IRS Cracking Down On IRA Rules

It seems that some of the rules the IRS has put in place with regard to IRAs have not always been watched very closely – and the IRS is stepping up efforts to resolve some of this.  According to the article in the WSJ, IRA Rules Get Trickier, an estimated $286 million in penalties and fees were uncollected for 2006 and 2007 tax years’ missed distributions, over-contributions, and the like.

The title of the article is a bit misleading, because the rules are not changing or getting “trickier”, the IRS is just going to be paying closer attention to what you’re doing with your account.  This is set to begin by the end of this year, after the IRS delivers their report to the Treasury on how to go about enforcing the rules more closely.

The first rule being monitored more closely is the contribution rule – for 2012, you’re allowed to contribute the lesser of $5,000 or your earned income, plus an additional $1,000 if you’re over age 50.  If you contribute more than the limit for the tax year, you will be subject to an over-contribution excise tax of 6% for each year that you leave the over-contribution in the account.  Over-contribution can also occur if your income is above the annual limits for your particular IRA.

One way to resolve over-contribution is to simply remove the excess funds from the account.  You need to make sure that you also remove any growth or income attributed to the over-contribution as well.  Another way to resolve this is to attribute the over-contribution to the following year’s contribution.  You would still owe the 6% excise tax for the prior year, but using either of these methods would get you back in shape.

Another rule is the minimum distributions rule.  If you are over age 70½ and you fail to take the appropriate minimum distribution for a particular year, there is a 50% penalty applied for the amount not distributed.

Resolving missed minimum distributions is a bit more difficult than the over-contribution, which can be a problem for inherited IRAs as well as an IRA owned by someone over age 70½.  This is especially true if you have missed more than one year of distributions, since each succeeding year depends upon the prior year’s distributions, and the calculations can get pretty messy.  See Unwinding the Mistake in the article at the link for more on how this is done. (The article applies primarily to inherited IRAs, but the method is the same for all excess accumulations, i.e., not taking timely distributions.)

Neither of these rules has a statute of limitations, so if your account is in error by one of these rules, you should take steps to resolve it as soon as possible – delaying further will only increase the penalties and interest charges.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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