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TIGTA addresses IRS action on excess IRA contributions

A new Treasury Inspector General for Tax Administration (TIGTA) report finds that IRS hasn’t done enough to address the problem of taxpayers making excess contributions to IRAs. The report suggests ways the agency could improve its outreach program for IRA custodians and its methodology for identifying noncompliant taxpayers.

Background. Traditional and Roth IRA contributions are reported by IRA custodians on Form 5498, IRA Contribution Information.

An individual has made an excess contribution for:

  • any amounts contributed to traditional or Roth IRAs for the year that exceed the annual contribution limit (e.g., for 2015, $5,500 ($6,500 if age 50 or older));
  • any amount contributed to a traditional IRA by an individual who has reached age 70½; or
  • any amount contributed by an individual who does not earn eligible compensation.

Individuals who discover they have made excess IRA contributions can withdraw the excess amount out of their IRAs by the due date of the tax return without penalty.

Distributions resulting from excess contributions are reported by IRA custodians on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., which includes a requirement to provide an appropriate distribution code explaining specific details surrounding the distribution. There is a 6% excise tax associated with excess contributions not withdrawn by the due date of the tax return, including extensions. This 6% tax is reported by individuals on Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.

IRA custodians must report information on Forms 5498 and Forms 1099-R to IRS and provide copies to IRA owners. A separate Form 5498 should be filed for each IRA held by an individual, and a separate Form 1099-R should be filed for distributions from each IRA or account held by an individual.

A TIGTA audit for fiscal year 2010 found that approximately 300,000 individuals potentially contributed more than $3.9 billion of unreported excess contributions to IRAs in tax years (TYs) 2006 and 2007.

Update on excess contributions problem. The new TIGTA report assesses the corrective steps IRS took to address the excess contributions problem and makes suggestions of its own. Here’s a summary of the report’s findings.

Outreach to IRA custodians has not occurred. IRS did develop and provide educational materials to individuals and tax return preparers explaining IRA rules and providing guidance if an individual is noncompliant with IRA rules. However, IRS did not develop education materials for IRA custodians, who serve a key function to assist individuals, return preparers, and IRS in identifying excess IRA contributions by providing Forms 5498 showing contributions made to IRAs by individuals.

When analyzing TY 2011 Forms 5498 for excess contributions, TIGTA found that approximately 834,000 (7%) of 11.9 million Forms 5498 filed by IRA custodians appeared to be inaccurate. For example, TIGTA found instances in which the IRA custodian appeared to mistakenly include rollovers from other IRAs in the “IRA contribution” box on Form 5498. Without outreach to IRA custodians, TIGTA said erroneous Forms 5498 may continue to be submitted to IRS.

Methodology for identifying noncompliance could be improved. As part of its broad-based strategy to address noncompliance with retirement plan provisions, IRS implemented processes to send so-called “soft notices” to a sample of individuals whom IRS identified as having potentially made excess IRA contributions in TY 2011. Soft notices do not require that the individual pay more tax, provide documentation, or even respond to IRS. Although the notice requests that the individual file an amended tax return if appropriate, it is not required. Instead, the notices are designed to serve as an educational tool, encourage self-correction, and improve voluntary compliance.

While IRS’s evaluation of the results of the TY 2011 soft notice sample is not complete, TIGTA says it has taken positive steps toward testing its strategy by adding controls to identify and address retirement provision noncompliance. However, TIGTA found IRS’s methodology for identifying noncompliance could be improved. TIGTA identified a significant number of individuals that IRS did not identify who potentially made excess contributions.

IRS response. IRS said that it planned to continue to inform IRA custodians of issues and errors affecting IRA administration. It also agreed to identify a more complete and accurate universe of individuals who potentially made excess contributions. This was a logical step in expanding the IRA soft notice program from its current state.