RMD Penalty Waiver: Using The 5329 Form For a Missed IRA Required Minimum Distribution

With all due respect to any financial masochists in the audience, nobody derives pleasure from paying taxes. But it's kind of part of the deal of living and working in the United States.

You have to pay Uncle Sam, and he's not about to start making exceptions for the money from your IRA. One of the requirements of IRA accounts is that you will have to take a Required Minimum Distribution eventually. Failure to do so  is something Uncle Sam frowns upon. In fact, he dislikes it so much that he'll send his minions to hit you with a massive 50% penalty.

The penalty is 50% on the amount you should have distributed from your IRA to yourself. This is tremendously annoying to a person who has otherwise been fiscally responsible, because they are essentially being punished for failure to pay themselves. From their own IRA. You know, the kind of account most of us save into for all of our working lives.

The irony of this situation is lost on nobody, but with that massive of a threat hanging over your head, you should know how to avoid it.

So, if you've been hit with the 50% penalty, don't throw yourself a pity party just yet. There’s some good news about how you can possibly get a RMD penalty waiver.

Steps To Getting the RMD Penalty Waived

In the event that you failed to take RMD for your IRA, you may be able to get a waiver for the penalty if you admit the mistake to the IRS by submitting the forms we'll talk about below (See Steps 2 and 3).  We all know Uncle Sam loves his paperwork, and yes, I'm telling you that you can possibly get back in his good graces with his favorite thing: more paperwork!

Fortunately, it's not an overwhelming amount of paperwork, especially for what you stand to gain (or more accurately, not lose). I'll describe the process in two simple steps, laid out in plain English.

Step #1: Take The RMD

Even if you know fully well that you intended to dodge the RMD, you're going to have to correct the "error" to get any sympathy from Uncle Sam. Better late than never. But you want to get this first step knocked out as expeditiously as you can, so you can move on to the super fun forms in Step #2.

Step #2: Complete Section IX Of Form 5329.

First, you'll need to say what you should have taken as an RMD. Using this number, you will calculate the penalty tax due. It's okay if you're not a math whiz—use a calculator

Now scroll down to Line 52. Here, you will need to put the letters "RC" next to the exact dollar amount you are requesting to have waived.

Step #3:  Attach a Missed RMD Letter of Explanation

Your statement of explanation will need to hit on two key points. The first thing you need to explain is the “reasonable error” that caused you not to take RMD. The IRS does not provide a precise definition or clear-cut circumstances for “reasonable error."  However, one expert I consulted with the IRS told me the IRS does respond well to oversights in a broad variety of situations where they can be persuaded the error was unintentional or otherwise not your fault.

Since these categories are vague, let's look at circumstances or situations that have worked for other taxpayers in this situation.  

Examples include suffering from a mental illness or falling victim to a damaging health situation or equally legitimate reason that may have stopped you from filing accurately.  If you've reached the age of 70 ½ years, or are new to taking RMDs, or fail to understand the requirement, these can also serve you. Other clients have succeeded in receiving waivers based on taking bad recommendations from a professional they had entrusted to help them, such as an advisor, custodian or accountant.

If one or more of these situations apply to you, list any and all of them. The IRS, despite its hawkish reputation, does certainly respond to logic and, if you're lucky, with empathy.

The second thing you need to explain is the reasonable steps you took or intend to take in the immediate future to remedy the mistake you made.

Showing Good Faith Gets You The Waiver

By the time you’re filing the exemption request, you want to have already contacted your IRA custodian. If you haven't by this point, be sure to do so before you file. This way, you can take the late RMD (see: Step 1). This means that as soon as you submit the RMD penalty tax waiver, you would be caught up and would have already remedied the error. Showing good faith is more likely to get you the waiver you need.

You can contact the IRS's Taxpayer Advocate Office as well for assistance following these steps, as well as more specific advice regarding your individual situation.

Keep in mind that RMD failures won’t go away. Uncle Sam is like an elephant: he never forgets. Sooner or later you’ll start getting collection letters from the IRS requesting the 50% penalty tax. The best way out of it is to get as ahead of it as you possibly can. You should correct your RMD failure, request the waiver, and fill out all of the necessary paperwork as soon as you learn of the looming problem.

This is especially if you have an inherited Roth IRA, as those withdrawals would ordinarily be totally tax-free! 

Conclusion

If you’ve been hit with a 50% penalty don’t panic. You may be able to get a waiver for the penalty if you admit the mistake to the IRS by filing a 5329. Come clean. Throw yourself at the mercy of the court.

You’re going to have to write a Statement of Explanation that outlines:

1. What makes your error “reasonable,” such as mental health issues or bad advice from a bad advisor. The IRS is, at times, capable of compassion.
2. The process you are planning to take, or have taken, to correct the error. If you’re on top of things, you’ve already taken the missed RMD. This makes everything clean, from your explanation for the error, to the enemy’s acceptance of your reasonable explanation.

Keep in mind that RMD failures don’t disappear. The IRS is a relentless, greedy machine. They WILL get their money. Get your error fixed!

Hopefully your panic level has dropped by now. The above is a simple, clear explanation of what steps you’re going to take. Essentially, your explanation will be that you already corrected the RMD failure as quickly as you could upon learning of the error.

If you are the beneficiary of an inherited IRA, check out our article, Calculating RMD For An Inherited IRA.