Mistake!! Partial IRA rollover during 72(t)

L1: Mistake!! Partial IRA rollover during 72(t)We have a client on a 72(t) distribution schedule and are only 6 months into it. A partial rollover was made 30 days ago to a non-traded REIT, and SEPP payments are still being made from the original IRA. It appears from my research on this board (very helpful I might add), that this violates the IRS’s position on changes to the plan and now the Managed accounts firm is coding the prior distributions as early withdrawals with no exception. Obviously, this defeats the purpose of the 72(t) and now is subject to a 10% penalty.
My questions are these.
Can we undo what we have already done and not be subject to the 10% penalty?
Can we start a new 72(t) distribution schedule based on the lowered amounts in the IRA and not have any future payments assessed the 10% penalty?
Any other ideas? BTW, the client will be 58 next Feb (2011). 2010-05-28 20:45, By: Ory, IP: [68.228.93.30]

L2: Mistake!! Partial IRA rollover during 72(t)I don’t think you have much to worry about here if all the client did was a partial transfer to another IRA. While the IRS did release PLR 2007 20023, they never explained the rationale for their ruling, and therefore this is considered an aberration. Thousands of partial transfers have been done without any problems whatsoever. As for the coding, the majority of custodians no longer offer the exception code on the 1099 R for various individual reasons, and the taxpayer simply attaches Form 5329 to claim the SEPP exception (Code 02). Accordingly, the attachment of the 5329 does not constitute a “red flag” to the IRS either.Therefore, there is no need to attempt a reversal of the transfer unless the client has investment concerns about the REIT. As a direct transfer, there should not even be a 1099R or a 5498 generated by the two IRA custodians other than the 1099R for the amount actually distributed. Client should just continue to distribute the correct annual SEPP distribution from the original IRA account.2010-05-28 21:28, By: Alan S., IP: [24.116.165.60]

L3: Mistake!! Partial IRA rollover during 72(t)That is great to hear. I figured as such, since the IRS would essentially be restricting your investment decisions and limiting you to some extent. This move was done to diversify his investment holdings a bit more and reduce his downside exposure, not to skirt any rules. I don’t think it would stand up in a dispute since the intent is to keep annual distributions the same, not limits to what you can or cant do with your money. Look forward to other responses as well. 2010-05-28 21:39, By: Ory, IP: [68.228.93.30]

L4: Mistake!! Partial IRA rollover during 72(t)One concern is the “non-traded REIT” because of the problem of valuing it every 12/31, and its illiquidity. He will have to make sure there is adequate cash flow from income, or he will have to sell some of the IRA investments. However, he should be aware that he can make “distributions in kind” (i.e. distributing an investment rather than cash), but I would expect that he needs cash, otherwise he would not have started “early distributions”.2010-05-29 03:41, By: dlzallestaxes, IP: [72.78.110.86]

L5: Mistake!! Partial IRA rollover during 72(t)Document that your “SEPP Universe” has expanded to include the Non-traded REIT, which I assume is in a separate IRA account. Distributionsshould continue at the same rate from the original IRA account.Now you have to decide how to handle the income distributions from the REIT … are they being reinvested into more shares of the REIT or being paid out in cash? If reinvesting then you have nothing extra to worry about. However, if the income is being paid out in “cash” then you have two options to deal with. The REIT custodian will either send you a check or EFT into the client’s checking account, or will establish a separate IRA account and typically invest it into a money market fund, inwhich case it’s no problem. If they are sending a check then you will have to take this into account along with the other IRA distributions to be sure the correct annual amount is distributed each year… no more and no less. Jim2010-06-01 15:24, By: Jim, IP: [70.167.81.119]

L6: Mistake!! Partial IRA rollover during 72(t)”If reinvesting then you have nothing extra to worry about” -The moneys in the REIT are being reinvested, so no income is being paid out at this time and there is no plans to do so in the future.
Sounds like we are in good shape on this issue, but was wondering if anyone has been audited regarding this issue and what the outcome was. If you came out in the clear, how did you prove that the partial rollover didn’t violate the 72(t) rules?

“While the IRS did release PLR 2007 20023, they never explained the rationale for their ruling, and therefore this is considered an aberration.” -Is this something that most CPA’s will be comfortable with? Is an aberration a common viewpoint for unsubstantiated reasoning? Will it stand up in an audit? I just want to be able to explain this to the client now vs. tax time and having a less than knowledgeable CPA cause unneeded concern with the client.
“However, he should be aware that he can make “distributions in kind” (i.e. distributing an investment rather than cash), but I would expect that he needs cash, otherwise he would not have started “early distributions”.
-the client does not need the income from this REIT because his income is coming out of the IRA’s we had already set up. All distributions are reinvested back into the fund and do not add to his income.

Again, great site and wish I had found this earlier in my career. 2010-06-01 22:08, By: Ory, IP: [68.228.93.30]

L7: Mistake!! Partial IRA rollover during 72(t)Ory,With respect to the partial transfer, I described it as an “aberration” based on the following events:1) Several years of partial tranfers with no IRS challenges2) Out of the blue comes 2007-200233) Don’t know if you saw this article posted here. Bill Stecker is an authority on 72t plans and requested a formal explanation from the IRS. He did get an answer, but it was not a meaningful answer as you will see in this link to the article: http://www.72t.net/Articles/ArticleShow.aspx?WA=ca625daf-c846-41a4-a730-83918da50e434) Following 2007-20023, there were probably a few cases where risk averse SEPP participants avoided such transfers, but for the most partthese partial transferscontinued for the most recent 3 years without any further problems from the IRS.Based on the above, this ruling can be taken with a large grain of salt, although the consensus here is that a negligible element of risk remains such that a partial transfer should only be done if there is a real benefit from doing so. In any event, in your situation here, undoing the transfer would not erase the problem if one ever developed and if fact would produce another such transfer and add complexity.The reinvestment of REIT dividends is also a positive in that additional distributions do not have to be dealt with such that the total SEPP distributions remain correct on a calendar year basis. This plan should be completed without incident as long as no other infractions are committed.2010-06-01 22:45, By: Alan S., IP: [24.116.165.60]

L8: Mistake!! Partial IRA rollover during 72(t)Thanks Alan S. for the great advice. 2010-06-01 22:49, By: Ory, IP: [68.228.93.30]

L9: CPA recommendations..The client is on board with this as I suspected, but his accountant is not so sure. Does anyone have any recommendations for someone in the Orange County, CA area that has some level of expertise in the 72(t) realm? Anyone one this board?2010-06-02 21:25, By: Ory, IP: [68.228.93.30]

L10: CPA recommendations..Can’t help with the referral, but am curious what the accountant would recommend. Accountant could be thinking that the the SEPP is so new that it wouldcurrently costvery littleto report the plan as busted and then start another SEPP plan currently. 10% would be due on distributions taken to date, and the interest portion would be very small. This might be a viable idea if the level of distributions for the original plan do not fit client’s needs and therefore client could be forced to bust the plan at some point during the next 4 plus years. On theslim chance that the IRS does have a problem with the partial transfer or anything else about the plan he may have identified as incorrect, then by the time the IRS contacts the client, a couple more years will probably have passed with many more dollars subject to penalty and interest. I could understand this approach if the client has problems sleeping because of this, but otherwise it seems like an unnecessary expense.Or perhaps accountant has a totally different perspective?Note: If client ends up with a busted plan, only the distributions taken prior to age 59.5 will be subject to penalty, even though an error made after 59.5 but before the plan modification date (5 years)would trigger that penalty.2010-06-02 22:24, By: Alan S., IP: [24.116.165.60]

L11: CPA recommendations..Since the client doesn’t need to depend on income from the REIT and willmake all SEPP Plan distributions from the other IRA, then you need to be aware of a potential problem that can arise with the REIT.Sometimes non-traded REIT’s will sell some of the properties and make a one-time distribution of the sale proceeds. If this happens then your client will probably receive a check for this distribution amount. Thisamount will have to be taken into account and adjust the distribution from the other IRA account for the year of the REIT distribution. Normally the client will receive advance notification of this one-time distribution so you can make the necessary adjustment. BE SURE YOUR CLIENT IS AWARE OF THIS POTENTIAL SITUATION AND TO BRING ANY COMMUNICATIONS FROM THE REIT TO YOU TO EVALUATE!Another annoyance with non-traded REIT’s is the “raiders” who try to purchase a client’s shares “for a song” … and a very bad song at that …by painting a dismal picture of the original REIT company which is a bunch of bunk. This is the second caution you need to be aware of and get ready to spend a lot of time explaining to your clients what’s going on. If you have a lot of clients in non-traded REIT’s, this action alone will drive you nuts! I speak from experience!Good luck.Jim2010-06-03 13:46, By: Jim, IP: [70.167.81.119]