Fouled 72t

Submitted by David Brenner on Wed, 2016-05-18 19:49

Client initiated a 72t election in 2011 at age 53 using the Fixed Annuitization schedule on her entire IRA balance (2 accounts). In 2013 client married and no longer needed the income. She exercised her “one-time switch election” to the RMD method. Unfortunately, the IRA custodian who calculated the new amount only used the value of the IRA account from which the distributions were taken. in addition, they arbitrarily decided to change the 1099 code from exempt to non-exempt.

Client’s accountant never questioned the 1099 change in 2013 and 2014 and reported the RMD distributions as “early, non-exempt” and client paid the 10% penalty. In 2015, the third year, accountant noticed distributions were consistent and contacted advisor to question why they were non-exempt. Advisor was unaware that custodian had changed the 1099. In addition, custodian had also not recalculated the RMD each year.

Custodian stands by their decision to change the 1099 code and also denies responsibility for recalculating the RMD amount.

Question – is there any corrective action that can be taken or are the first 2 1/2 years of withdrawals now at risk of being non-exempt?



Submitted by Alan - IRA critic on Wed, 2016-05-18 20:52

  • While the IRS has occasionally allowed a plan to survive an unintended “executory error” in a PLR request, I do not recommend spending the time and money on a PLR in this situation. I would simply amend the 2013 return to reflect a busted plan and pay the penalty for the 2.5 years using Form 5329.
  • The reasons for this conclusion include the cost and time of a PLR request, the rather poor odds of a favorable ruling, the fact that the plan was busted in multiple ways, and negative impact of additional distributions that are not needed for the tax year of any makeup distributions the IRS would allow. Client would also forfeit tax deferral on the extra distributions.
  • A 72t plan is basically between the taxpayer and the IRS.Custodians may assist in supporting a plan, but are not responsible for errors unless they specifically assume that responsiblity in writing, or fail to distribute an amount the taxpayer has requested.  Most custodians no longer underwrite the accuracy of a plan due to the number of pitfalls, one of which occurs when more than one IRA account is included in the plan. Therefore, they usually enter a code 1 in Box 7 of the 1099R and the taxpayer then overrides the 1099R by filing Form 5329 showing exception code 02. Therefore, the 1099R itself is not indicative of whether the exemption is valid or not. It is possible that the custodian changed the code to 1 for all 72t plans on which they were reporting rather than the one time switch to RMD. Apparently, whoever knew enough to recommend the one time switch was not aware, or forgot that this plan consisted of two IRA accounts, not just one.
  • Since this plan was busted in 2013, any recent distributions in the last 60 days could be rolled back since this plan technically ended on 12/31/2013. Again, the tax savings and additional tax deferral from having the plan end may more than offset the cost of the penalty and interest on the first two years of distributions.

 

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