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L1: IRS SEPP AuditI have not posted here before but have read the information on this site. I thought some of you might be interested in this. I had been looking at an SEPP since the late 1990’s and I have two friends who have completed their SEPPs. My 2008 tax return was audited because I’m now taking an SEPP. Fortunately the outcome for me was a “No Change” letter but they sure put me through the wringer for the last 9 months. I started my SEPP in November 2007.
I received the audit notice in early December 2009 from the IRS saying they didn’t think I was taking an SEPP and stated I could provide them with a revised 1099-R form Vanguard (my IRA custodian) to show them I was. Like others have stated here, Vanguard does not enter anything other than reason 1 on the 1099-R. The IRS gave me no other information as to why they didn’t think I was not taking an SEPP. Neither my enrolled agent or myself had any idea what they wanted. I tried to call the toll free number they gave on their letter but there was no answer and no voice mail. After several days I gave up on that. I ended up sending them a copy of the 5329 form that was filed with my 2008 return. They gave me a month to respond.

I received a form letter from the IRS in February saying I would hear from them in early March. Indeed I received a letter from them along with forms saying how much they calculated I owed. The letter also said they didn’t believe I was taking an SEPP because my IRA withdrawals for 2006 – 2008 were not equal. The gave me one week to respond. Of they were not equal because I only had 2 months in 2007 and 2008 was the first full year. I sent them copies of my Vanguard statements for those 3 years detailing why the years were not equal and calling their attention to the equal monthly distributions.

I received a couple of letters from the IRS delaying their response. In early June I received a phone call from an IRS agent. He said they agreed I was taking equal payments but now wanted to see the “actuaries” (i.e the calculations) I made so they could be sure I was not taking larger payments than I was entitled to. He said he would send out a letter to me requesting this information and if I showed I was not taking too much that they would lift the penalty. I said I wouldn’t wait for the letter but I’d get my response out to this phone call ASAP.

I sent them a very detailed letter referencing paragraphs in IRS Revenue Ruling 2002-62. I had selected the amortization method to calculate my maximum withdrawal. I put that formula in the letter and then referenced RR 2002-62 for each variable in the formula to show them I had followed the rules exactly and that I had selected an interest rate much lower than what was allowed back in October 2007. I also provided a copy of the interest rate table and the life expectancy table. I also performed a “worst case” calculation for them using the year’s lowest IRA balance, the alternate life expectancy table that has a longer life expectancy, and the lowest interest rate to show them I was still taking less than allowed.

On June 28th the promised letter arrived and it gave me one day to respond. So we went from a month to respond, to a week to respond, to a day to respond. A troubling aspect of this letter was that it implied that they believed that once an SEPP was started, you had to take it for your life expectancy, 31.4 years in my case! I quickly put together another letter referencing RR 2002-62 explaining that the rule was 5 years or age 59 1/2, whichever was later.

A week later I received a certified letter from the IRS telling me to pay or go to tax court. No mention was made of the detailed letter I had sent them in June. At this point I contacted the local Taxpayer Advocate and got started with them. I sent her all the information I had sent to the IRS. She said I’d hear from her by August 31.

Fortunately though, in the last week of August I received a form letter from the IRS saying they were making “no change” to my 2008 return and that they had closed my case. The Taxpayer Advocate also called me to tell me the case had been closed.

In retrospect, the best I can tell, the audit was triggered because the 1099-R reason for exemption from the 10% penalty (#1) did not agree with the reason on the 5329 from (#2). The IRS kept asking for a revised 1099-R and I kept telling them that Vanguard could not provide that.

I have no advice on how not to get audited. Just hope you don’t. It was the most anxiety ridden 9 months of my life.2010-09-03 02:05, By: Chuck, IP: []

L2: IRS SEPP AuditThank you for such a detailed explanation of what the IRS put you through. Fortuneately, this is not typical and I really don’t think the 5329 triggers these since there are now very few custodians coding the 1099R with the exception code. But those of us who post here will find your story quite educational and we appreciate this post.
Actually, itsounds like your return was chosen strictly by chanceand then referred tocertain IRS staff who had no clue as to what they are doing with respect to 72t plans. Not only that, but the general way they conducted this inquiry is demeaning and unproductive if taxpayers are to expect that the IRS operate with some degree of efficiency.
It also seems that in some cases, providing the IRS with too much detailed info overwhelmsthem, and while it is tempting to include every detail to try to make the problem go away, often we find that “less is more” and trying to anticipate their next question is actually counter productive becauseit assumes a logical thought pattern on their part.
A potential problemwith your case it that it could discourage people from undertaking a 72t plan. But most people do not experience what you did. However, it does serve as areminderthat an ordeal can be triggered by electing overly complex 72t plans. It shows that simple is best if at all possible since a simple plan is more likely to be understood by the IRS as well as being less likelyto incuran actual error in ution.
Thanks again.
2010-09-03 03:16, By: Alan S., IP: []

L3: IRS SEPP AuditThanks for your story. I have a question – What is the taxpayer advocate able to do that you were not able to do? What magic pixie dust do they possess that you were not able to get ahold of? Or do they, by intervening, make the IRS aware that you are not going to back off and the IRS then forwards your case to a group that actually knows what an SEPP is?
When you called the advocate, were they completely familiar with an SEPP plan already?2010-09-03 12:30, By: mikex, IP: []

L4: IRS SEPP AuditThe TAXPAYER ADVOCACY SERVICE ( TAS ) is an “all powerful” watchdog over the operations of the IRS. Nina Olsen is the NATIONAL TAXPAYER ADVOCATE, and there are offices around the country. She issues a report to Congress semi-annually, highlighting problems that IRS should address in their operations. The only more influential group to get IRS to correct a matter is Congressmen.
Tax Practitioners go first to the PRACTITIONER PRIORITY SERVICE ( PPS ) ( formerly the Practitioner Hotline) to try to resolve issues that IRS auditors, agents, etc. do not handle properly. PPS usually gets it resolved within 60 days, depending upon their workload.
Tax practitioners are permitted to contact TAS only after the IRS or PPS have not resolved an issue within a reasonable time. TAS almost always gets the issue resolved within their 30 day deadline.
TAS utilizes IRS technical specialists whenever necessary in specific situations.2010-09-03 15:26, By: dlzallestaxes, IP: []

L4: IRS SEPP AuditGood questions and I can’t completely answer them because the Taxpayer Advocate route didn’t completely run its course before the IRS closed my case. In the end I don’t think they really did anything other than forward a copy of all my information I had already sent to the IRS. Supposedly they were to take an independent look at my case and make an unbiased recommendation. That did not happen and I was dismayed when they told me they were just forwarding my paperwork to the IRS.

On the form I filed with the Taxpayer Advocate they ask what you want them to do for you. I told them I wanted to talk to someone familiar with SEPPs and who had the authority to make decisions so we could go over any issues and get this settled. That never happened.

The whole issue boiled down to just two question. Was I taking equal payments and had I not exceeded the maximum allowed? It took the IRS 6 months to ask those questions and another 3 to decide I was doing it correctly. If someone familiar with SEPPs had called me back in December 2009 I could have answered those questions in one phone call.2010-09-03 15:27, By: Chuck, IP: []

L5: IRS SEPP AuditAlan S.I agree with you; simple is better.
I was audited this year for 2008.Sent them the calculation sheet done by the plan custodian when the 72t was established and after 6 weeks of nail biting IRS agreed that all was OK.
Started at the first of the year so amount withdrawn year-to-year agrees to the penny. Don’t mess with a good thing!!
State also questioned it two years ago and they had no argumentafter receiving our straightforward documentation either.2010-09-03 23:47, By: JB, IP: []

L6: IRS SEPP AuditWhat state – CA? (CA has 2.5% early withdrawal penalty).2010-09-04 03:43, By: Alan S., IP: []

L7: IRS SEPP AuditState was AR. They wanted 1% for early withdrawal.2010-09-04 13:25, By: jb, IP: []

L6: IRS SEPP AuditIf I implied I was sending them complicated documentation then I misled you. I only sent them documentation to answer their questions, nothing more. I sent them a copy of the 5329 we filed in response to their first letter because they asked for a revised 1099-R which I couldn’t get. In their second letter they wanted me to show I was taking equal payments. I sent copies of my Vanguard statements to show them I was. In their third letter they asked to see the calculations I had performed to arrive at the yearly sum I was taking. I sent them those calculations referencing RR-2002-62 to show that I was following the rules. I don’t think there was much less I could have sent them and still have answered their questions.
The 3rd request was probably the most frustrating because they had all the information at that time to answer their own question if someone had just plugged the numbers into the formula.2010-09-04 15:28, By: Chuck, IP: []

L7: IRS SEPP Audit>>I sent them a copy of the 5329 we filed in response to their >>first letter because they asked for a revised 1099-R which I couldn’t get
Based on the comment above, my guess is that the IRS audit was caused by a 1099 using a code of ‘1’ and that when you filed your 1040, you didn’t include the 5329 to claim the exemption – or did I misread your post?2010-09-04 16:20, By: Gfw, IP: []

L8: IRS SEPP AuditA 5329 was filed with my return each year since I’ve been taking my SEPP. The 1099 was coded “1.” The 5329’s were coded “2.”2010-09-04 18:58, By: Chuck, IP: []

L9: IRS SEPP AuditThisseems trivial and may not even matter, but the IRS computer will be looking for a two digit entry on the 5329. Using “2”might createa flag you don’t want created.
All the self assigned Form 5329 exception codes are two digit entries from 01 to 12. The one you want here is “02”. 5329 codes are a different series than 1099R codes even though you are altering the 1099R coding in Part I of Form 5329.
Of course, the “2” is what you would have liked to receive on your 1099R, but custodians are more and more inclined not to use this code for SEPPs.
2010-09-04 21:35, By: Alan S., IP: []

L10: IRS SEPP AuditAfter reading this post, I wonder if there will be a problem if annual recalculation is being used for the SEPP. Also, the IRS (just by reviewing the return) can’t tell if the annual amounts for the SEPP are the same because multiple exceptions can apply. For example, you might have an exception for SEPP and also for education expenses. Both are valid exceptions. In this case for coding for 5329 would be a ” 12 ”
2010-09-10 13:25, By: Garyrt, IP: []

L11: IRS SEPP Audit>>After reading this post, I wonder if there will be a problem if annual recalculation
Probably not a problem. There have been a few PLRs since 2002-62 allowing annual recalculation.
If you are using multiple exceptions from teh same account (ex SEPP & Education) you do so at your own risk and you should know in advance that you will probably get flagged.2010-09-10 14:14, By: Gfw, IP: []

L12: IRS SEPP AuditGordon:
They could be from different IRA’s. For example, distributions from one IRA are all SEPP and no other distributions are made from that IRA. A distribution is made from a different IRA for education expenses. Both are valid. The Form 5329 would be coded as ” 12 “. Correct?
2010-09-10 14:21, By: Garyrt, IP: []

L13: IRS SEPP AuditGary,
Correct and good point.
This is where the 5329 instructions do not anticipate questions due to abbreviated inforequested fromthe taxpayer. You would think that they would request a breakdown for the Code 12 total by exception type. I would advise attaching a statement with that breakdown to the return or attaching a different 5329 for each exception if doing a paper return. I doubt that any software will support more than one 5329 per taxpayer SSN.2010-09-10 18:46, By: Alan S., IP: []

L14: IRS SEPP AuditI think that my software, CCH PROSYSTEM FX supports multiple 5329 forms. I had someone with 2 1099-R forms with early distributions, which were taxable, but I do not remember if 2 5329 forms were generated or just 1, because they were both the same reason for taxation, not exclusion.2010-09-10 21:35, By: dlzallestaxes, IP: []

L15: IRS SEPP AuditMy only concern in filing multiple F5329 is if the IRS data conversion program will allow entry of two forms for the same taxpayer ( or SSN ). If it will not allow multiple entries, I would be concerned that all the required infomation would not be input. In that case, it would be better to have one form that had exception code 12.2010-09-10 22:08, By: Garyrt, IP: []

L16: IRS SEPP AuditPerhaps. Don’t know whether 2 forms per SSN would cause any IRS entry issues. Since most people and all preparers use software, the code 12 with explanatory statement including the breakdown is probably the way to go.
On all the forums where I post, I have yet to see any posts with respect to problems with the Code 12 selection.2010-09-10 22:33, By: Alan S., IP: []

L17: IRS SEPP AuditI have a question for Chuck, the OP: Did you use a tax preparer? If so, what kind? If not, what sort of software, if any, did you use?2010-09-12 05:13, By: Eureka, IP: []

L18: IRS SEPP AuditEven though I am a CPA, let me give you some perspective on the area of tax preparers.
1. Just because someone is a CPA, it does not mean that he knows everything, or anything, about taxes, let alone SEPP 72-T. Many CPAs are actually accountants (preparing financial statements, and if a sole practitioner, then probablybusiness tax returns and individual tax returns), or auditors who work for larger firms ( in which case they rarely, if ever, prepare tax returns).
2. Another category of tax preparers are “public accountants” ( PAs), who are similar to CPAs, except that they never took or passed the CPA exam. The exam is more about financial statements, accounting, and auditing, than about taxes. They are usually sole practitioners, and very knowledgeable about individual taxes, but not necessarily SEPP 72-T.
3. Enrolled agents are tax specialists, who rarely know much, if anything, about financial statements, accounting or auditing. They must pass an exam given by the IRS. They are well-versed on taxes, but not necessarily on SEPP 72-T.
4. Partners in regional and large CPA firms rarely prepare tax returns, but have staff accountants prepare the tax returns, and they have absolutely no idea what SEPP 72-T plans are.
5. When I do presentations on retirement planning, the audience of CPAs and Public Accountants usually have blank stares or yawn when I mention or discuss SEPP 72-T or NUA, including other presenters about taxes.
6. If you do your own taxes, the tax software rarely will guide you in the area of SEPP 72-T, other than form 5329, and if applicable, form 8106 ( re non-deductible IRA contributions).
7. Your best source of a qualified tax preparer in this area is a personal referral from someone else who has gone thru SEPP 72-T.
8. Retirement and Tax planning are an integral part of the SEPP 72-T process.
I hope that this information is helpful. By the way, tax preparers have clients thruout the country, even though their practice may be “local”. Do not think that you have to find someone “nearby”. For example, this past year I was contacted by a couple of constables from Pittsburgh, 300 miles away, who had heard my presentation on special tax provisions that affect them, and I got them each $ 15,000 in refunds because their local tax preparers did not know about this special provision. The knowledge of the tax preparer is more important than his location.2010-09-12 14:11, By: dlzallestaxes, IP: []

L19: IRS SEPP AuditAfter reading the post for the third time, I see Chuck used an enrolled agent.2010-09-12 19:05, By: Eureka, IP: []

L19: IRS SEPP AuditMinor clarification on your point #6: it is form 8606, not 8106, to report non-deductible IRA contributions.2010-11-19 16:04, By: Jim, IP: []