The IRS Tightens Enforcement on IRA Violations

December 15, 2010

Individual Retirement Arrangements, or IRAs, are commonly used to shelter and grow retirement funds. According to Forbes, Americans hold $4.3 trillion in IRAs.

The U.S. Treasury Inspector General for Tax Administration (TIGTA) recently conducted a review of compliance with IRA rules. The TIGTA urged the Internal Revenue Service (IRS) to crack down on IRA violations by an estimated half a million taxpayers. Understanding what is allowed and what is prohibited with an IRA can help investors protect their savings and avoid costly IRS tax penalties.

Individual Retirement Arrangements (IRAs)

Traditional IRAs allow individuals to put some of their earnings into retirement accounts where the money is taxed as income when it is later withdrawn from the IRA instead of in the year it is received. This tax deferral is beneficial because people often are in lower tax brackets in retirement; therefore, the amount of tax paid on the income when it is deferred is less than it would have been if the earnings were included in individuals' annual gross income while working.

Required Minimum Distributions (RMDs)

The law requires individuals with IRAs to begin taking "required minimum distributions" (RMDs) of money from the IRA after they turn 70.5 years old. People who have inherited an IRA generally must take RMDs regardless of their age. If an IRA owner does not take a required payout, the IRS will charge a penalty of 50 percent of the amount of the required distribution.

Congress suspended the RMD in 2009 to allow IRA balances to recover from the investment losses of 2008, but RMDs were reinstated for 2010. The TIGTA's compliance review found, however, that 43 percent of IRA owners over age 70 were not taking their RMDs. According to Forbes, the IRS is expected to increase enforcement of the penalties for missed RMDs because they are a much-needed source of additional money for the federal budget.

Other Possible Violations

In addition to missed RMDs, there are other violations of IRA rules that can cost investors. These violations include:
- Early Withdrawals -- Individuals generally may not take distributions from their IRAs before they are 70.5 years old. After age 59.5, a distribution may be made, but it will incur a 10% early withdrawal penalty in addition to ordinary income tax.
- Excess Contributions -- The maximum amount that can be put into an IRA for 2010 is $5,000 a year or $6,000 for people over 50 years old until age 70.5. A contribution over the limit, or any contribution made by someone over 70.5 years old, is subject to a 6 percent excise tax for every year the money is improperly in the IRA.
- Rollover Mistakes -- IRA owners have 60 days to take money from one IRA and roll it into another IRA. The IRS may waive the requirement if good cause for the delay is found, but it is not forgiving of mistakes where the money is deposited into a taxable account instead of another IRA, according to Forbes.

Despite the challenges, complying with IRA rules is not impossible. IRA owners can help protect their retirement funds and avoid IRS penalties by taking the following steps:
- Take RMDs early in the year and keep good records of IRA accounts. If something happens to the owner later in the year, the family or beneficiaries will be able to verify easily whether the RMD was taken.
- Consider an automatic RMD service. Financial institutions that offer IRAs may be able to send a monthly check to an IRA owner, move the RMD amount into a taxable brokerage account, or roll it over in a direct inter-institution transfer.
- Report mistakes. If an RMD is missed, take it as soon as possible and report the violation on the IRS's Form 5329. Acceptable excuses for a late RMD are listed on the form, and investors may avoid the 50% penalty if they qualify for an exemption.

Understanding and following the rules governing IRA accounts can be difficult, and the advice of an experienced tax law attorney is extremely valuable. Consulting with a knowledgeable tax lawyer when making decisions about IRA contributions, distributions and investments can help investors avoid excess income taxes or IRS penalties. In addition, a tax law attorney can assist individuals in resolving IRA violations or other income tax matters.

Article provided by Law Offices of Jeffrey S. Freeman
Visit us at www.freemantaxlaw.com