SEPP mistake – Need PLR to correct???
We have a client who has been taking SEPPs under 72t. In 2007, because of a change from one type of investment to another type of account, the client received an extra monthly payment due to an error by the brokerage firm. All other monthly distributions have been made timely and for the same amount.
Does this require a PLR to correct or has anyone been succesful in just writing to the service with the problem and dealing with it by correspondence??
Permalink Submitted by Alan Spross on Mon, 2009-09-21 21:07
The IRS has issued quite a few “executory error correction” PLRs in recent years, however the delay in this case may endanger a similar finding. The error should have been obvious when the 2007 1099R was issued in Jan, 08 and in 2008 there should only have been 11 monthly distributions taken to make up for the 2007 overage.
The 2007 1099R should have been a red flag to the IRS – have they notified the client of a busted SEPP yet? If not, the dollars at risk by doing nothing are dependent on the amount of total dollars distributed since day one and how long it is until the SEPP modification date. The PLR seems to be a 50-50 proposition if client has a very good reason for reporting the breach this long after the infraction. It goes downhill from there.
The PLR request costs around $10,000 plus legal fees and will take some time. However, I don’t think there is much chance at all of getting relief without a formal PLR request. This is a very tough situation to be in.
If you want a list of a few error correction PLR #s to review, let me know. But I don’t think any of them have this long a gap period for action after the error.
Another option – notify the brokerage firm if the IRS busts his plan, he intends to take legal action to recover the monetary damages from the broker. Then ask the broker if they will pay for a PLR and provide a statement of responsibility for the error???
Permalink Submitted by [email protected] on Tue, 2009-09-22 13:14
Unfortunately, the client was not very responsible. She ignored the extra distribution in 2007 and ignored the second 1099 received in 2007 which was for the one extra monthly distribution received late in December 2007. Now after getting a notice from the IRS imposing the 10% penalty for 2007 only, we are concerned that she will try to put the blame on us (we manage her account) since it was an error that resulted in the extra 2007 distribution to start with.
The client failed to call us about the extra distribution and didn’t call about the extra 1099 received in early 2008 so this is developing into a finger pointing exercise.
If we can deal with it thru correspondence, we will handle it, if it requires a PLR, we are going to stick it on the client.
Permalink Submitted by Alan Spross on Tue, 2009-09-22 18:16
Yes, these shared responsibility errors are always a real mess. It is strange that the IRS is only asking for the penalty on the 2007 distribution. Was that the first year for the SEPP? That leaves 2008 and 2009 distributions in limbo as well, since a busted SEPP plan ends that plan and in most cases results in penalties plus interest for subsequent years as well.
Permalink Submitted by Bruce Steiner on Wed, 2009-09-23 02:15
How does the IRS know to ask for the penalty for 2007? Taxpayers seeking to set up a series of substantially equal periodic payments to avoid the penalty don’t generally seek IRS approval of the plan.
Permalink Submitted by [email protected] on Wed, 2009-09-23 16:00
IRS is imposing 10% penalty because our broker/dealer Securities America sends out all 1099s with a code 1 in box 7 if the client is under 59 1/2 and we (the reps) did not tell them that the client is disabled or one of the other (non SEPP) sec 72 exceptions. Securities America will not code their 1099s with code 2 for SEPPS because (at least this is what they told us), the service required them to be responsible for the accuracy of all SEPP calculations reported on a 1099 sent by them. This is impossible for them, they have to rely on their independent reps all over the country to do SEPP calculations so they just threw up their hands and said we will code them all with a code 1 and leave it to the client to file a form 5329 with their return.
This client did not file a 5329.
This is a really bizarre story and may have a happy resolution as of yesterday. You gotta love my business.
Client receives $1,200 per month as a SEPP and as I said above received an extra $1,200 payment in Dec of 2007. Broker dealer issued two 1099s, one for $14,400 and one for $1,200. Client is an alcoholic and has all kinds of health issues due to the disease and does not work so she is not very responsible. She loses the 1099 for $14,400 and takes the one for $1,200 to her tax preparer. Tax preparer is just an older relative of hers with no training and happens to be legally blind so she can barely read the 1099 and thinks the $1,200 is actually $12,000 so that is what is reported on the tax return. When the IRS sends out the notice of additional tax and the 10% penalty, the tax preparer calls the service and tells them that her client is an alcoholic and is disabled. The IRS reps asks some questions and just tells her to file a 5329 for the penaly and pay the tax on the unreported difference.
I don’t have to do anything now. Thank you Lord.
Permalink Submitted by tomd37 on Wed, 2009-09-23 16:05
I have heard of the term “blind drunk” but this story beats them all!
Permalink Submitted by Alan Spross on Wed, 2009-09-23 19:41
It might be too soon to celebrate.
1) The IRS has not confirmed anything in writing yet
2) The IRS may still not realize this is part of a SEPP. While Securities America 1099R coding is now typical for issuers including big names like Vangaurd, and the 5329 is therefore required for most SEPPs, the SEPP exception code is 02. If she files the 02, then the IRS sees that the penalty should not apply, but they also see that a different amount was distributed than in prior years. This is likely to trigger yet another inquiry. Note that a SEPP plan is considered terminated in the event of death or disability, therefore if the client actually meets the disability definition, the 5329 coding should be 03 instead of 02. That would solve the problem of the extra contribution busting the SEPP plan. The key element here is whether she has enough medical documentation to support the disability definition.
Further tax filings should be done by someone else – obviously!
If you want me to post the disability standard, please advise.
Permalink Submitted by Bruce Steiner on Wed, 2009-09-23 20:09
The IRS still has no way of knowing what the correct amount of the distributions should be. There are various ways to calculate the distributions under a series of substantially equal periodic payments.
I have generally not been enamored of the idea of taking distributions before age 59 1/2. There is a tremendous income tax benefit to keeping as much money as possible in a retirement plan for as long as possible. Converting to a Roth may also provide substantial income tax benefits. In addition, of course, for someone of modest means, the assets can be a source of financial security in the person’s later years.
In most cases, someone who uses up all of his/her nonretirement assets before age 59 1/2 and is looking to tap retirement benefits is not an ideal client.
There are exceptions, of course. Several clients have had extremely large retirement benefits, where it would not have made sense for them to live well below their means until age 59 1/2 (or age 70 1/2 when they would have to begin taking distributions).
Permalink Submitted by [email protected] on Thu, 2009-09-24 01:03
We have a number of clients who have used the disability standard to take distributions while under age 59 1/2 without having to start a SEPP. Virtually every one of them both lost their job due to the disability and are receiving social security disability benefits and therefore have never worked again since leaving their job. It seems that if a person has been fired because they are disabled and SS has ruled them disabled, it falls within the sec 72(t) definition. Unfortunately this particular client is not receiving SS disability and was not dismissed from her job due to her condition although she has never been able to work since retiring in 2002.
I know the definition is “an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration”.
I would appreciate any guidance on where the most recent case law has been heading in this area.
Permalink Submitted by mk foss on Thu, 2009-09-24 01:33
You don’t have to be terminated because of a disability to use the disability exception. Also it’s not required that you be on Social Security disabilty, but that helps. IRS has been strictly enforcing the rules. In a recent case, the IRS said that a person wasn’t disabled until they received a letter from SSA approving disability payments. The court agreed with the taxpayer to say that the disability went back to the date they applied for SSA disability.
In other court cases, people have left a job because of disabilty and then took a new job – that doesn’t meet the definition of disabled. The IRS will not give a PLR on whether someone is disabled because it’s a matter of fact and not of law.
A medical determination is part of the requirement, so before attempting to claim the disabilty exception, you should obtain a letter from a doctor stating that the person is unable to work because of disability.