The reader would prefer to pay the lesser of the two penalties
Dear Dan,
In a recent column you wrote: “The “Secure Act 2.0” reduced the penalty from the long standing 50% to a still significant 25%. In certain circumstances, the penalty can be reduced further to 10% or even waived.“ I was glad to read that. I was hospitalized in late November of last year and didn’t get out until Jan. 10. As a result, I missed taking my RMD. How do I get a waiver or at least get the penalty to 10%? The RMD was a bit over $40,000 and a $4,000 penalty would be much better than $10,000!
— Sam in Boulder
My goodness. That’s an awful way to spend the holidays. I sure hope you are on the road to a full recovery.
To reduce the penalty from 25% of the shortfall to 10%, the missed Required Minimum Distribution (RMD) situation must be corrected during a “correction window.”
From the statute:
“(2) CORRECTION WINDOW.—For purposes of this subsection, the term ‘correction window’ means the period of time beginning on the date on which the tax under subsection (a) is imposed with respect to a shortfall of distributions from an individual retirement plan, and ending on the earlier of—
“(A) the date on which the Secretary initiates an audit, or otherwise demands payment, with respect to the shortfall of distributions, or
“(B) the last day of the second taxable year that begins after the end of the taxable year in which the tax under subsection (a) is imposed.”.
In other words, you must get it corrected before the earlier of whenever the IRS catches it, or two years have passed. You have identified the issue very quickly, so you are off to a good start.
The approach that we’ve seen most often goes like this. Distribute your 2024 RMD based on your Dec. 31, 2023 balance. Then, distribute an additional $40,000 for the missed RMD from the previous year.
Could you just take the $40,000 missed 2023 RMD now and the 2024 RMD later? Probably, but some tax experts would say that doesn’t work because every dollar that comes out of an IRA is deemed to be coming out to satisfy the RMD for the current year up to the point the RMD is fully distributed. Either way, the same taxable income amount goes on your 1040 so I’m not sure I buy that. What I do buy is most tax advisers prefer to see the two RMDs taken as two separate transactions to make tracking the corrective activity easier.
Once you have documentation that the 2023 RMD has come out of the IRA, you should file Form 5329, explaining the shortfall was due to reasonable error, the error has been remedied, and ask for a full waiver. I can tell you in the past, I have never seen a “first time offender” fail to get a full waiver of the old 50% penalty using this approach.
However, the consensus is this recent change to lower the penalty to 25% and lower it further upon timely correction was enacted to encourage the agency to impose the penalty more frequently. The belief was so many people got waivers because the 50% penalty was severe, and the agency was reluctant to impose it on many seniors. Time will tell. Good luck and get well.
If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.
Originally published on MarketWatch. Read the original article here.