One of the stiffest penalties in the tax code is the one for not taking the correct required minimum distribution (RMD) from an IRA or other qualified retirement plan.
You pay a whopping 50% of the amount that was supposed to be distributed but wasn’t. This penalty is in addition to paying income taxes on the distribution. The penalty is called the “excess accumulations tax.”
You probably know the basics of the RMD rules. A review of the rules and key strategies for RMDs was in our February 2017 issue. The IRS is on the hunt for RMD mistakes. It realized a few years ago that many people take the wrong RMD or none at all. The IRS adjusted its computer systems and the information retirement plan custodians have to re-port to make it easier to identify RMD mistakes. Yet, the IRS can waive the penalty and readily does so. The process for having the penalty waived is relatively easy.
The important step is to review your RMDs to determine if you made a mistake. Don’t wait for the IRS to find the mistake and contact you. It will be difficult to have the penalty waived at that point unless you qualify for a few narrow exceptions. If you’re uncertain about the RMD rules, have a tax advisor review your RMDs. Once you discover you didn’t take an RMD or didn’t distribute the correct amount, the first step is to have the correct amount distributed. The IRS will waive the penalty when the distribution shortfall was “due to reasonable error” and “reasonable steps are being taken to remedy the short-fall.”
So, the first step is to remedy the shortfall by having the correct amount distributed. You’ll include it in gross income in the year in which it was actually distributed, not the year it was supposed to be distributed. It is best to receive the distribution in the form of a check so you can make a copy of the check and submit that with your penalty waiver request. If the distribution is made in another form, be sure to have documentation proving the distribution was made. Don’t combine this distribution with any other distribution or shortfall. You want to clearly show the IRS the amount was distributed. When the shortfalls were made over more than one year, make separate distributions for each year so that you’ll have clean, clear documentation.
You ask for the penalty to be waived by filing Form 5329, using Part VIII. If you haven’t already filed your income tax return for the year the mistake was made, you can include Form 5329 as part of your return for that year. Otherwise, you separately file 5329. File a separate 5329 for each year there was a mistake.
Enter on line 52 the amount of the RMD that was supposed to be taken. On line 53, enter the RMD actually taken. On line 54, enter zero, not the difference between lines 52 and 53. You enter the zero because you’re re-questing a waiver of the penalty. Also, if you can, write “RC” in the margin next to line 54. These are the line numbers for the current version of the form. The numbers are different for previous years. Finally, attach to Form 5329 a statement describing your reasonable cause and proof that the shortfall has been distributed.
The difficulty is that the IRS hasn’t issued regulations or other guidance stating what it considers to be reason-able cause for not initially distributing the correct amount the first time. Tax professionals who’ve handled a number of RMD penalty waiver requests say a request is most likely to be granted when the mistake was due to an error by a financial institution or the serious illness or mental incapacity of the taxpayer. It also is likely that a penalty will be waived if a third party, such as a court or financial institution, has tied up the IRA. Another good reason is your IRA owns hard-to-value assets and you didn’t receive a valuation in time or the valuation later was revised.
In cases for other types of penalties, waivers sometimes are granted when someone for whom the taxpayer was a caretaker had a serious illness. That reason might work for the RMD penalty. Other than that, we have no guidance. If you believe there’s a reasonable cause, you might as well file a penalty waiver request. The worst that can hap-pen is the IRS denies the waiver and you have to pay the penalty.
The IRS won’t acknowledge initial receipt of your request and will take at least a few months to respond. You’ll receive either a notice that the return was accepted as filed or a bill for the penalty. If Form 5329 is included with your regular tax re-turn, you won’t receive an acceptance notice. You’ll receive either a bill for the penalty or nothing.
Don’t include a check for the penalty with your return. Older versions of the instructions to Form 5329 say to do that, but recent versions don’t.
Details about the penalty are in IRS Publication 590-B and the instructions to Form 5329. Or you can read the IRS regulations for tax code §4974(d).