72T, missed payment?

Submitted by Terry Dadd on Mon, 2009-02-02 17:50

I did not take out the 72T distribution for a client in calendar year 2008. I have spoken with the IRS and they were very unclear as to how I might remedy this. They suggested a Private Letter Rulling and gave me a number of one that was already published PLR 2005-03-036. Has anyone had any success with this issue?



Submitted by Alan Spross on Mon, 2009-02-02 18:40

There have several letter rulings preserving the validity of a 72t plan when the custodian makes an error and the taxpayer is not at fault. Two of the more recent are PLRs 2008 40054 and 2008 35033.

That said, a custodian’s error would be viewed differently than an advisor’s error, who represents thet taxpayer, so that PLRs may only be marginally applicable to your situation. You probably need to locate one where an advisor or taxpayer error was the cause.

In cases where an error of this nature has been made, the make up distribution is taken early in the following year, and the taxpayer’s return will then vary for 4 straight years as a result, so no telling how many explanations this would require to preserve the plan.

If the amount subject to penalty is sufficient, considering your own PLR may be viable. But if the current plan is not producing the best distribution level relative to current needs, you could also voluntarily bust the plan in 2008 and start a new one in 2009.



Submitted by mk foss on Tue, 2009-02-03 00:27

You should also consider the cost of a private ruling. The IRS fee is currently $9,000 and it could be $5 to $10 thousand in professional fees to draft the request and shepherd it through the IRS ruling process.



Submitted by Terry Dadd on Tue, 2009-02-03 02:00

Thank you both for your quick replies. I have taken the distribution in 2009, does anyone have suggestions on how one would contact the IRS, send a letter with the request to waive the penalty, etc. The PLR seems a little expensive. Does one use the existing rulings in the letter to the IRS with the tax return?
Thanks again,
Terry



Submitted by Alan Spross on Tue, 2009-02-03 03:53

Here is a summary of the PLR you first mentioned. Check it closely to see if you feel you have an equal amount of documentation behind you. Then try to factor in the cost of a PLR vrs the cost of a busted plan. You are much less likely to get a favorable ruling if you simply make a logical presentation to the IRS without a formal PLR, but the IRS may be more sympathetic with taxpayers this year following the loss of assets from the meltdown, and poor examples set by the politicians. One problem is the turn around time where you will be in limbo and still needing to either start a new plan or keep the old one alive hoping for a favorable ruling.

>>>>>>>>>>>>
IRS Allows a 72(t) Correction
PLR 200503036
For the first time, IRS has let a taxpayer correct a 72(t) payment schedule by allowing a missed
72(t) payment to be made up in the following year. The taxpayer, who we’ll call “Tom”, retired
before reaching age 591⁄2, received a distribution from his plan and rolled that over to an IRA.
Tom’s financial advisor set him up with a 72(t) payment schedule under the annuity factor
method to provide a stream of income that would be penalty free. Tom’s 72(t) payment schedule
was set up on a calendar year taking a certain amount each year under the schedule.
Let’s assume that Tom’s annual 72(t) payment was $12,000. Tom had already taken $10,000 for
2003 and met with his financial advisor to request a withdrawal of the remaining $2,000 to
complete the 2003 72(t) payment requirement. He signed the distribution request that included
the account number of the IRA where the withdrawal was to be taken from, the withdrawal
amount and the account number of the account where the funds were to be transferred (his
personal, non-IRA account), and the amount of federal taxes he wanted withheld. Tom gave this
form to the advisor who passed it on to the financial institution holding the IRA.
This sounds like Tom certainly was diligent and on top of making sure his total 72(t) distribution
requirement for 2003 was satisfied. Too bad his advisor and financial institution were not as
careful. They never processed the withdrawal request! This was not discovered until the next
year. This left Tom with a 72(t) payment that was short by $2,000 for 2003. Now what? Tom
immediately made up the $2,000 missed 72(t) payment in 2004. That would mean that his 72(t)
payments for 2004 would be $14,000 instead of $12,000. But the right amount of payments,
$24,000, was made for the two years taken together.
Tom requested a PLR from IRS asking if this was ok? IRS said, “Yes.” Tom specifically
requested a ruling stating that the missed 2003 payment and the make-up of that payment in
2004 would not be considered a modification of his series of substantially equal periodic
payments that would trigger the 10% penalty.
You might be thinking, “How could this not void the 72(t) exception?” Several factors helped
here. First, as soon as the error was discovered, the shortage was immediately distributed. This
sends a message to IRS that you never intended to miss a distribution and that it was corrected
immediately upon your discovery, not the IRS’s.
Second, there was clear intent on Tom’s part to take the right amount of 72(t) payments for each
year and he had documentation to prove it. IRS stated that Tom “did all that he could in order to
ensure that he received the balance of the annual payment from IRA X and had no reason to
believe that Company M would not make the distribution as he requested. Taxpayer A (“Tom”)
did not intend to modify the series of substantially equal periodic payments….Rather, the
modification is due to the failure of Company M to make the remaining distribution of Amount F
from IRA X…”
Lessons Learned:
Documentation Counts!
Documentation proves intention. Keep all documentation requesting 72(t) distributions in case
this happens to you. Keep copies of everything relating to your 72(t) payments, including
calculation of payment amounts, withdrawal requests, IRA statements, and statements of the
accounts where the payments were deposited, as Tom did here. IRS referred to Tom’s
documentation several times in the ruling. Without documentation or evidence of your
intentions, IRS has no way of knowing what you truly intended or whose mistake it was.
In this case Tom was clearly able to show that he requested the distribution in order to satisfy the
total amount of his 72(t) payment requirement and that the error was that of the financial
institution who did not process his request. He was not simply trying to pass the blame to the
financial institution. He was able to prove that it really was their fault.
Take Immediate Corrective Action
That’s what Tom did as soon as he discovered the error. In many rulings and situations that
involve penalties, IRS places importance on actions taken upon discovery of an error. This is
also true when a missed RMD is discovered. It shows good faith to IRS when a taxpayer takes
immediate corrective action upon discovery of an error, as opposed to IRS discovering the error
first and finding that no action was taken. In that case, IRS has no way of knowing that you
would have complied. When you take immediate action to correct an error, it is clear to IRS that
you were not trying take advantage of any oversight or get away with anything.
>>>>>>>>>>>>>>>



Submitted by mk foss on Tue, 2009-02-03 05:00

A PLR is directed to the person that requested it. The IRS does not have to rely on it for any other taxpayers. Some custodians are unwilling to cooperate with a requested action no matter how many PLRs you show them. Also some taxpayers try to push the cost of the PLR off on the custodian/advisor who they think caused the problem.



Submitted by Terry Dadd on Tue, 2009-02-03 09:46

My understanding of the 72T rule is that if the client does not take the distribution, the prior year distributions, in this case 3 years @ $7K each are penalized the 10% penalty and the plan has to be closed. A woman at the IRS showed me that the fee for a 72T ruling was $500 but I can’t find it now and as I research the actual form, I can see why it may be necessary to have professional help in submitting the PLR. In this case if I do nothing, am I right in assuming the client could be on the hook for $2,100 in penalties + interest?



Submitted by Alan Spross on Tue, 2009-02-03 20:10

The penalty is 10% of all distributions taken under the plan plus interest from when those 10% payments would have been due. In this case, a 5329 could be filed busting the plan as of 12/31/08, and a new plan could then be started for 2009. That would avoid any penalties for 2009 distributions if any 09 distributions already taken can be incorporated into any new 72t plan. The minimum 5 year term portion of the plan would then start over in 2009.

Unfortuneately, the $500 PLR cost only covers rollovers under 50,000. The cost of a 72t letter ruling is 9,000. and the legal costs for drafting it are in addition to that. That’s 5 times the penalty cost, so would not be cost effective.



Submitted by Terry Dadd on Wed, 2009-02-04 03:47

Thanks again Alan. One last question, if I were to write a letter to the IRS, explain the situation, provide a copy of the letter sent to me by the client requesting that I make the withdrawal, would you send it to the IRS immediately or wait and send it with the tax return? I’m asking of course for your opinion, not an official ruling!
Thanks,
Terry Dadd



Submitted by Alan Spross on Wed, 2009-02-04 04:10

Given the cost of a formal PLR vrs the retroactive penalty, your suggestion appears to be the most cost effective compromise. It would have a lower chance of a favorable ruling than a bona fide professional PLR request, but the reduced cost makes that risk worthwhile.

I think I would send it with the 2008 return along with a copy of the makeup distribution statement this year. You would be requesting IRS approval to waive modification of the 72t plan with respect to both the deficient amount distributed in 2008 and the makeup distribution taken in 2009. You could also incorporate as much of the rationale in the 2005 PLR that you consider helpful to the client.

Part I of Form 5329 can also be completed with a reference to the letter on line 4. Lines 1 and 3 would show the total taken under the plan so far that received the penalty waiver.



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