Beneficiary IRA: Years of Late RMDs & An Excess Contribution

Submitted by Cheryl Moss on Sat, 2023-01-21 22:12

I have a new tax client presenting with these past issues – Sorry it’s so long, but you’ll see why!
Client’s father died in 2005 with a small IRA ($20,000) that was transferred to an inherited IRA with the same Custodian “A”. Automatic RMD’s were taken for 2006-07. In 2007, a new financial advisor (FA 1) transferred the inherited IRA to Custodian B. Since the transfer in 2007, no distributions were taken. This FA 1 (a CPA, CFP and former IRS manager), also prepared the client’s tax returns for 2007-2021. Due to newly inherited money in late 2022 and held at Custodian C, the client decided to move his inherited IRA at Custodian B to Custodian C. The new advisor, FA 2 at Custodian C, discovered the late RMD issue for 2008-2022.

To make matters worse, at the same time in 2007, FA 1 also transferred into the inherited IRA, funds from an insurance company cash management account that was funded by life insurance proceeds received from dad in 2005. So, about $12,000 of non-IRA monies got added to the inherited IRA account at Custodian B.

I’ve obtained the entire transaction history and year-end balances of the Custodian B account and calculated the amounts attributed to each of the inherited IRA and non-IRA deposits to the account (deposits plus earnings.) I’ve also calculated the late RMD’s for 2008-2022 (except for 2009 & 2020 when they were waived.)

Thoughts and questions:
– The extra amount of non-qualified funds (about $12,000) plus earnings (total about $26,000) needs to be removed from the the account. Is this considered an Excess Contribution and Corrective Distribution for purposes of the 6% excise tax? Is the custodian responsible due to accepting the non-qualified funds in the first place? Could they simply go back and correct the error, splitting the account into an inherited IRA share and non-qualified share? If they won’t or can’t do this, is the client liable for the 6% per year excise tax on the $12,000 for every year from 2007-2022?

– The late RMD’s, about $20,000, will be taken as soon as possible along with 2023’s, probably after the non-qualified portion is removed.

– Amended returns need to be done for 2008-2021 to include Form 5329 to report the 50% (and 6%/year, if applicable) penalties. (The statute of limitations does not run since the 5329’s weren’t filed.) The 2022 return also needs to include Form 5329. We’ll request IRS waive the 50% penalty for all these returns due to very bad professional advice as reasonable cause. What are the odds of getting this waiver due to how far back it goes? If the 6% excise tax applies, it doesn’t look that that can be waived like the 50% penalty could be. Do late payment penalties and interest also apply to the 5329 penalties from the time the 5329’s should have been filed?

– The amended returns would also include the dividend income earned on the non-qualified portion of the account. Does the statute of limitations apply to how far back the income would need to be included? (Small amounts and not a fraud case.) Or does the fact that amended returns need to be filed to report the 5329 issue(s) require this income to be included since we obviously know about it? (The income and tax isn’t much, but interest and penalties would add up.)

– What responsibility does FA 1 bear for financial impact of this situation on the client. I think a financial advisor could brush it off as being tax advice and thus the client’s and his tax advisor’s error and a tax preparer could say they didn’t know about the inherited IRA. But the same person was the advisor and tax preparer in this case.

– Am I on the right track or missing anything else? Many thanks in advance for any comments and ideas!



Submitted by Alan - IRA critic on Sun, 2023-01-22 02:06

  • You are pretty much on the right track. Two items to note are that the excess contributions are included in the account balance for RMD calculation purposes, and the corrective distribution of the excess does not count toward the RMD for the year the excess is distributed.
  • When the excess contributions are corrected by distribution after the due date per Sec 408(d)(5), there is no earnings calculation involved. Just the actual excess contribution amount (12k) must be distributed, and the IRA custodian must be made error that this distribution is per 408(d)(5) so that the 1099R is issued with box 2a left blank (no taxable income).
  • Custodian should not have accepted the 12k contribution, but due to the time that has passed there is no realistic recourse, and the amount is modest.
  • A 1040 X with a 5329 reflecting the missed RMDs and the excess contribution 6% excise tax should be filed for each year an RMD was missed, as well as the excess contribution excise tax was due. The penalty waiver should be requested with a short explanation of the “reasonable cause” for the missed RMD. The IRS will likely grant the waiver.
  • I doubt that the Secure 2.0 provision starting a 3 or 6 year SOL for these two violations by filing Form 1040 will apply retroactively, that is for 1040 forms filed prior to the date of enactment. Not sure if waiting for clarification from the IRS on this question is worthwhile since there is likely a very small chance that the provision is retroactive.
  • The IRS may or may not charge late interest on the late payment of the excise taxes.

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