As a tax preparer, encouraging your clients to meet their retirement plan Required Minimum Distributions (RMD) is crucial to avoid the associated penalties. However, even the most meticulous taxpayers can sometimes miss the mark. Thankfully, the Internal Revenue Service (IRS) offers solutions for those caught in the web of RMD excess accumulation penalties, including a potentially reduced penalty and the very liberal "reasonable cause" waiver. Here are strategies to manage these situations effectively.
Understanding RMD Excess Accumulation Penalties - The IRS imposes a steep penalty for failing to meet the RMD requirements: a hefty 25% excise tax on the shortfall of the required amount. Fortunately, if the oversight is corrected in a timely fashion, the penalty can be reduced to 10%. Yet, even with these penalties, the IRS provides a path for waiver based on "reasonable cause."
The "Reasonable Cause" Waiver - One of the most taxpayer-friendly aspects of the RMD penalty system is the IRS's permissive stance on the "reasonable cause" waiver. If a taxpayer can demonstrate that the shortfall was due to reasonable cause and that steps are being taken to rectify the situation, they can request a waiver for the penalty altogether.
Applying for the Waiver - Here's a step-by-step guide on how to help your clients apply for this waiver:
- Begin by completing Form 5329, "Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts". This form is essential for reporting the penalty and requesting the waiver. Make sure to fill out Part IX, which pertains to missed RMDs.
- Along with Form 5329, attach a statement explaining:
- The nature of the reasonable cause for not taking the RMD.
- The fact that steps have been taken to rectify the error, such as taking the missed distribution as soon as possible.
- Any additional information that supports the taxpayer’s claim of reasonable cause, like changes in personal or financial circumstances that contributed to the oversight.
- Acknowledge in the statement that the error has been corrected timely if the penalty reduction to 10% is being claimed. This shows proactive compliance with IRS regulations.
Completing Form 5329 – Generally filed with the taxpayer’s tax return for the year of the shortfall but can be filed separately if the taxpayer isn’t otherwise required to file a return.
- Line-by-Line Completion:
- Part IX is dedicated to the excise tax on excess accumulations. Indicate the amount by which the RMD was not met.
- Calculate the excess accumulation penalty on this shortfall and input the result.
- Clearly state that the intent is to waive the penalty due to reasonable cause.
- Form Instructions: Refer to the IRS instructions for Form 5329, which thoroughly explain the completion process. This ensures that all necessary steps are accurately followed and enhances the likelihood of waiver approval.