The IRS is successful at finding and penalizing taxpayers who did not take their full required minimum distributions. IRA owners should know about the penalty and how to avoid or minimize it.
A few years ago, the IRS discovered that many people either weren’t taking RMDs or incorrectly calculated them. So, the IRS tweaked its systems to identify taxpayers who might not be in full compliance with the RMD rules. It is quick to impose penalties.
The good news is that the SECURE Act 2.0 finally reduced the penalty for not taking the full RMD.
For decades the penalty was 50% of the amount that was supposed to be distributed as an RMD but was not. The 50% rate was selected because that was the maximum individual income tax rate when the law was enacted. The penalty was not changed when income tax rates were reduced.
Now, the penalty is only 25% of the amount that should have been distributed but wasn’t.
Even better, the penalty can be reduced to 10% if the mistake is corrected in a timely manner.
To qualify for the 10% penalty, the IRA owner generally must distribute the RMD amount before the IRS sends a notice of deficiency or before the last day of the second taxable year that begins after the year in which the RMD should have been taken, whichever is earlier.
Even better, the penalty can be avoided completely if the IRS issues a waiver. The IRA owner must apply for the waiver and convince the IRS there was a reasonable cause for missing the RMD.
To receive a waiver, a taxpayer files Form 5329 with his or her income tax return. On the form, the taxpayer reports the delinquent RMD and requests a waiver of the penalty.
There is no assurance the IRS will waive the penalty or when it will respond to the request.
Reasonable excuses that were excepted at the old penalty level included confusion over the rules, health problems, a death in the family, and receiving incorrect advice from either the IRS or a professional advisor.
It is unknown if the IRS will be tougher on waiver requests now that the penalty is reduced.
If the IRS owner’s application for a waiver is denied, the period for qualifying for the 10% penalty is likely to have expired by the time the denial is received. The IRS owner would be stuck with the 25% penalty. So, there might be a risk to seeking a waiver.
Most IRA custodians compute RMDs for their customers and include the amount in at least one of the monthly statements or the online account.
But IRA owners should not rely on this computation. In a recent case, an IRA owner was hit with a penalty by the IRS because the custodian had the wrong birth date for the customer in its records and computed the wrong RMD amount.
