403B and IRA Catastrophe

[Guest 401kguy]

A retired taxpayer has both a 403B and an IRA. For several years she has been combining the values of the two accounts for the purposes of the RMD and distributing from the IRA only. The law states that RMDs must come from each of the accounts. But, in reality the tax effect is the same as if she had followed the law. Any advice on how to approach this situation with the IRS to confess and ask for forgiveness? The potential tax liability (50%) is about $127,000 not including penalties and interest. Thank you.

[mbozek]

Even though she took the amount of distributions required under both the 403b plan and IRA she still failed to take the required MRD from the 403b plan which means she is subject to the 50% excise tax on the amount of the MRDs that were not taken from the 403b plan. Since she did not file the 5329 form there will never be a s/l on this tax which will only expire at her death. I don't think the IRS can offset the excise tax due by the amount of the excess tax paid on the IRA because the IRA distributions are always subject to income tax. However the IRS doesn't have any way to determine if MRDs are not taken so it is unlikely that the IRS will ever discover that the MRDs were not taken from the 403b. Best option may be to roll over the 403b plan assets to the IRA so that all the MRDs will continue to be taken from the IRA. Its not the best solution but its better than paying a 127k tax.

How many years back taxes does she owe?

If she had a tax advisor she could ask the IRS to mitigate the penalties because she received bad tax advice but I don't know if the IRS can reduce penalty tax.

[Lou S.]

The IRS has the authority to waive the 50% excise tax. The best course of action given the size of the penalty is to get a CPA who understands the issues or a tax attorney to give you advice on the best way to correct and get the penalties waived.

Very likely the participant will have to take all back RMDs from the 403(b) plan and request a waiver of the 50% excise tax for reasonable cause (in this case bad advice on aggregating RMDs from IRA & 403(b)).

[Lou S.]

The RMDs from the 403(b) are not eligible for rollover so the advice to transfer the 403(b) w/o taking RMDs could open the tax payer to further penalties of 6% per year (I think that in the tax rate on ineligible rollovers) for each year the ineligible RMDs remain in the IRA. That would be in addition to the 50% excise tax taht might be imposed for not taking the RMDs in the first place.

[QDROphile]

Where is the 403(b) plan in all of this? RMDs are a requirement for the plan, too I think Rev. Proc. 2013-12 offers some options.

[Peter Gulia]

Imagine the taxpayer engages a lawyer to propose (without revealing the client's identity) a closing agreement with these provisions: (1) for all back years, the taxpayer is treated as if she met her minimum-distribution requirements from her 403(b)s; (2) the taxpayer pays a sanction in some modest amount (perhaps $100 x the number of affected years, or $1,000).

Do you think the Internal Revenue Service would accept such an offer?

[mbozek]

While the MRD rules apply to 403b annuities it applies to the contract, not the plan. There are many 403b plans where the 403b funds are held in an individual contract which is under the sole control of the participant as to when to take distributions. Its no different than an IRA where the IRA owner is the only party who can elect to make a distribution.

If you add the 50% excise tax penalty, income taxes on the MRD, interest and penalties on the 254k of distributions that were not taken, just how much of it will the taxpayer actually retain? I would not want to be the tax adviser that informs the taxpayer that 80% or more of the distributions will be paid to the IRS.

[QDROphile]

I don't think you get to blow off the possibilites under EPCRS that readily. See Rev. Proc. 2013-12 sections 6.09(2) and 8.04, Example 5.

[Peter Gulia]

We recognize that an employer seeking a correction regarding the plan would have different circumstances.

But what about the one individual seeking a closing agreement only for herself?

[mbozek]

How does a plan force a participant who owns an individual annuity contract to commence benefits at 70 1/2? Most 403b plan don't have records of former participants who have deferred benefits because they never kept such records. Its easier to write a regulation than it is to find out if it is not being complied with. This is no different than IRA owners who fail to commence MRDs which can not tracked by the IRS.

I was recently informed by a 403b provider that they cannot force a participant to commence benefits at 70 1/2.

[QDROphile]

Then the contracts are not compliant and no tax deferral. Issue 1099-R for the entire difference,.