I'm meeting with a tax professional on Tuesday, I'm just a bit anxious and want to understand what I'm walking into.
The gist:
Worked for a grocery company from 2014-2020 that had an ESOP. Fully vested when I left.
In 2023 they paid out the disbursement. Gross distribution was about $56k, taxable amount around $44k. The 1099-R showed about $11,700 in Net Unrealized Appreciation (NUA) in Box 6, and Distribution Code 1 in Box 7. No federal tax was withheld (Box 4 was blank).
I used FreeTaxUSA to file. There's a specific section for "Form 1099-R / Retirement Plan" and that's where I entered it. I'm 99% sure I uploaded the PDF, the software autopopulated the boxes, and I went through verifying each number. It's been too long to know for sure and none of my other 1040s have any files uploaded with them. When I filed my 2023return, I owed about $6,500 which was unusually high but made sense to me given the extra income from the disbursement. Paid my return, forgot all about it.
I sat on the entire disbursement until my tax return was paid specifically because I wanted to make sure I could pay the income tax. After I paid my 2023 taxes, I did not roll the money into another retirement account. Used most of it on a home project and put the rest in a HYSA as an emergency fund.
Yesterday I got a CP2000 notice from the IRS saying I failed to report the $44k distribution. Here's what they want:
Proposed additional tax: $14,165
10% early withdrawal penalty (under 59½): $4,419 (this is included in the $14,165)
Accuracy-related penalty: $2,833
Interest: $2,796
Total proposed: $19,794
I pulled up my filed 1040 on FreeTaxUSA and here's what I found:
Lines 5a and 5b (Pensions and Annuities) are completely blank. The $44k was never reported as retirement income.
BUT - I did report the NUA portion. My Schedule D and Form 8949 show the $11,731 capital gain from the ESOP shares. So the return partially reported the distribution, just not the retirement income portion.
It looks like FreeTaxUSA took my correctly-entered 1099-R and routed the whole thing through Schedule D as a stock sale instead of also putting the taxable amount on Line 5b as retirement income. The NUA piece landed correctly, but the ordinary income piece disappeared.
So my questions:
Is my understanding correct that the 1099-R should have generated entries on BOTH Line 5a/5b (retirement income) AND Schedule D (for the NUA portion)?
If FreeTaxUSA autopopulated the 1099-R correctly from the retirement section and still failed to put $44k on Line 5b, is that a software error? Does their accuracy guarantee cover penalties and interest in this situation?
How strong is a penalty abatement request here? I entered the form in the correct section of the software, verified every box, and clearly attempted to report this since the NUA portion did make it onto my return.
Is there any chance the IRS's proposed changes are double-counting anything, given that I already reported the $11,731 capital gain?
Thanks