If you failed to take required minimum distributions (RMD’s) from your IRA, then you are subject to a 50% penalty. The penalty is 50% on the amount you should have distributed from your IRA to yourself. It’s a steep penalty for simply failing to pay yourself from your own IRA and it’s something every IRA owner with RMD needs to understand. For my prior article explaining RMD rules for IRAs, please click here.
WAIVER OF 50% PENALTY TAX
If you’ve failed to take RMD for your IRA, you have a chance at obtaining a waiver from the penalty but you must admit the mistake to the IRS by filing IRS form 5329. In the instructions to form 5329, the IRS outlines the waiver process to avoid the 50% penalty tax. Here’s what you need to do.
- Complete Section IX of Form 5329. You need to specify what you should have taken as RMD and then you calculate the penalty tax due. You then write the letters “RC”next to the amount you want waived on line 52.
- Statement of Explanation. Attach a Statement of Explanation outlining two items.
- First, explain what was the “reasonable error” that caused a failure to take RMD. The IRS does not provide a definition or acceptable examples of “reasonable error”. See IRC 4974(d)(1). From my own experience and from examples I’ve heard from colleagues, the IRS does recognize reasonable errors and oversights in most situations where there is reason for the error. This would include situations such mental health, to turning 70 ½ and being new to RMD, to relying on bad advice from an advisor, custodian or accountant, to holding an ill-liquid asset for sale in a self directed IRA.
- Second, explain the reasonable steps taken to correct the error. Ideally, by the time you’re filing the exemption request you would’ve already contacted your IRA custodian and would’ve taken the late RMD so that by the time you submit the RMD penalty tax waiver, you would be caught up and would have already remedied the error. This makes for an easy and clean explanation of what steps you’re going to take as your explanation will be that you already corrected the RMD failure once you realized the error.
Keep in mind that RMD failures won’t go away as your IRA custodian will be updating your account each year with the IRS. Eventually, you’ll start getting collection letters from the IRS requesting the penalty tax. Consequently, IRA owners are well advised to correct the RMD failure and request the wavier as soon as they become aware of the error or oversight.