Is the Internal Revenue Service doing enough to catch taxpayers who fail to take required minimum distributions from their IRAs? Not according to a new report by the Treasury Inspector General for Tax Administration, which calls on the IRS to “proactively” reach out to taxpayers on this issue.
“People are making mistakes, but they aren’t getting caught,” says Barry Picker, a CPA in Brooklyn, N.Y., adding, “The IRS wants people to comply, but they don’t want to penalize them.”
TIGTA identified nearly 639,000 taxpayers with IRAs worth $40.4 billion who may not have taken required distributions in tax year 2012. In addition, TIGTA identified nearly 6,500 taxpayers who self-reported that they did not take required distributions in prior years, paying excise taxes totaling $6.2 million. Those are taxpayers trying to come clean; the penalties are calculated as 50% of the amount that should have been taken out. 335 of them got the penalties waived in full.
There are people with $1 million IRAs getting this wrong. That means they are avoiding a current income tax hit on the missed distributions, and the money stays in the IRA compounding tax-deferred. When taxpayers don’t take the money out as required, the Treasury loses revenue because taxpayers are sheltering IRA funds from taxation.
If you fail to take out a required minimum distribution from your Individual Retirement Account by... [+]
TIGTA says the IRS could use date of birth information from the Social Security Administration to directly notify taxpayers who have IRAs and are turning 70.5 or older of the requirement to take mandated withdrawals (the IRS agrees this would help, but says it can’t pay for this). Similarly, the IRS could use date of death information to notify the estates of deceased individuals of distribution rules associated with IRA inheritances, which would increase the likelihood of beneficiaries complying with the distribution rules of inheriting an IRA (the IRS pooh-poohs that idea).
Since TIGTA issued a 2010 report on IRA noncompliance, the IRS has been trying to get the message across through generalized educational materials and by issuing “soft” notices to 1,500 potentially non-compliant taxpayers so far. TIGTA says the IRS should communicate directly with taxpayers to inform them of the distribution requirements, and the IRS should broaden the scope of ferreting out noncompliant taxpayers by including small business IRA owners, not just traditional IRA owners in its sights.
If it’s a true mistake, you can take out the missed distributions in one fell swoop, and file for a standard waiver (Form 5329) of the 50% penalty on missed distributions. The IRS notices sent to potentially noncompliant taxpayers explains this: “If you can show that your failure to take RMDs was due to reasonable error and that you are taking reasonable steps to correct the error, we can consider waiving the 50% tax.”
Picker says waivers are granted regularly. He’s helping a woman now who had multiple IRAs who took the required minimum distribution from only one of the bunch and failed to take out the rest that was required (you can add up required distributions across IRAs and take the total amount from just one account). In another case, he helped someone who had an inherited IRA for five years and had never taken a distribution come into compliance.
The rules for taking required distributions from traditional IRAs and small business IRAs (SEP-IRAs and Simple IRAs) are the same. You have to take your first annual distribution by the year following the year you turn 70.5. The amount you have to take out is calculated based on the prior year-end balance and IRS-provided life expectancy charts.
For inheritors, there are special rules for spouses who inherit an IRA from a deceased spouse, but for anyone else they have to start taking distributions the year after they inherit the account. Lastly, there is the tricky year of death trap. If the deceased didn’t take a required minimum distribution in the year of death, then the beneficiaries have to take it. Note: There are no required distributions for Roth IRAs you set up, but if you inherit a Roth IRA, there are required distributions.
Your custodian should report the amount of the required distribution to you or offer to calculate it for you by Jan. 31 of the year in which the amount must be distributed. Some custodians bury this in a year-end fair market value statement. Others mail out a separate notice, and a reminder later in the year if you haven’t yet taken money out.
Even more obscure is Form 5498—which goes to the IRS and the taxpayers. If the box is checked, you must take a distribution for that year. But the fine print also says: “An RMD may be required even if the box is not checked.” And it says to see Publication 590 for details.
This whole topic is so unwieldy that last year the IRS split Publication 590 into two parts: the 62-page Publication 590-A Contributions to IRAs (covering rollovers and conversions) and the 60-page Publication 590-B Distributions from IRAs (covering required minimum distributions and IRA beneficiaries).
The TIGTA report is titled Improvements Can Be Made to Educate and Notify Taxpayers of Required Minimum Distribution Requirements From Individual Retirement Arrangements.
