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IRS Stepping Up IRA Enforcement

The IRS has identified, and is determined to end, growing noncompliance with the minimum distribution rules.

Natalie Choate, 09/10/2010

Do you have your own solutions/suggestions? Leave a comment at the end of the article!

Top estate planning and investment professionals rely on Natalie Choate's best-selling book Life and Death Planning for Retirement Benefits, often called the "bible" of retirement benefit distribution planning, for everything they need to know about the rules governing their clients' retirement plans and IRAs. Order Natalie's book for $89.95 plus shipping by calling 800-247-6553, or on-line at www.ataxplan.com.

Have you ever had a client audited by the IRS for compliance with the minimum required distribution rules? Most practitioners report that such audits are rare to nonexistent, but that may be about to change. The IRS has identified, and is determined to end, growing noncompliance with the minimum distribution rules. Your clients can improve their chances of avoiding a time-consuming audit by taking their required distributions as early as possible.

Question: Do you have a recommendation regarding whether an individual who turns age 70 1/2 in 2010 should take the year-2010 minimum distribution for his IRA in calendar 2010, or postpone it until April 1, 2011? Is there any reason a client should take a required distribution earlier in the year rather than later?

Natalie: In March 2010, the Treasury prepared an internal "Audit Report." The report concluded that there is "growing noncompliance" with the minimum distribution rules (and also with the rules for IRA contributions--but that's a subject for another day). Extrapolating from a statistical sample, the report concluded that there were over 250,000 individuals who failed to take their minimum required distributions during the tax years 2006-2007.
The auditor and the IRS management who reviewed the report agreed that a "service-wide strategy" is needed to address retirement plan noncompliance.
So they are going to do something about this--but what? And how can our clients steer clear of IRS audits on this subject?

Here's the IRS's problem. Right now the IRS has only one way (short of individually auditing every taxpayer over age 70 1/2) to check whether individuals are taking their IRA required distributions, and that is to match "Form 5498" with "Form 1099-R." Every IRA provider must file with the IRS, each year, a Form 5498 for each IRA that provider administers. Form 5498 tells the IRS the name, address, and Social Security number of the IRA owner; the balance in the account; and whether a minimum distribution is required for the year in question. In any year when the IRA actually makes a distribution, the IRA provider must also file Form 1099-R with the IRS, reporting how much was distributed.

The only way, short of an individual audit, that the IRS can figure out whether an IRA owner is taking his required distributions is by seeing whether a 1099-R was filed with respect to each individual who had the "distribution required" box checked on his Form 5498. But this method of checking minimum distribution compliance is pretty crude. It does NOT tell the IRS whether the individual took his full required distribution--it just alerts the IRS to whether the individual took ANY distribution.

Another problem with this method is that it turns up too many false positives. For the tax years 2006-2007, the computer matching program found many thousands of people for whom Form 5498 was filed with the "distribution required" box checked and no Form 1099-R filed. There were so many of these people that the IRS could not audit all of them individually. So the IRS audited two subsets of these apparent minimum distribution non-takers: The IRS audited every member of the group whose IRA exceeded $1 million, plus a random sample of the rest.

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