Is there a 'reasonable cause' exception to avoid the add'l tax on excess Roth IRA contributions?

[Dave W]

My first year with these clients.

Clients live with each other, but 1040 filing status has been 'married, filing separately' for decades.

One spouse has been funding a Roth IRA since 2011. However, clients' financial adviser did not financially advise clients to avoid filing separately. No other tax preparer (since 2011, at least) has ever advised clients to avoid filing separately.

Spouse has now taken corrective distributions for 2020 and 2021 Roth IRA contributions. In addition, all future scheduled Roth IRA contributions have been stopped. However, there still remains the small issue of about 9 years of excess Roth IRA contributions for the years 2011 through 2019. I haven't prepared the 5329's for those years, but I expect the penalty to be in excess of $25,000 (before interest).

I am hoping that there is a reasonable cause exception to the penalties to help these nice folks out, but I don't see where the 5329, Part IV has the space to list an exception to the penalty. Does anyone have any options to offer, other than "Make your check payable to U.S. Treasury"? 

Many thanks!!!

[sjrcpa]

The term you mean is waiver. You can request a waiver. There should be a place to enter a reason.

When people forgot to take RMDs, the waiver request was always granted. 

I have no experience with this situation. What's going to be your reason? I don't think "No one ever told me  to avoid MFS" is not going to cut it. Is this a financial advisor's responsibility? They are not supposed to give tax advice, are they? And why does this matter? Income limitations?

[BobKamman]

As a general rule, people who put their money in Roth IRA's are dumb.  (There are some exceptions.)  The only people who are dumber, are the financial advisers who recommend Roth IRA's.  

Client: "I have $6,000 to invest.  Can you help me?"

FA: "I'm not good at investments.  Pay $2,000 of it in taxes and I'll try to figure out something to do with the $4,000 that's left."

But that doesn't solve your problem here.  But neither does asking for a waiver.  Is that even available?  I thought it applies only to retirement plans with RMD's.  You seem to agree.  So we're talking about the 6% penalty, and not the 50% penalty, right?  But the 6% is assessed each year that there is an excess accumulation.  

When does the statute expire on those 5329 taxes, when a 1040 was filed for the year?  Can IRS assess 5329 taxes for 2011, or can they only go back to 2018 now?  

I would tell the client to withdraw all contributions since 2011, and their earnings, from the account now.  Then, pay tax on the earnings on the 2021 return.  The client may be obligated to file some amended returns but I'm only obligated to tell the client about that and offer an opinion on whether IRS will ask for them.  

Might be cheaper for him to file for an annulment.  

[George4Tacks]

If there was excess Roth IRA contributions in those 9 years, penalty is due on all of them UNTIL THE CONTRIBUTION IS WITHDRAWN. Fixing 2020 and 2021 may not be enough. 

Consider amending to MFJ for open years?

[jeffmcpa2010]

Agree with Bob.🤑

Paying $1500 tax now to (for a 30 year old) avoid paying tax on $ 200,000 (and much more eventually as you are not subject to RMD's) that would be accumulated  by age 70, at reasonable realistic investment rates is totally foolish.

(Now where is that **bleep** sarcasm font)

[Dave W]

Thank you for taking the time to reply. Because the taxpayers filed separately each year in question, their annual Roth IRA contributions phase out range was $0 to $10,000. Not that it really matters, because  even if they had filed jointly, their combined AGI exceeded Roth IRA max for all years in question.

I realize that IRS may chuckle at my "dumb Financial Advisor" waiver request (thank you for correcting me), but that is all I have to offer my clients. My problem is that I don't see how to physically enter the request on the 5329. 

[Dave W]

George, thank you for taking the time to reply. Amending open years is not a viable option. Taxpayers' combined AGI in open years exceeded annual Roth IRA contribution cap for MFJ.

[Dave W]

Bob, thank you very much for taking the time to reply. Yes, I am dealing with the 6% penalty here. Because it is cumulative, the total of 9 years' worth of 6% penalty will be in excess of $25,000. (Spouse funded Roth account each of those nine years.)

It is my understanding that the SOL doesn't start until the 5329's are filed but I am most willing to listen to any arguments to the contrary. And I have seen nothing in my research that even mentions the possibility of a reasonable case waiver for the 6% but, again, I am most willing to listen to any arguments to the contrary.

I will share your idea of annulment with clients. I hope they find it as amusing as I did!

[BobKamman]

This is what the Internal Revenue Manual says about the SoL on 5329.  They probably have something to back it up. 

4.71.27.1.6 (12-23-2020)
Overview of Form 5329 Examinations
This section provides procedures for examining and closing Form 5329.
Except for IRC 72(t) tax, Form 5329 taxes aren’t part of a discrepancy adjustment case.
Reminder: Don’t use Form 4549-E with a Form 5329 case.
Although often filed with a Form 1040, Form 5329 is a distinct return from the related Form 1040.
Form 5329 has its own statute of limitations date. The statute of limitations for tax required to be reported on Form 5329 begins to run when Form 5329 is filed.

[Dave W]

Bob, thank you again for your input. This is not what I wanted to hear, but it is what I NEEDED to hear. 

Now, if anyone has any innovative ideas for a "Reasonable Cause" waiver request, I am all ears!

[JudyB]

Please tell me your thinking on Roth IRAs . Thank you 

[qbteachmt]

I agree with Jeff, but the date would be 72, now. Considering all the likely growth for a side-by-side comparison for the same investments in Trad vs Roth (assuming you did this right and invested well), it sure seems a shame to pay income taxes on that Trad IRA as you take your forced RMDs. But, hey, someone has to pay to keep the country operating. Just not me.

[BobKamman]

The leading case on this issue seems to be Paschall (see link below), which is both pathetic and funny. The taxpayer got conned by a major accounting firm, Grant Thornton, into a scheme where he converted a $1+ million traditional IRA into a Roth IRA, without paying any tax on it. That happened in 2000. By the time IRS caught up with him, the statute for assessing income tax had expired, so he could laugh all the way to the bank on that one. But they assessed the 6% penalty for all the years from 2002 to 2006 when he did not file a Form 5329. Then they assessed the 25% late-filing penalty – are you figuring that in your calculations?

He argued that he did this on the advice of tax professionals, but the fact that he had paid $120,000 for that advice, which came with a guarantee that they would defend him if challenged, convinced the Court that the advice was not impartial.

The Tax Court agreed with IRS that the 5329 is a separate return, so filing a 1040 didn’t count. The opinion acknowledged that there was a line on the Form 1040 to report 5329 taxes, but noted that this line was blank. It didn’t even show a zero. Would that have mattered? I wouldn’t want to depend on that argument, and your client’s return probably doesn’t show a zero either.

The taxpayer didn’t even try to argue that the “excise tax” is subject to waiver provisions. He tried that on the late filing penalty, and it didn’t work.

I shudder every time someone uses the term “red flag” in connection with IRS processing of tax returns, but if there is anything that qualifies for this description, it’s a request for a waiver that draws attention to a tax that can’t be waived. So share that with your client.

https://www.leagle.com/decision/intco20110705a24 

[Dave W]

Bob, are you looking for work as a tax researcher??? I am looking to hire one. Thank you AGAIN for your time and expertise.

I told the clients that the @ $25,000 was the additional tax only and that I could easily see that amount being doubled with interest and penalty. It appears I may have understated the problem! Nevertheless, I've prepared 5329's for all years in question, along with 843's asking the Service to blame stupid Financial Advisor for all the clients' problems. I told clients at our meeting last week that there was no guarantee that IRS will accept our 'reasonable cause' defense. Now, I am of the opinion that their chances of getting the additional tax forgiven are slightly better than a snowball in you-know-where. I can only hope that IRS is still in the "gotta help the economy" mood if/when client decides to sign and mail 5329's/843's.

[BobKamman]

@JudyB  "Please tell me your thinking on Roth IRAs"

Are you asking me?  It's high-school math.  

C times [(1 + r  to the nth power)] times (1 - T)  -- where A is the contribution, r is the investment rate of return as a percentage, and T is the effective tax rate as a percentage

is always the same as 

[C - (C x T)] (1 + r to the nth power)

Or something like that -- it's easier to show on paper.  For example, you have $10,000 to invest and you can earn 10% on it.  In a traditional IRA, it will be $15,000 after five years. (More than that with compounding, but let's keep it simple.)  Your tax rate is 20%.  When you withdraw the $15,000 you pay $3,000 tax and have $12,000 left.  Or, you can pay $2,000 to start with, let the other $8,000 grow for five years, and you have $12,000.  

As the saying goes, six of one and half a dozen of the other. 

If you're paying annual fees to a financial adviser based on the value of the account, maybe you save money by starting out with less.  

If you're in California or New York and plan on moving to Nevada or Florida, a Roth lets you pay some state taxes that you could have avoided in retirement. 

If your retirement income is going to leave you in a 10% bracket compared to the 28% bracket while you are still employed, you are signing up for high tax rates because you ignore the lower ones in the future.

For several of my clients I have seen what I call an "Alzheimers Roth."  They have large balances in their traditional IRA, but nursing home care or home assisted living costs $60,000 to $180,000 a year.  The money comes out of the IRA tax-free.