Julie Jason: Deceased IRA owner? Check the final RMD
Last December, I wrote about the importance of reviewing required minimum distributions when an IRA owner dies over the age of 70 1/2, and warned that it’s important to seek tax advice, because the rules aren’t so straightforward. This column is an important update that goes through how to actually fill out a tax form if you miss taking the RMD on time and want to get a waiver of the tax penalty. Look for the paragraph about line 54 of Form 5329, and thank you, Natalie Choate, for providing the correction. If you would like to see a sample of the form filled out correctly, go to juliejason.com (hover over Columns, click on For Readers).
When someone passes away after age 70 1/2, the family needs to check to see if the deceased took out the required minimum distributions (RMDs) for the year from his IRA (individual retirement account). If not, the beneficiary needs to act before the end of the year to avoid severe tax penalties. If you are in this situation, don’t delay.
Let’s take an example. “Mathew’s” father passed away in June at the age of 80. Mathew is the sole beneficiary of his father’s IRA.
His father’s practice was to wait until November to take his yearly RMD, so no IRA withdrawals had been made in 2017. Mathew’s father should have withdrawn about $5,300 in 2017, based on a balance of $100,000 as of Dec. 31, 2016.
In order to avoid a tax penalty of $2,650 (50 percent of $5,300), Mathew needs to withdraw his father’s final RMD before the end of December.
The RMD will trigger 2017 taxable income for Mathew.
The method of taking the RMD may differ based on the custodian. For example, the form that Mathew would file to set up an “inherited IRA” in his own name may have a section that directs the custodian to calculate and withdraw the RMD before transferring the remaining assets into Mathew’s inherited IRA. (If you would like to see sample language, email me.) Another custodian might transfer the deceased’s entire IRA into the inherited IRA before the RMD can be requested.
While there is time pressure for Mathew to act quickly, imagine what happens if the IRA owner dies on the last day of the calendar year (Dec. 31).
According to attorney Natalie Choate of the law firm Nutter McClennen & Fish LLP, “the beneficiaries are supposed to take [the RMD], as we know, but in reality they have a few hours [or minutes] between the time [the IRA owner] dies and the ‘end of the year.’” Choate is the author of “Life and Death Planning for Retirement Benefits: The Essential Handbook for Estate Planners.”
The solution? “The beneficiaries should take the RMD for 2017 as soon as possible in 2018, and request from the IRS a waiver of the 50 percent penalty for failure to take the 2017 RMD in 2017,” explained Choate.
“The beneficiaries would clearly get the waiver — they couldn’t possibly take the RMD [in 2017] because there wasn’t enough time,” explained Choate.
But they would have to explain the circumstances to the IRS. For example, the IRS might demand to know why the decedent hadn’t taken the RMD earlier. There may be “good cause” for waiting if the IRA owner was sick or dying for a substantial period of time in 2017.
The beneficiaries would file with their 2017 income tax returns IRS Form 5329 in order to explain why the penalty should be waived, even though the RMD was not taken in calendar year 2017. You’ll want to read the instructions to the form, focusing on Part IX, “Additional Tax on Excess Accumulation in Qualified Retirement Plans (Including IRAs).” This is the part of the form the beneficiary will complete “if you did not receive” the RMD in 2017.
Line 52 of the form asks for the RMD.
Line 53 is the amount actually withdrawn during the calendar year.
For line 54, you subtract line 53 from line 52.
Line 55 is the additional tax (50 percent of line 54).
Let’s use Mathew’s numbers for the example:
Line 52 is $5,347.59.
Line 53 is zero.
Here is the complication: Even though the form calls for subtracting line 53 from 52, that leads to the wrong result. That is, the instructions to the form clarify that more is involved and it’s all about the “shortfall.” Logic suggests that in Mathew’s case the shortfall is $5,347.59 — but that logic is wrong, according to Choate. The correct amount to enter on line 54 is “zero” ($0.00). Why? Because you are claiming you missed the RMD due to reasonable cause; therefore, there should be no penalty. Line 54 is the amount of the (actual) shortfall minus the amount for which you are requesting a penalty waiver — net, zero.
Beneficiaries would file Form 5329 with their 2017 income tax returns. They take the (late) RMD in 2018 and report it as income in 2018. Instructions for Form 5329 must be followed to the letter, advises Choate.
What instructions? “Waiver of tax. When you complete lines 52 and 53, enter ‘RC’ [reasonable cause] and the amount you want waived in parentheses on the dotted line next to line 54.” In this case, you would write “RC $5,347.59”on the dotted line next to line 54.
The IRS will determine whether to grant a waiver of the penalty based on this: You need to “show that any shortfall in the amount of distribution was due to reasonable error and you are taking reasonable steps to remedy the shortfall.” You need to explain your rationale in a written statement attached to Form 5329. You might wonder what happens next. An IRS spokesperson advised that if you don’t hear from the IRS, you’re good.
One more piece of advice: If you are in this situation, get a tax adviser to help you.
These are just a few of the complexities of IRAs. Send me your questions on the topic at firstname.lastname@example.org.
Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford, Conn.) and award-winning author, welcomes your questions/comments (email@example.com). To hear Julie speak, visit www.juliejason.com/events.