the money directly to Vanguard.

So yesterday, we got the 1099-R from the 457 plan, describing the distribution for tax purposes. However, the form describes the transaction as though the money were transferred into a Traditional IRA, which would be a pre-tax account that didn’t generate taxable income. After a few phone calls, they do seem to think that some sort of error occurred, as their paperwork indicates they thought that they were transferring the money to a Traditional IRA when in fact they transferred it to a Roth IRA. They don’t seem to understand the concept of transferring the money directly to a Roth IRA, which was added to the tax law in 2008. (Previously, you’d need to transfer to a Traditional IRA and then convert that to a Roth IRA, which Congress and the IRS eventually realized was just adding extra steps for no benefit.) And yet, they did do a direct transfer to a Roth, they just didn’t realize it and aren’t reporting it that way.

So, they’re supposed to call us back this evening with an update on whether they’ll be able to send us a corrected 1099-R.

It’s somewhat frustrating when I know exactly what I’m supposed to filing for taxes, but the companies are reporting contradictory information to the IRS, and so I probably shouldn’t file just yet until I get this all cleared up. All this work, for $300 of reportable income…