Under the current law, Required Minimum Distributions (RMDs) are the minimum amounts that an Individual Retirement Account (IRA) owner must withdraw annually starting after the year that he or she reaches age 72. IRA owners are responsible for taking the correct RMD each year from their IRA.
The RMD for each year is the IRA balance at the end of the preceding year divided by the distribution period from the IRS’s “Uniform Lifetime Table.” The effect of this is to allow IRA owners to withdraw the funds over their expected remaining life. Most IRA owners are familiar with the requirement to begin taking distributions from their IRAs after reaching age 72. However, if an IRA owner fails to take the annual required minimum distribution by December 31 or if the distribution is less than the required amount, the IRA owner must pay a 50 percent excise tax on the amount not distributed. This excise tax or penalty as it is usually called can be quite large, particularly in cases when an IRA owner has failed to take RMDs for multiple years.
Issues with RMD Rules
Several problems associated with complying with the RMD rules can occur. First, the RMD requirement was suspended for 2020 as part of the Covid-19 tax relief; this was a one-year suspension only. Many IRA owners are under the mistaken impression that this RMD suspension was permanent and this has resulted in an upsurge of penalty cases in the 2021 tax year.
One recurring problem involves inherited IRAs. An inherited IRA is an individual retirement account that is received through a will or similar legal instrument upon the previous IRA owner’s death. A common misunderstanding among beneficiaries of inherited IRAs is that the RMD rules for an inherited are the same as for a non-inherited IRA and therefore, RMDs are not required until after age 72.
However, for an inherited IRA, the beneficiary must begin taking RMDs almost immediately, regardless of his or her age at the time of the inheritance. The distribution rules are somewhat complex and have changed for years after 2019 but, in general, beneficiaries of inherited IRAs are required to begin taking RMDs shortly after inheriting an IRA. As most beneficiaries in these cases are well under age 72, this misunderstanding frequently results in non-compliance with the RMD rules.
Fortunately, the penalty may be waived if the account owner establishes that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall.
Steps to Take
Here are some recommended action items:
- Keep copies of all IRA year-end statements, as these are needed to compute the RMD amount.
- Make a separate RMD withdrawal for each tax year involved and do not combine a current year RMD withdrawal with late RMD withdrawals for prior years. The IRS requires proof that the required amount was withdrawn for each tax year.
- Consult with a tax adviser for assistance when making a late RMD withdrawal. Depending on your circumstances, IRS may waive the penalty.
- Seek advice from your tax adviser if you inherit an IRA, as inherited IRAs generally require RMD withdrawals regardless of the beneficiary’s age.
We’re Here to Help
Bennett Thrasher’s Tax Controversy practice can help you comply with RMD requirements and minimize any penalties for late withdrawals. To learn more about our service, contact James Pickett, Director of our Tax Controversy practice, by emailing Bennett-Thrasher@btcpa.net.