Cut Down on These IRA Tax Reporting Errors
Tax reporting season is around the corner, and now is the time when many financial organizations audit their year-end IRA reporting data to catch and correct errors before tax documents are printed and mailed out.
Unfortunately, mistakes occur, and for a variety of reasons. Perhaps your long-time IRA administrator has retired, or your IRA department has experienced turnover in recent years and, as a result, retaining IRA expertise has been a challenge. Or, as a smaller organization, everyone from those in the front to back offices may be assisting clients with their IRA or health savings account (HSA) transactions, resulting in higher error rates. Often a financial organization’s internal transaction processing system doesn’t have updated compliance logic for reporting changes, resulting in reporting errors.
It can be tricky to keep up with all the IRA rules, and this is especially true today with the introduction of new IRS forms, ever-changing regulations, and potential legislative changes in the works.
Whatever the reason may be, the IRS does not consider lack of training or computer programming issues as valid reasons for reporting mistakes. Financial organizations are ultimately responsible for any penalties that may result from reporting errors. These penalties can become costly if an audit reveals errors.
Common IRA Reporting Mistakes
At Ascensus, we assist many of our financial organization partners in reducing the amount of tax season compliance errors that are discovered after they submit the information to us. In fact, we specialize in these types of transactions to ensure our financial organizations remain in compliance. Without Ascensus’s help, these errors may not be caught until the tax forms are sent out and discovered by account owners or the IRS. Catching these tax reporting errors early mitigates your risk as a financial organization. Here are three of the most common compliance errors that we find.
Distribution Codes Applied Incorrectly, Based on IRA Owner’s Age
One of the most challenging aspects of reporting IRA distributions is determining the proper distribution code(s) to enter in Box 7, Distribution code(s) on IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc.
A frequent compliance error occurs when the wrong distribution code is used, based on the IRA owner’s age. If the IRA owner is under age 59½, code 1, Early distribution, no known exception, is to be applied for Traditional, SIMPLE, and SEP IRAs, and only if codes 2, 3, and 4 do not apply. If the IRA owner is age 59½ or older, then code 7, Normal distribution, is used in Box 7.
Incorrect Withdrawal Reporting for a Deceased IRA Owner’s Account in Year of Death
A distribution reported as being taken by a decedent could be a red flag for an IRS audit. Often the mistake is made when an incorrect reason code is used for the withdrawal of a required minimum distribution (RMD) by the beneficiary from the decedent’s account.
When an IRA owner dies in a year in which an RMD has not been satisfied, the beneficiary must take that RMD by December 31 of the year of death. The newly proposed RMD regulations do provide some relief for this rule, however, by allowing beneficiaries until their tax return deadline, plus extensions, to withdraw the required amount and avoid a penalty (the proposed regulations do not actually extend the deadline, though this could be addressed in more detail in final regulations). If the RMD isn’t removed within this relief period, however, the beneficiary could face a 50 percent excess accumulation penalty tax.
Distribution Codes Applied Incorrectly
When an IRA owner takes a distribution, the distribution code will not only vary depending on the IRA owner’s age or if there is an exemption, but also on the type of IRA that the distribution was taken from. A Traditional IRA distribution can be incorrectly coded as a Roth IRA distribution, or vice versa. For example, a Roth distribution should not be coded as a 1, 7, or 4.
Roth IRA distributions should be reported using
code Q, Qualified distribution from a Roth IRA, if the IRA owner has met the five-year waiting period and is either age 59½ or older, has died, or is disabled (as long as your organization received proof of the disability);
code T, Roth IRA distribution, exception applies, if the five-year period hasn’t been satisfied, or if it’s not known whether the period has been satisfied, but the IRA owner is at least 59½, has died, or is disabled; or
code J, Early distribution from a Roth IRA, when codes Q and T don’t apply.
A Stress-free Solution to Eliminating Tax Reporting Errors
Ascensus’s Fully-Administered Program can take the stress out of tax reporting for IRAs, HSAs, and Coverdell ESAs. Your organization can use one of two transmission methods to send us information. Under the first method, your team can input individual transactions into our secure online processing system, called IRAdirect®, and our built-in forms wizard will inform you of a reporting error immediately, so that the form is filled out correctly. Under the second method, your financial organization can send us a file with the total annual transactions.
With both methods, our compliance logic can find errors and help ensure accurate reporting, saving you time and money. Often, a financial organization’s core system does not catch these types of errors, which could subject an organization to IRS penalties if not found and corrected. Our Fully-Administered Program reduces the risk of incomplete or incorrect tax reporting.
Our compliance logic is always updated with the latest IRS regulations and new forms, so there’s no need to worry whether your IRA program is compliant. Our beneficiary claim processing, a popular feature, can also take the stress out of beneficiary payout options and other death procedures.
In addition to eliminating tax reporting errors, Ascensus’s Fully-Administered Program can provide the following services: generating and mailing tax forms to account owners, the IRS, and applicable state agencies; providing fair market value statements, required minimum distribution notifications, and providing call center support for your team.
To learn more about how Ascensus’s Fully-Administered Program may assist your financial organization in complete administrative, operational, and compliance support, email us at salessupport@ascensus.com.
