Seven Ways the IRS Knows…

By Jeffrey Levine, Chief Retirement Strategist 
Follow Me on Twitter: @IRAGuru4EdSlott

It’s not a good question to be asking, and it’s certainly not the right question to be asking, but one fairly common question asked by both advisors and clients is “How are they going to know?” The “they,” they’re referring to, is the IRS. For those that have ever wondered, here are the answers to seven common “How are they going to know” questions.

How are they going to know?

1)…that I need to take an RMD?

Each year, custodians are required to file Form 5498. Box 11 is a little check box that asks whether the owner is subject to RMDs.

2)…that part of my IRA distribution represents a tax-free return of basis?

You have to tell them! The way you do that is by keeping your IRA basis information up to date using Form 8606.

3)…that I made a qualified charitable distribution (QCD)?

You have to tell them! This is all handled on your Form 1040. The gross amount of the QCD is included on line 15a, but the amount is NOT included on line 15b. The difference between the two lines is explained by writing “QCD” next to line 15b.

4)…that I contributed too much to an IRA or Roth IRA?

In the past, the IRS has admittedly been poor at this. In fact, several Treasury Inspector General for Tax Administration (TIGTA) reports have noted the IRS hasn’t done a good job with compliance in this area. But they have the tools to do so. Form 5498 includes information about your contributions. With technology getting better all the time, it shouldn’t be hard for the IRS to look at all the Form 5498s they receive for a person each year and determine that they are over the annual contribution limit.

5)…that my trust qualifies as a see-through trust?

This one’s probably only going to come up on an audit. There is no requirement to send the IRS a copy of your trust, and frankly, even if you did, they probably wouldn’t have the bandwidth to review it anyway.

6)…how many days it has been since I received my IRA distribution?

The 60-day rollover clock starts once someone “receives” an IRA distribution. So how is the IRS going to know that? Are they monitoring everyone’s mailbox? No. But nevertheless, there may be a way to tell. If your IRA distribution arrived via electronic deposit into your account, or if it was sent to you with a tracking number, there’s a definitive way to know when it what received. If it was sent via regular mail, there may be a “fudge factor” of a few days that would be hard for IRS to determine, but that’s no different from our tax system as a whole. It’s largely and honesty-based system.

7)…how long it has been since my first Roth IRA?

This question becomes important when you want to show that your Roth IRA distributions are qualified. There’s nowhere on your return to record this information, but the IRS should theoretically be able to tell when you opened your first Roth IRA by reviewing old 5498 forms. If they ever question the tax-free nature of your Roth IRA distributions, you want to be able to back up your claims. With that in mind, consider keeping a copy of your first Roth IRA Form 5498 or the statement showing the contribution into that account indefinitely.


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