Who Doesn’t Need to Take a 2016 RMD by Dec. 31?

By Sarah Brenner, JD, IRA Analyst, Ed Slott and Company, LLC

2016 RMDFall is in the air and the holidays are just around the corner. For many retirement account owners, this means that an important deadline is approaching. Most of those who are 70 ½ or older will need to take a 2016 RMD by December 31, 2016. However, that deadline does not apply to everyone. If you are age 70 ½ or over, when would an RMD not be required to be taken from your retirement account by the upcoming December 31 deadline? Here are some exceptions that might apply to you.

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Rulings to Remember: The $425K IRA Mistake

Client Should Have Realized CPA Firm’s Tax Deal “To Good to be True”

Robert K and Joan L. Paschall V. Commissioner of Internal Revenue
(No. 2: Nos. 10478-08, 25825-08, Decided July 5, 2011

IRA Mistake results in taxesRobert Paschall, a married resident of California and an MIT graduate, worked for Rockwell International for his entire career until he retired in 1996.  Early in 2000, Paschall paid Grant Thorton, a national accounting firm, $120,000 for advice on his regular IRA that had a value of $1,391,942.  They presented Paschall with a plan, which he accepted, to “restructure” his regular IRA into a Roth IRA – the $425K IRA Mistake.

Under Grant Thorton’s guidance, Paschall rolled his IRA over into a self-directed traditional IRA.  He also opened a self-directed Roth IRA, funding it with $2,000, and created two corporations.  The Roth IRA purchased all the stock of one corporation for $2,000, and the traditional IRA purchased all the stock of the second corporation for close to the traditional IRA’s balance. The second corporation transferred the purchase amount (plus $120,000 paid as consideration in a merger) to the fi rst corporation.  The fi rst corporation then transferred the proceeds ($1,272,802) to the Roth IRA, which then transferred the funds into a second Roth IRA.

He was caught by IRS and got hit with penalties for excess Roth contributions, late filing and negligence penalties for multiple years.  He essentially made a $1.4 million excess contribution to a Roth IRA in a year when the contribution limit was $2,000.  The IRS assessed deficiencies against Paschall and his wife totaling more than $425,000 for tax years 2002 to 2006 for the excise tax on the excess contribution and assessed penalties of more than $103,000 for the same years for failure to file Form 5329.

In 2008, Paschall and his wife petitioned the Tax Court for relief.

What happened?

The Paschalls argued that the statute of limitation barred the assessment of the excise tax for 2002-2004, since they had filed Form 1040 for those years.  The taxpayers also argued that the penalty for Paschall’s failure to fi le Form 5329 should not apply, since his failure to file was due to reasonable cause –specifically, his reliance on the certified public accountant.

The court ruled on July 5, 2011 that the IRS was right and that it was unreasonable for Paschall to rely on the opinion of a tax advisor who was actively involved in the planning of the transaction in question and was tainted by an inherent conflict of interest.

The Paschalls owed income tax on their Roth conversion.  Interest was owed on the late tax. They owed accuracy-related penalties.  They owed failure to file penalties for not filing Form 8606.

The court stated, “Mr. Paschall should have realized that the deal was too good to be true.”  Despite his doubts during the process, Paschall never asked for advice from an independent advisor, the court said.

What you can do

If you have doubts about advice you are receiving, get a second opinion!  IRS holds the tapayer responsible for taxes, interest, and penalties.

Work with someone you trust and don’t fall for “too good to be true.”

Copyright 2016 Ed Slott and Company LLC
Photo credit: 401(K) 2013 via Foter.com / CC BY-SA

Avoiding Charitable IRA Beneficiary Mistakes in 5 Easy Steps

Can IRAs be used to benefit a charity?

Avoiding Charitable IRA Beneficiary MistakesIRAs can be a great source of funds to provide a benefit for a favorite charity, but using these funds can create several traps that must be avoided to maximize benefits to both the charity and other IRA beneficiaries.

1. Name the charity directly on your beneficiary form. The money will go directly to the charity, avoiding both the time and expense of probate. Additionally, the distribution to the charity will not be considered income to the estate of the deceased IRA owner.

2.  Set up separate accounts. Consider transferring the portion you intend to leave to charity into a separate IRA account. If other beneficiaries inherit the same IRA as a charity and the charity’s portion is not “cashed out” or split within the IRS prescribed time frames, the stretch IRA for the living beneficiaries will be lost.

3. Reverse your bequests. If you have made provisions for certain charities under your will and also have retirement plans, an effective tax strategy would be to reverse the bequests with non-retirement assets. This way, the charity receives the same amount that you were going to leave them in your will, but your heirs will end up with more, because the money they will inherit will not be subject to income tax, as the retirement plan would be.

4. Don’t convert assets you plan to leave to a charity. Many charitable organizations and religious groups are structured tax-exempt organizations. When an IRA is left to one of these charities, the charity does not have to pay income tax on the distribution as other beneficiaries would. As a result, if you intend to leave your IRA to charity, converting it to a Roth IRA is generally not a wise move. Why pay income tax on the conversion when the money will be going to the charity tax free anyway?

5. Beware of naming a charity as a trust beneficiary. A charity is known as a “non-designated beneficiary,” because it does not have a life expectancy. In general, trusts are also non-designated beneficiaries. Certain trusts, known as see-through (or look-through) trusts allow for post-death distributions to be stretched based on the trust beneficiary with the shortest remaining life expectancy. Since a charity has no life expectancy, if it is named as a beneficiary of a trust that is also inheriting an IRA, it can eliminate the stretch for the remaining trust beneficiaries.