The first baby boomer turned 70½ in 2016. That first baby boomer and all others born between January 1, 1946 and January 30, 1946 had until April 1 of 2017 to begin taking required minimum distributions (RMD) from their IRAs. Since then, an estimated 240,000 baby boomers have passed that deadline with another 120,000 approaching the deadline next Spring. It is an important deadline for those holding investments in a traditional IRA. Failure to take RMDs on time results in a 50% tax penalty on the amount of money required to be withdrawn.
Traditional IRA accounts are not the only type of accounts that have RMDs. Those reaching age 70½ who hold funds in employer-sponsored plans such as 401(k) or 403(b)s must also take RMDs unless they qualify for the still-working exemption.
RMDs are not just for those reaching age 70½. Non-spouse beneficiaries of traditional IRAs and Roth IRAs are required to begin taking RMDs for an inherited IRA or Roth IRA by December 31st of the year after the year of the original owner’s death if they want to stretch RMDs over their life expectancy. Be sure to check if the deceased owner was subject to RMD requirements and, if so, that the RMD was taken before the IRA is converted to a beneficiary IRA.
If this is already starting to sound complicated, it is. RMD rules can be extremely complicated. This is why taxpayers often make mistakes by taking the wrong RMD amount, taking an RMD from the wrong account, the wrong type of account, or missing an RMD completely.
Fortunately, the IRS recognizes how complicated the RMD rules can be. They have been willing to waive the 50% penalty when the mistake was a reasonable error and the taxpayer has taken reasonable steps to make it right.
Fixing a missed RMD starts with taking it as soon as it has been discovered. It is best to take it as a separate distribution (not comingled with the current year). After this, file Form 5329 for each year that an RMD was missed. Note that the version of Form 5329 should be the version for that year. Reporting a missed RMD for tax year 2018 should be done on a 2018 Form 5329. The IRS website contains downloadable versions of Form 5329 going back to 1975.
The following steps are from the 2018 Form 5329:
Line 52: Minimum required distribution
On this line, indicate the total amount of the RMD. Only include the total for the accounts that had a shortfall.
Line 53: Amount actually distributed
List the amount that was taken. If nothing was taken, enter zero.
Line 54: Subtract line 53 from line 52
When seeking a waiver of the penalty, enter a zero on this line. To the left of the line write “RC” (abbreviation for reasonable cause). Besides RC, write the amount of the RMD shortfall.
Line 55: Additional tax. Enter 50% of line 54
When seeking a penalty waiver, this line will also be zero. Even if the taxpayer does not receive a waiver, they are not required to pay the penalty in advance.
Repeat this procedure with any additional Form 5329s for other tax years where an RMD shortfall occurred. Once all forms are completed and signed, they can be mailed to the IRS as a standalone form(s)along with a letter of explanation. There is no need to file a 1040X to amend the year the RMD was supposed to be taken. Tax on the amount taken to correct the RMD shortfall will be due in the year the funds were distributed.
Form 5329 only documents the numbers. The form doesn’t explain why the mistake was made. The taxpayer must write a letter of explanation stating their case for why the penalty should be waived. The letter should be brief and cover the relevant points:
- Why it was missed
- It has now been taken
- You have taken steps to make sure RMDs will be made on time from now on
Some taxpayers do not think they need to correct missed RMDs going back further than three years. This misconception comes from the IRS website regarding audits.
“Generally, the IRS can include returns filed within the last three years in an audit. If we identify a substantial error, we may add additional years. We usually don’t go back more than the last six years.1”
The keyword here is “generally”. The IRS can audit the most recent three years for any reason. They can go back six years if there is a “substantial understatement of income” which is defined as a more-than-25% understatement. But there is no statute of limitations in the event of fraud.
The U.S. Tax Court reached a decision2 in 2011 regarding a Roth conversion “strategy” that occurred in 2000 but wasn’t discovered by the IRS until 2008. The taxpayer argued the statute of limitations had run out because he had filed his returns each year. The IRS argued Form 5329 is a return unto itself. Because the taxpayer did not submit any Form 5329s, the clock never started on the statute of limitations. The court ruled in favor of the IRS.
The bottom line resulting from this court decision is that there is no relief from a missed RMD without filing Form 5329. The smart course of action when an RMD error is found is to fix it promptly and file Form 5329 seeking relief from the penalty. The IRS generally grants relief when errors are self-reported and rectified promptly.
- Failure to take RMDs on time results in a 50% tax penalty.
- Taxpayers often make mistakes by taking the wrong RMD amount, taking an RMD from the wrong account, the wrong type of account, or missing an RMD completely.
- The IRS often grants penalty relief for missed RMDs when they are self-reported and rectified promptly.
1 IRS.gov search IRS Audits
2 Paschall v. Commissioner, Docket Nos. 10478-08, 25825-08, filed July 5, 2011