Issue Correcting IRA Rollover Coding Error
It was recently discovered that 2 years ago, my client’s IRA rollover was incorrectly deposited into a non-IRA brokerage account. It was then put into an annuity with an insurance carrier, but still networked with the brokerage account. The error has been corrected with the brokerage account with a corrected tax document sent and accepted by the IRS. So according to the IRS, it is not considered a distribution. However, the insurnace carrier where the money actually is, will not change the ownership or structure of the non-qualified contact without a private letter ruling. Any ideas of resolving this? Thanks.
Permalink Submitted by Alan Spross on Mon, 2012-07-16 18:58
What documentation has been provided by the IRS that they accepted this and what did the brokerage submit to the IRS?
If this was not considered a taxable distribution by the IRS, the IRS must have approved a rollover. And if that is the case, the insuror must re process the annuity as an IRA annuity rather than a NQ annuity.
Perhaps if the existing documentation is clear, a PLR will not be necessary. However, if a PLR is the only solution, at least the IRS charges for rollovers are much less than other rulings and based on the amount of the rollover.
Permalink Submitted by Jose Morales on Wed, 2012-07-18 16:57
How can you possibly have a rollover without first having a distribution? or are you incorrectly calling an IRA to IRA Transfer a rollover?
Permalink Submitted by Don Morris on Wed, 2012-07-18 21:22
Yes, I incorrectly said it was a rollover while in fact, it was an IRA to IRA transfer. The brokerage firm sent the client and IRS a corrected tax document (Form 5498). The IRS sent a letter to client indicating they accepted the corrected document and that the client did not owe any taxes on the transferred amount. However, the money is still sitting in a non-qulaified contract with the annuity carrier. Since, the IRS has accepted the corrected form, I think a PLR is an extreme and unnecessary requirement from the insurance company to re-code the account.
Permalink Submitted by Alan Spross on Wed, 2012-07-18 23:01
What account number shows on the 5498? A 5498 is used to report an IRA contribution. Since the funds were distributed from an IRA to a taxable brokerage account and from there to a NQ annuity, this was never an IRA to IRA transfer, but a distribution that the IRS considered taxable but then relented when the 5498 was issued reporting receipt of a rollover contribution.
But the present problem is the inconsistency of a 5498 with a NQ annuity account if the annuity AC number is entered on the form. That must be corrected and for the 5498 to be considered valid the account number shown on it must be an IRA account number. I think the issue needs to be elevated to someone with the insuror that understands this and knows how to transfer the annuity contract into an IRA annuity. As things stand now, the big loser is not the client because he has a tax free distribution to an annuity with possibly full basis. The US Treasury has a non existent IRA on which they will never collect income taxes or RMDs. The client then appears to have IRS leverage behind him in getting this corrected to an IRA annuity.
It seems odd that the insuror would allow this error to persist.
Permalink Submitted by Don Morris on Fri, 2012-07-27 20:48
The account number on the 5498 is the IRA brokerage account number, as the annuity contract number is not mentioned anywhere. I am not sure what could eventually happen since the annuity company won’t change the ownership of the contract. I don’t want my client to have problems down the road, but it sounds like my client might come out ahead if nothing is done. What is the worse that could happen in this situation?
Permalink Submitted by Alan Spross on Fri, 2012-07-27 21:53
In your first post you indicated that the rollover IRA was deposited into a non-IRA brokerage account. Apparently, the rollover IRA custodian issued a 1099R which generated the initial tax bill. In your last post you indicated that the brokerage account was actually an IRA account, and a 5498 was generated that can only be issued on an IRA account. The IRS then waived the tax bill because the 5498 showed the prior distribution was rolled over. So everything is fine with respect to the money rolled to the IRA brokerage account.
Then we have funds transferred to an annuity that you think is not an IRA annuity. Are you sure of this? When you indicated that annuity was networked with the IRA brokerage account, in what way is it networked? There was no mention of a 1099R issued showing a distribution from the brokerage account, and since this happened two years ago, any 1099R would have long since been issued.
Has the insurance company clearly stated that the annuity is NOT an IRA annuity? The lack of a 1099R from the IRA brokerage account suggests that a non reportable transfer from the brokerage IRA to an IRA annuity took place.
In the event some snafu took place under which the funds ended up in a NQ annuity with no 1099R being issued, the insuror would be keeping track of the amount invested in the contract as the client’s basis. RMDs would not begin at 70.5, but eventually when the client had to take distributions the 1099R issued by the insuror would NOT have the IRA box checked and there would be a taxable amount shown on the 1099R. The taxable amount would be limited to annuity earnings, but the earnings would come out first, so the first few distributions would be taxable. After that, the principal would come out tax free.
However, if client annuitized the annuity, then each check would include some earnings and some principal until the principal amount was paid out. After that, distributions would all be taxable. The net result is that whatever amount the insuror allocates to principal would be recovered tax free. For an IRA annuity, unless the client had made non deductible IRA contributions and filed Form 8606, all distributions would be taxable. If that is the case, client would pay less in income taxes.
However, if there was an error, an effort should be made to correct it since a later discovery of the error would lead to retroactive tax problems if any distributions had been taken.
Permalink Submitted by Don Morris on Mon, 2012-07-30 19:46
I agree that everything is fine (with the IRS) with respect to the money rolled to the IRA brokerage. The money was orginally put incorrectly into a non-IRA brokerage account. From that account, it went to an annuity company and into a non-qualified annuity contract and definitely not an IRA Annuity. A 1099R was not issued by our company as at that point, no one knew it should have been an IRA account. The 5498 correction was completed indicating that the funds that were originally deposited into the non-IRA brokerage account, was in fact, a rollover to the client’s IRA account. The annuity is now displayed in the client”s IRA account at the brokerage account (networked) for viewing purposes only. The asset values, tax reporting, etc in the future is done by the annuity company as that is where the assets are located. So the viewing of the annuity in the brokerage account is only for the convenience of the client.
The 1099R was issued to the client two years ago when the account was orginally transferred. The client never remembered getting the 1099R, so the distribution was never recorded for tax purposes. Otherwise, all this could have been resolved then. The client received a letter from the IRS a couple of months ago asking for the taxes on the distribution the client did not report, which brought all this to light.
The annuity company has refused to changed the ownership of the non-qualified annuity to our company, FBO the client as an IRA. This would straightened all this out. As it stands now, the annuity company will be treating this like a non-qualified contract keeping track of basis, withdrawing and taxing earnings first, etc.
In summary, client has a non-qualified annuity contract and will be reported as such by the annuity company. Our brokerage firm does not have the annuity assets, but reported the original deposit from the client as an IRA to IRA transfer. The IRS has accepted this. The annuity company will not report RMD requirements as it is not an IRA to them. It sounds like the client got the benefit of moving their IRA to a non-qualified annuity contract with getting a 1099R and considering this a distribution. Since the annuity company won’t work with us in changing the non-qualified contract to an IRA, I don’t know what other actions we can take.
Permalink Submitted by Alan Spross on Mon, 2012-07-30 22:43
The brokerage IRA account is considering that the transfer of funds to the insuror was an IRA to (annuity ) IRA transfer? Having some evidence of that is the only way they would be allowed not to issue their own 1099R.
If their records show a T to T transfer but the receiving account was somehow NOT an IRA account, then something must have gone haywire with the usual processing requirements and it’s not clear which entity is responsible for the error and therefore needs to take steps to correct it.
The client benefits from an annuity with a high cost basis, the IRS sees no tax revenue for an IRA distribution, and the IRS is therefore bearing the brunt of this error. It is probably unlikely that the IRS will notice a large drop in 5498 reported IRA value in a single year since IRAs invested in volatile stocks suffer large losses quite frequently, and some stocks become worthless.
There is always a chance the IRS might determine what happened here, but it’s not likely. The client should definitely keep a record of efforts made to date to get the annuity company to restructure the annuity as an IRA annuity in the event the IRS levies penalties if they detect the omission in the future. But I can relate to a client that is not willing to go to expensive and extraordinary means to seek correction of an error made by IRA custodians.
I wonder how many other annuities this insuror has processed in the same manner….if there is alot of them, it is likely the IRS finds out at some point and it could prove costly to the insuror not to have listened to customers trying to point out the error. But no way to know how the client will be impacted.