By Julie Jason, originally posted on Forbes.com.
Surprise: Failed RMDs Can Affect Beneficiaries of Any Age
One of the stiffest tax penalties for an individual taxpayer is a whopping 50% — an excise tax that attaches to failed or insufficient required minimum distributions (RMDs) from retirement accounts such as tax-deferred IRAs (individual retirement accounts).
Normally, RMDs are a problem for “the elderly” — IRA owners over age 72.
If you are younger (under age 72), you may be thinking that you’ll never run across a situation that will trigger this excise tax, but I’ll bet you will — sooner or later, if you inherit an IRA. It is highly likely, after all, that you are a beneficiary of a parent’s, sibling’s or other family member’s IRA.
A Young Beneficiary’s Story
A forbes.com reader brought this situation to my attention, which I adapted and fictionalized for the benefit of other forbes.com subscribers.
Jane, age 30, inherited a traditional IRA from her father, age 75. He died in March 2021. It turned out that her father had not withdrawn any money from his IRA in 2021. Since he did not have multiple IRAs, that meant that he did not satisfy his 2021 RMD. (If you have multiple IRAs, you can add up all the RMDs together and pull the withdrawal from any one of the IRAs; this rule does not apply to 401(k)s.)
Insight: Always check RMDs of deceased loved ones to make sure the final year-of-death RMD was withdrawn before year end.
Your Own Tax Adviser
As with any situation involving taxes — and especially RMDs — my first and most important piece of advice is to get the help of your tax adviser, as each taxpayer’s situation is unique. But, in the meantime, I can share some general guidance.
I reached out to Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting, for some perspective. Wolters Kluwer is one of the world’s largest providers of tax and accounting software and publications.
Who is responsible for Jane’s father’s final year-of-death RMD?
Since her father died in March of 2021 without taking his RMD for that year, Jane, his sole beneficiary, would need to make that year-of-death RMD withdrawal happen before the end of the calendar year (2021) — or else. The “or else” is Jane having to pay that steep 50% penalty. See taking an RMD from an inherited IRA in the year of an IRA owner’s death.
Say the 2021 RMD was to be $10,000, and zero was actually withdrawn in 2021. The excise tax would be 1/2 of $10,000 or $5,000. Jane’s father’s RMD of $10,000 would go to Jane; the RMD would increase her taxable income by $10,000 for 2022 (when the RMD was received); and Jane’s 2022 tax bill would also increase by $5,000, the amount of the penalty.
That’s not a good situation to be in — who likes surprises like this? And, a surprise it likely will be — after all, why would you expect young beneficiaries to know about RMDs?
Is Jane Stuck Paying the Penalty?
Since the problem with the RMD was caused by the custodian (it can happen), Jane can request a waiver of the excise tax for “reasonable cause.” She must also show that the RMD failure was or is in the process of being corrected (“reasonable steps are being taken to remedy the shortfall”). RMD penalty waivers are governed by section 4974(d) of the Internal Revenue Code.
The IRS will want to know the details, and the way to tell the story is by using IRS Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts,” with attachments that explain the situation: A copy of the written instructions Jane gave the custodian; a letter explaining what caused the delay; a copy of the check or statement that proves the RMD was actually withdrawn (in this case in 2022); and a request for an abatement of the 50% penalty.
Jane will have a choice as to when to file Form 5329 with the IRS. She can wait until 2023 when she files her 2022 tax-year return. Or, she can file the form now instead. That’s a better way to go, since there is no benefit to waiting. However, Jane would need to mail Form 5329 to the IRS (it cannot be filed electronically since it is not being filed with her 2022 Form 1040, the annual income tax return). The ball is in the IRS’s court to either approve or deny the request.
Notice that there is no mention of attaching a check to pay the penalty.
Should You Pay the Penalty?
Normally, the excise tax due on a missed RMD is payable with the filing of your tax return. (The excise tax increases the amount due to the U.S. Treasury dollar-for-dollar.) However, when requesting a waiver for reasonable cause, as in Jane’s case, there is no need to pay the penalty with the submission of the waiver request, explained Luscombe. If the IRS disapproves the waiver request, they will let you know.
Where to Find RMD Experts
Before moving on, let me repeat my strong recommendation: If you find yourself in Jane’s situation, you will need a competent tax adviser who is an expert in tax-deferred accounts — the sooner the better, due to time constraints that trigger steep penalties. If you don’t know where to turn, write to me. If there is enough interest from forbes.com readers, I’ll follow up with a post on how to find tax lawyers and accountants with RMD expertise.
A Few Insights to Pass Along to Family Members
- Beneficiaries may not be familiar with year-of-death RMD rules.
- Beneficiaries may be responsible for handling the owner’s year-of-death RMD.
- In such cases, beneficiaries may be liable for an excise tax if the RMD withdrawal is not accomplished by Dec. 31 of the owner’s year of death.
- Beneficiaries need to know about Form 5329 to request a waiver of the excise tax if the owner’s RMD failure was due to reasonable cause.
- IRA owners need to alert their younger family members that they may need to take quick action when a member of the family who is an IRA owner passes away.
Inform Family Members
If you are the owner of a tax-deferred IRA (or other retirement plan), give your beneficiaries a copy of this post, along with Bob Carlson’s The IRS Can And Does Waive The Penalty For Incorrect RMDs. Wolters Kluwer has a resource titled “Required Minimum Distributions (RMD) from IRAs.” Also note that beneficiaries themselves have RMD requirements of their own to meet starting the year after the owner’s death. That’s a subject for an upcoming post.
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