L1: IRS ExamIn the spirit of helping others faced with the same or similar circumstance, I will go through my recent experience with an IRS Exam of my 2008 tax returns.
I am 60 yrs old and started72(t) SEPP distributions on two separate traditional IRAs I have with Fidelity and Vanguard in 2005 (55 yrs of age). To complicate matters, different methods of determining the SEPP amounts for each IRA were used. I used only Turbo Tax to prepare my returns and did not use any outside services for dealing with the IRS Exam. I did, however, find this discussion forum. It helped me see how others dealt with the IRS on this issue.
I received my noticed of Exam in May, 2010 and had the normal 30 days to respond – or pay the $8000+ in taxes and penalties the IRS said I owed. I called the IRS Exam office in Kansas City and got very little advice – other than they felt my exam was triggered by the fact that the distribution code on the 1099-Rs did not match the distribution code on the form 5329 I filed with my return. The IRS examiner I spoke with would not advise me as to what needed to be in my response. She would only say to send any and all documentation I could think of to support my claim.
In my response to the IRS I included:
A statement from Fidelity explaining that they code all 1099-R’s with a 1Û no known exception and leave it up to the taxpayer to file the 5329 to claim a 2Û for the SEPP distribution. Vanguard did not provide a statement so I sent a copy of the section of their SEPP packet that explained the same thing.
A table showing all the inputs (interest rates used, prior year-ending account values, life expectancy factors) and calculations how the distribution was determined for both IRA’s for 2008 only. For my Fidelity IRA I used the Single Life Expectancy Factor method and for Vanguard, the Fixed Amortization Method.
Documents that showed the life expectancy factors and interest rates used in the calculations.
End-of-the-year statements from the prior year (2007) to show the IRA account values used in the 2008 distribution calculation.
Copies of the 2008 1099-R’s from both Fidelity and Vanguard to show that the amount distributed agreed with my calculated amount. Note: I did not include 1099-R’s for prior years. I simply stated that the amounts distributed were determined in the same way.
I also made sure to stress in my response when the distributions began and that the required 5 year period has not yet been completed.
In addition to the above, one other piece of advice to anyone who deals with an IRS exam- always be sure to respond to the deadline the IRS states in their correspondence. I went so far as to send my replies via registered mail so I had a signed receipt from someone in their office mailed back to me for my records.
Two weeks ago I got my no changeÛ letter from the IRS stating they now agreed with my original returns or, as I told my wife, we were acquitted of all chargesÛ.
I hope this helps.2010-11-19 19:12, By: Jim, IP: [22.214.171.124]
L2: IRS ExamCongratulationsAnother case where having the right documentation probably helped the IRS reach the right conclusion.
2010-11-19 23:43, By: Gfw, IP: [126.96.36.199]
L2: IRS ExamThis is yet another case of a 1099-R code 1 triggering an audit on a 72(t) SEPP return due to IRS ignorance. It should not have been audited. It shows why so many people, including me, place a high value on any custodian who is still willing to put code 2 on the 1099-R for a SEPP: to decrease the likelihood of future erroneous audit headaches.
Some on this forum have expressed surprise that people are so hung up on the 1099-R code 1 vs 2 issue when the 5329 code 2 is all that is required. Well this case shows the reason: IRS incompetence.2010-11-20 18:02, By: kepler, IP: [188.8.131.52]
L3: IRS ExamIf everyone that had a code on 1 and completed a 5329 received an audit, there wouldn’t be enough IRS agents to handle the process.
Could the difference in codes cause the audit? Possibly. Could there have been many other reasons that caused the audit? Very possibly.
No one really knows what causes the audit and it could clearly have been luck of the draw by a mere computer program. The real key is not what causes the audit,but rather having the documentation that is needed to stop it in its tracks. Having a code of ‘2’ is not a guarantee that there won’t be an audit.
2010-11-20 18:32, By: Gfw, IP: [184.108.40.206]
L4: IRS ExamAnother factor to consider is that IRS agents trust custodian 1099R data much more than they trust taxpayers. If the IRS does not realize that most custodians are opting NOT to underwrite SEPP plans or provide exception coding, they would be justifiably concernedthat taxpayer overrides are flawed.
But by now, the sheer volume of responses to these inquiries including documentation supporting the taxpayer’s position should have triggered a reduction of inquiries OR a renewed campaign to require custodians to follow the IRS 1099R rules. They should enforce the custodian rules or change the rules if they feel the rules are too difficult for custodians to navigate.2010-11-20 18:55, By: Alan S., IP: [220.127.116.11]
L3: IRS ExamIn all fairness to the IRS, I need to add that there was another issue raised by the IRS in this exam. Since I was taking distributions from an IRA that was funded, in part, by non-deductible contributions I made between 1982 and 1997, I reduced the taxable amount of distributions by a pro-rated amount. The IRS exam said no – I would owe taxes on the full amount of the distrubution. As it turned out this issue took more explaining than the 72(t) part.I did, however, eventually prevail on this issue as well.
The IRS examiner I initially talked to said my 8606 forms (for me and my wife) were not with my return – which is odd since I filed electronically through Turbo Tax.It very well could be this is what triggered the exam and then they saw the 1099-R coding did not agreed with my 5329.2010-11-20 22:09, By: Jim, IP: [18.104.22.168]
L4: IRS ExamThanks for adding the additional data, and you are probably correct that the missing 8606 was the key to this audit. While the after tax vrs. pre tax breakdown does not affect the SEPP in any way, it does directly affect the tax bill and is therefore critical.
FYI, but not material to the main issue: Note that 1987 was the first year that IRA contributions were not fully deductible, so you could not have made non deductible contributions prior to 1987.2010-11-21 02:57, By: Alan S., IP: [22.214.171.124]
L5: IRS ExamI always submit an 8606 not only for the year of the non-deductible IRA contribution, but EVERY YEAR thereafter, whether or not tehir are any additional non-deductible contributions. I also include on on-going updated schedule listing every non-deductible IRA contribution by year, with the total agreeing to the figure on the 8606 of “IRA BASIS”.
This way the IRS, taxpayer, and I all have annual documentation of the tax status of the IRA, and we do not have to be bothered tracking back to get copies of 8606 forms and page 1 of all of the applicable years since 1987to prove that no deductible contributions were taken in those years.
I’ve never had any client’s tax return questioned on this issue, and have had only 10 client tax returns audited in 48 years of practice, most resulting in “no change”. I submit lots of documentation with the initial returns, burying the IRS in paperwork. I kid my clients that I get “paid by thepound”. ( And I don’t mean my weight.)
2010-11-21 04:09, By: dlzallestaxes, IP: [126.96.36.199]
L5: IRS ExamAlan –
You are correct. I did make contributions to the IRAs from 1982 through 1997 but, as you pointed out, only 1987 through 1997 were included in the non-deductible IRA basis. By the way – savingyear-endstatements from the IRA custodians as well as all8606 forms for the yearscontributions (and distributions)are made was very helpful.
2010-11-23 16:07, By: Jim , IP: [188.8.131.52]