Failure to Take the RMD from Your IRA Can be Costly - Rodgers & Associates
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Failure to Take the RMD from Your IRA Can be Costly

IRA-egg

A recent audit report found that in fiscal year 2014, IRS revenue officers collected $222 million less than they did in 2011 (7% less) and closed 34% fewer cases. The IRS’s budget has been reduced by more than $1.2 billion between 2010 and 2015. These budget reduc­tions have forced the IRS to make personnel cuts among other cost savings. The IRS attributes the decreases in collec­tions to the reduction in IRS personnel and field revenue officers. Field collection revenue officers are down 28% since 2010 and Automated Collection Service contact repre­sen­ta­tives are down 21%. The inventory of delin­quent taxpayer accounts has grown and become older and more cases stay unresolved.

This doesn’t mean taxpayers are neces­sarily ignoring their tax oblig­ation. Taxpayers who attempt to contact collection repre­sen­ta­tives are faced with longer wait times. The audit report stated that taxpayers whose calls were answered spent an average of eight minutes longer waiting for a contact repre­sen­tative. Taxpayers may become frustrated and remain noncom­pliant if they are unable to reach a contact repre­sen­tative to resolve their tax issues.

Budget cuts since 2010 have resulted in the loss of 16,000 IRS employees who could have helped to reduce the nation’s tax compliance gap. The IRS believes another factor that hindered basic collection efforts was under­funding of their technology resources which prevented them from updating its laptops and software. Computer downtime alone amounted to more than $32 million in lost revenue collection.

This doesn’t mean taxpayers can ignore IRS rules without concern for the conse­quences. Especially when it comes to taking their IRA minimum distri­b­u­tions once they reach age 70 ½. A report issued (PDF) in May of this year shows the IRS is proac­tively reaching out to taxpayers who fail to take required minimum distri­b­u­tions (RMD) or who have taken the wrong amount. RMD rules require the first distri­b­ution to be taken by April 1st of the year following the year the IRA owner reaches age 70 ½. The person whose 70th birthday is on July 1, 2013 turns 70 ½ on January 1, 2014 and must take their first RMD by April 1, 2015. The twist on this rule is that if they waited until the first quarter of 2015 to take the first distri­b­ution their second distri­b­ution would be due by December 31, 2015. For tax planning purposes they may not want to take two distri­b­u­tions in the same tax year.

What if a taxpayer forgets to withdraw the minimum amount at age 70½, or makes a mistake on their RMD and does not withdraw enough? The penalty is 50% of the “under-withdrawal,” the difference between what was withdrawn and what should have been taken out to meet the RMD. IRA custo­dians generally report the amount of the RMD or offer to calculate it. Some custo­dians include the infor­mation in a year-end fair market value statement. Others mail out a separate notice, and send a reminder later in the year if withdrawals have not been taken. However, it is ultimately the taxpayer’s respon­si­bility to comply. The IRS says they don’t want to penalize taxpayers for mistakes, they want people to comply.

The IRS identified nearly 639,000 taxpayers (IRA values of $40.4 billion) in tax year 2012 with IRAs who may not have taken RMDs. There were also nearly 6,500 taxpayers who admitted they did not take RMDs in prior years. The tax on the missed RMDs totaled $6.2 million. The penalty on the missed distri­b­u­tions is calcu­lated as 50% of the amount that should have been withdrawn. In total 335 of these taxpayers were able to get the penalty waived in full. The report stated that if a taxpayer fails to take their RMD by the December 31st deadline, the sooner they report the error and ask for a waiver, the more likely the IRS is to waive the 50% penalty.

The IRS has access to date of birth infor­mation from the Social Security Admin­is­tration and are aware of which taxpayers are turning 70 ½ or older. IRA custo­dians are required to report year end account values of IRAs on Form 5498. This form contains a checked box if the account owner is required to take a distri­b­ution that year. IRS Publi­cation 590 says: “An RMD may be required even if the box is not checked.” Taxpayers who delib­er­ately avoid taking distri­b­u­tions thinking the IRS won’t find out are mistaken. Ferreting out missed RMDs is low hanging fruit for the IRS and can easily be discovered by computer cross refer­encing.

Taxpayers who miss taking their RMD by mistake should take out the missed distri­b­ution promptly. Then file for a standard waiver (Form 5329) of the 50% penalty on the missed distri­b­ution. If the taxpayer can show that failure to take the RMD was due to reasonable error and that reasonable steps have been taken to correct the error, there is a good chance the IRS will can consider waiving the 50% penalty.

Rick’s Tips:

  • IRS budget cuts have caused the agency to fall behind in collection efforts over the past 4 years.
  • The IRS has access to infor­mation allowing them to identify which IRA owners have RMD require­ments.
  • The penalty for failing to take an RMD is stiff: 50% of the amount not taken.