Reasonable Cause for a Missed Required Minimum Distribution
Have you ever wondered about the rationale behind required minimum distributions (RMDs) from retirement plans?
Retirement plans were designed to help build retirement nest eggs by deferring taxation on the contributions and earnings until the funds are withdrawn after age 59½ for use during retirement. Retirement funds were not, however, intended to primarily provide the participant’s beneficiary with benefits. As such, Congress created Code Section 401(a)(9) for the purpose of disbursing retirement benefits to the participant while alive. Participants who ignore the RMD rules must pay a 50% excise tax as outlined in Code Section 4974(a) .
Reasonable Cause for a Missed RMD
Fortunately, Internal Revenue Code section 4974(d)** anticipates that errors may occur, and, if they occur for a reasonable cause, the IRS may waive the 50% penalty. Specifically, If the taxpayer establishes to the satisfaction of the Secretary that the shortfall described in subsection (a) in the amount distributed during any taxable year was due to reasonable error, and reasonable steps are taken to remedy the shortfall, the Secretary may waive the tax imposed by subsection (a) for the taxable year.
The RMD shortfall must be withdrawn as part of the steps to be taken to have the penalty waived. In addition, IRS Form 4972 must be filed with the tax return for the year of the missed RMD. If necessary, an amended series 1040 Form must be filed to reflect the RMD being withdrawn and taxed for the year it should have been originally withdrawn.
Many Reasons for a Missed RMDs
Plan administrators can miss RMDs for many reasons, such as an incorrect date of birth in the system. An incorrect date of birth can be caused by a typographical mistake; getting lost or incorrectly transferred during a merger or acquisition; illegible handwriting; or a transposition of the date of birth year (e.g. 1948 typed as 1984). It can even happen when participants don’t want to disclose their actual age to an employer. Any of these errors could result in a participant getting left off the list of participants attaining age 70½ for the year.
The required beginning date for non-five percent owners (participants) is defined in most qualified plans as April first of the year after the later of: the year the participant attains age 70½, or the year the participant retires.
When a participant is actually retired can be a “facts and circumstances” determination. Has the participant been laid-off, or completely severed from employment? Is the participant on an unpaid leave of absence or on a medical or disability leave? Is the participant completely retired or still working two days a week? These factors can all compound the plan sponsor’s understanding of the participant’s retirement status. If the non-five percent participant is still employed, there is generally no RMD. Conversely, if the non-five percent participant is not employed the RMD will be April 1 of the year after work ceased, if work ceased after age 70½.
A missed RMD resulting from an employer’s misunderstanding of the employee’s retirement status could be a good case for a reasonable cause to have the 50% penalty waived. The employer needs to make the determination as to the retired status of the employee, even if the employer has to hire a labor or human resource attorney for help.
IRS Form 5329 and Waiver of the 50% Tax
Once the RMD mistake is discovered, the participant must take all missed RMDs from the plan and refile the relevant year’s tax returns with a Form 5329. To file for the waiver of the 50% tax, the participant must complete Form 5329 (see below), which emulates Code Section 4974(d). Note that filing Form 5329 does not guarantee the IRS will agree with the reasonable cause provided for the waiver. The agency will review the explanation for the reasonable cause, but if they do not agree, the 50% penalty will be assessed.
FORM 5329 Instructions, Part VIII:
“Waiver of tax. The IRS can waive part or all of this tax if you show that any shortfall in the amount of distributions was due to reasonable error and you are taking appropriate steps to remedy the shortfall. If you believe you qualify for this relief, attach a statement of explanation and file Form 5329 as follows.
- Complete lines 52 and 53 as instructed.
- Enter “RC” and the amount you want waived in parentheses on the dotted line next to line 54. Subtract this amount from the total shortfall you figured without regard to the waiver and enter the result on line 54.
- Complete line 55 as instructed. You must pay any tax due that is reported on line 55.
- The IRS will review the information you provide and decide whether to grant your request for a waiver.
Voluntary Correction Program
The Voluntary Correction Program (VCP) part of the Employee Plans Compliance Resolution Systems (EPCRS) has a streamlined filing Form 14568-H for bringing a plan back into compliance when the only plan failure is missed RMDs. From 2006 until Rev. Proc. 2015-27, the IRS offered a special discounted VCP fee based on the number of participants who missed an RMD. If up to 50 participants missed an RMD, the fee was $500. Rev. Proc. 2015-27 changed the fee to the following:
- $500 for the first 150 missed participant’s RMDs
- $1,500 for 151 to 300 missed RMDs
- 300+ missed RMDs use the general fee schedule amount.
As of Revenue Procedure 2018-4, the special discount for missed RMDs has been eliminated and the general VCP fee schedule now applies for any missed RMDs. For VCP RMD filings made in 2018, the general VCP fee schedule (based on the number pf participants in the plan) applies rather than the discounts we were familiar with for many years.
Nonetheless, there are two advantages of the plan administrator filing under VCP. First, if the filing is approved, the plan administrator will receive a compliance statement that the plan has corrected the missed RMDs and the IRS is satisfied that the plan is restored to a compliant status. Secondly, the plan administrator may check off a box on Form 14568-H for the Code Section 4974 penalties to be waived for all affected participants. If this box is checked, these participants will not have to file the Form 5329 to ask for a waiver of the 50% penalty. However, if the missed RMD is for an owner-employee or a 10% owner of a corporation, the plan administrator must provide the reason why the owner-employee or 10% owner of a corporation’s RMDs were missed for the IRS to consider waiving the 50% penalty for those individuals.
Recent Missing Participant Safe Harbor Guidance
Code Section 401(a)(9) defines a qualification requirement that all qualified plans must meet by distributing RMDs. If a plan fails to make an RMD, the plan sponsor may be subject to a sanction for failing one of the qualification requirements of Code Section 401(a).
Until recently, missing participants who arrive at the Required Beginning Date (RBD) have posed a difficult administrative situation. Plan administrators must either mail an RMD to a known bad address for a missing participant or not make the RMD and then have a 401(a)(9) plan qualification failure. Neither option offers an ideal solution to a missing participant scenario. Fortunately, there is a workable solution.
The safe harbor announced by memorandum from Acting Director of Employee Plan Examinations, Tom Pettit (in October 2017 for qualified plans and in February 2018 for 403(b) plans), enables plan administrators to follow steps for locating missing participants and if they yield no results, to not pay an RMD and also not worry about the plan failing 401(a)(9). Please refer to my previous blog, What to Do with Missing Participants and Required Minimum Distributions, for more information.
The IRS doesn’t take missed RMDs lightly, and as a plan sponsor or administrator, neither should you. However, the IRS does understand there are reasonable causes for missing them. When in doubt about a participant’s legal status, consulting with a compliance expert can help prevent missed RMDs in the first place. However, if you missed some RMDs and think they might fall into one of the “reasonable cause” categories, following the steps outlined above may help participants avoid paying the 50% penalty and help plan administrators to avoid failing to comply with Code Section 401(a)(9).
William C. Grossman, ERPA, QPA, APA, MBA is the Managing Member of WCG ERISA CONSULTING, LLC. He assists TPAs and financial institutions in complying with IRS and DOL regulations regarding qualified plans, such as 401ks, as well as 403(b)s and IRAs; and has spoken on a wide variety of retirement plan topics at ASPPA and NIPA national conferences.
As a contributing author to PenChecks Trust, Grossman writes about current retirement plan compliance and implementation issues.
The views expressed in this article are those of the author and do not necessarily represent the views of PenChecks Trust, its subsidiaries or affiliates. PenChecks Trust makes certain external or third-party content available on its website. The information, views and opinions contained in third-party content are those of the authors of said content. PenChecks Trust is not responsible for the accuracy, reliability or correctness of the information supplied by external sources. Users wishing to rely upon this information should consult their own legal, tax, investment or other professional adviser.