Last week, we discussed the reduction of the excise tax (penalty) for failure to take a required minimum distribution, or RMD, from 50% of the minimum amount not distributed to 25%. That change came about as a result of the SECURE 2.0 Act, effective beginning this year, 2023.
We left the discussion of the SECURE 2.0 Act's limited-case reduction to 10% for this column.
The statute provides for a 10% penalty, but it is dependent on timing the correction properly. The 25% penalty is reduced to 10% if the RMD is "timely corrected," quoting the IRS website (tinyurl.com/yfwcubn4).
IRS Publication 590-B (tinyurl.com/yc6tx8dh) defines the correction window:
"You may be subject to a reduced excise tax rate of 10% of the amount not distributed, if, during the correction window, you take a distribution of the amount on which the tax is due and submit a tax return reflecting this excise tax. The 'correction window' is the period of time beginning on the date on which the excise tax is imposed on the distribution shortfall and ends on the earliest of the following dates:
-- The date of mailing the deficiency notice with respect to the imposition of this tax; or
-- The date the tax is assessed; or
-- The last day of the second taxable year that begins after the date of the taxable year in which the excise tax is imposed."
While this seems complicated, it isn't.
Let's take an example. Assume you miss your 2023 RMD. The "second taxable year" would be the 2025 tax year. If you don't get a deficiency notice or a tax assessment from the IRS before Dec. 31, 2025, the correction window closes Dec. 31, 2025. The RMD for 2023 would need to be taken before the end of tax year 2025.
As for when the excise tax is "imposed," an IRS spokesperson explained, "The tax is legally imposed in the year there is a shortfall." That is, if the RMD is for 2023, the tax return you file in 2024 for 2023 will deal with the imposition of the penalty.
Further, when there is an RMD shortfall, "[t]he tax is due for the tax year that includes the last day by which the minimum required distribution must be taken," quoting the instructions for IRS Form 5329, "Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts" (tinyurl.com/mv72yhhs).
The SECURE 2.0 Act did not address requests for waivers of the penalty for "reasonable cause." With a waiver, the penalty would be zero instead of 25% or 10%.
You would file IRS Form 5329 to request a penalty waiver. Under current procedures, the IRS can waive all or part of the excise tax if "any shortfall in the amount of distributions was due to reasonable error and you are taking reasonable steps to remedy the shortfall." See the "Waiver of tax for reasonable cause" section in IRS Form 5329, Part IX.
Keep in mind the motivation behind the change in the excise tax for missed RMDs in the SECURE 2.0 Act, as expressed by the House of Representatives' Committee on Ways and Means: "The Committee recognizes that in many cases, failures to take a required minimum distribution are inadvertent. The Committee thus wishes to reduce the overall excise tax that applies to such failures, in particular in the case of an individual who discovers such a failure and takes steps to correct it" (tinyurl.com/9bprn8fn).
Regarding the 10% penalty and its two-year correction window, the IRS spokesperson noted, "In many respects, it is a somewhat unusual statutory provision." He added that the SECURE 2.0 Act is new, and the IRS is "looking at what formal legal guidance may be needed."
For more information on the penalty, read Q8 on the IRS website page "Retirement Plan and IRA Required Minimum Distributions FAQs" (tinyurl.com/yfwcubn4).
Bottom line: Take your RMDs on time. If you miss one or fail to take the full RMD, act as quickly as possible to make up the difference. And be sure to inform your tax adviser.
DISTRIBUTED BY ANDREWS MCMEEL SYNDICATION