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Yes, it is true that the withdrawal will be reported to the IRS. However, that does not make it taxable. Since the funds were replaced the tax reporting, by you, will be different. If you look at last years tax return you will see that there are both (a) and (b) lines for reporting the withdrawal. The (a) line is where the withdrawal, at gross amount, will be reported. The (b) line will be used to report the taxable amount of the withdrawal. Thus, for example, if the withdrawal was $10,000 and you put all of it back the (a) line will show the $10,000 (matching to the 1099-R) and the (b) line will be zero (reflecting the replacement of the funds. If you did not put all the money back only the money retained by you will be reported on the (b) line.
Jackson National sent a 1099 stating the the entire $43,000 was taxablle. Can I still report the withdrawal as you described in your answer? I am asking because our accountant included the $43,000 on our 2011 tax return but decided it wasn't taxable since I returned the money. Now, the IRS has questioned the tax return saying we owe $10,000 extra in taxes plus $2,000 in penalties.
can we get the annuity company to change the 1099-R? So far they refuse to and state that it is an IRS rule that all withdrawals are taxed (except for a rollover) regardless of whether a mistake was made or not.