Charging a Fee For a Direct Rollover of IRA Funds to a 401(k) Plan

Posted by James M. Carlson
Jul 21 2014

A financial institution should consider instituting a fee if it agrees to directly rollover a customer’s IRA funds to his or her account within an employer’s 401(k) or 403(b) as discussed in the following email situation/question. It is only logical and right that a financial institution receive a reasonable fee for helping a customer when it agrees to issue a check directly to the 401(k) plan. You are helping your customer and also the 401(k) plan.

Technically, a direct rollover cannot occur between an IRA and a 401(k) plan as the law defines a direct rollover as only being between an employer sponsored plan and an IRA. But the IRS has adopted the rule that the reporting rules applying to a direct rollover from a 401(k) plan to an IRA are also to be used if the funds move from an IRA to a 401(k) plan.

The email question/situation:

Question regarding an IRA rollover from our bank to the customer’s 403b retirement plan. Assume the best is to issue a check directly to the customer and code the 1099-R as a G code? The customer will have to sign an IRA distribution form?

Please let me know if this is correct?, I have not had a request like this before, it is usually the reverse from a retirement plan into an IRA at the bank. Thanks so much for your help!

CWF’s answer/response:

The easiest approach for the bank is to issue the check to her and you would use code 1 if she is under age 59½ and 7 if she is over age 59½. You treat it as a normal distribution. Then she makes a rollover contribution to the plan.

The tax code does not require an IRA custodian to issue the check to the plan. However, many plans require the check to come from the IRA issued to the plan since this simplifies the plan administrator’s administrative concerns regarding accepting a rollover contribution.

If your institution decides to be nice and accommodate your customer, you will issue the check to ABC 401(k) Plan fbo Jane Doe. Use CWF’s Form 69 or a similar form as prepared by the plan administrator. And then you would use the reason code G in box 7 of the Form 1099-R. When G is used box 2, taxable amount, is to be completed with 0.00 as you know the amount the is non-taxable as you sent the funds directly to the plan. As you indicated it is the reverse of a direct rollover coming from a pension plan to an IRA.

An IRA custodian may have a fee for this special service as long as it has been disclosed. Like with transfer fees, we expect many customers would be willing to pay a fee for this special service.

Categories: Pension Alerts, Traditional IRAs

No Bankruptcy Exemption For Funds Within an Inherited Individual Retirement Account

Posted by James M. Carlson
Jul 21 2014

Those who work in the legal profession like to think the law is primarily logical and efficient. After all we are a nation of laws rather than individuals. We tend to forget that laws are enacted by politicians with input from their constituents. Many times there are self-serving motives. And sometimes judges do not like the laws which they must interpret and enforce or at least they see flaws needing to be corrected. Rather than have the legislature correct such flaws, sometimes courts choose to correct such flaws by a court ruling.

In 2005, the federal bankruptcy laws were changed. One major change dealt with credit card debt. It is now much harder to eliminate credit card debt by a bankruptcy filing. A second major change dealt with increasing the amount of funds in retirement plans and IRAs that a person could exempt from his or her bankruptcy estate. In general, the limit for IRAs is now $1,000,000 and the amount for funds in an employer sponsored pension plan is unlimited.

The public policy of the bankruptcy laws is that a person should be able to provide for himself or herself during their retirement years. However, the granting of such a large exemption for IRAs and pension plans means that many times creditors are left unpaid when an individual files for bankruptcy. Some people, including many judges, would consider such a large exemption amount to be contrary to the legal framework for bankruptcy. Yes, a person should be able to have a fresh start after incurring financial difficulties, but creditors are still entitled to be paid a reasonable and fair amount and that an individual should not have a “free pass” to an unfettered new and improved financial health.

The U.S. Supreme Court recently decided the case, Clark v. Rameker. Ms. Clark had inherited an IRA from her mother with an original balance of approximately $450,000 in 2001. The amount in her inherited IRA was approximately $300,000 when she filed for bankruptcy in October of 2010. Rameker is the bankruptcy trustee and has argued that Ms. Clark is not entitled to exempt the $300,000 from her bankruptcy estate. The bankruptcy court adopted the trustee’s position that Ms. Clark was not entitled to the exemption. Ms. Clark then appealed to the District Court. The District Court reversed the decision by ruling that Ms. Clark was entitled to exempt the amount in her inherited IRA. The trustee then appealed to the 7th Circuit Court of Appeals that which reversed the District Court. Since there had been split decisions in the circuit courts, the Supreme Court agreed to rule on the case to settle the issue.

The U.S. Supreme Court affirms the 7th Circuit position of no exemption for inherited IRA funds.

The legal analysis and rationale. The U.S. Supreme Court ruled, by a unanimous vote, that “The text and purpose of the Bankruptcy Code makes clear that funds held in inherited IRAs are not retirement funds within the meaning of section 522(b)(3)(C) is bankruptcy exemption.” Justice Sotomayer wrote the court’s opinion.

As discussed below, the U.S. Supreme Court had to strain the law to reach the result that allowed the bankruptcy trustee to win and Ms. Clark to lose.

How does Bankruptcy Code section 522(b)(3)(C) read ?

Bankruptcy code section 522(b)(3)(C) provides an exemption for “(C) retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.” Code section 401 defines the laws for a qualified plan. Code section 403 defines the laws for tax sheltered annuities. Code section 408 defines the laws for traditional IRA and IRA annuities. Code section 408A defines the laws for Roth IRAs and Roth IRA annuities.No Bankruptcy Exemption For Funds Within an Inherited Individual Retirement Account

Note that there is no special tax code section for inherited IRAs. An inherited IRA is not a special type of IRA as the court tries to define it. An inherited traditional IRA is simply one that comes into existence after the IRA accountholder dies.

Also note that there is no express indication that the retirement funds must be the retirement funds of the bankruptcy debtor. This is what one expects when one has funds in a 401(k) plan or an IRA. These funds are within a legal and tax entity independent of the individual’s will or estate. There is a 401(k) plan agreement or an IRA plan agreement which requires the individual to designate one or more primary beneficiaries. Such plan indicates that the beneficiary acquires his or her share upon the death of the participant or IRA accountholder.

Notwithstanding that the account is called an inherited individual RETIREMENT account, the U.S. Supreme Court on June 2, 2014, ruled that funds within an inherited IRA are not retirement funds within the meaning of Bankruptcy Code section 522(b)(3)(C).

Federal bankruptcy laws allow an individual to exempt certain property from his or her bankruptcy estate. This is property he or she is allowed to keep after the bankruptcy and that cannot be claimed by the bankruptcy trustee. The approach of the bankruptcy laws is to give a person the ability to have a fresh start after incurring financial difficulties. Of course, there should be and there are limits as to the ability of a person not to pay his or her debts.

The attorney for the bankruptcy debtor argued that Bankruptcy code section 522(b)(3)(C) was clear – funds within any traditional IRA, including an inherited traditional IRA, as established under Code section 408 were entitled to the exemption. The District Court in this case, the Fifth Circuit in a different case and the Eighth Circuit in a different case had the same understanding. The rationale of the District Court was that the exemption covers any account containing funds originally accumulated for retirement purposes. This is consistent with the legal operation of a traditional IRA. It is a special tax-preferred revocable trust. It has two express purposes. Contributions and the investments will be used for the retirement of the IRA accountholder and then after his or her death will be used to benefit the designated beneficiary over a time period which may be as long as the life expectancy of the beneficiary.

The U.S. Supreme Court reached a different conclusion. In order to be entitled to claim the exemption of Bankruptcy Code section 522(b)(3)(C) , the court ruled that an individual has to meet two requirements, not just one requirement. First the funds must be retirement funds. Second, such funds must have been in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986.”

The U.S. Supreme Court wrote that the two words “retirement funds” as set forth in Bankruptcy Code section 522(b)(3)(C) mean more than just funds in the enumerated tax code sections. A cardinal rule of statutory construction is, “a statute should be construed so that effect is given to all its provisions, so that no part will be in operative or superfluous. The first six words, “retirement funds to the extent that” in order not to be superfluous must have a meaning or purpose independent of the enumerated sections.

The court then found that since there was no definition of “retirement funds” within the Bankruptcy Code that it must define the term and it did so. It defined retirement funds as sums of money set aside for the day an individual stops working.

The court then reasoned that there are three principal reasons why inherited IRA funds are not retirement funds. First, the beneficiary is unable to make any additional contributions. Second,No Bankruptcy Exemption For Funds Within an Inherited Individual Retirement Account the required distribution rules apply to an inherited IRA and distributions must be taken long before retirement age. Third, the 10% penalty tax does not apply to a beneficiary and so the beneficiary is able to take a distribution at any time and use the funds for current consumption. It is this later reason which seems to have influenced the court’s decision the most. The court stated its dislike for the possibility that a person who has an inherited IRA could file for bankruptcy, claim the exemption for retirement funds and then after the bankruptcy has been granted eliminating his or her debts immediately withdraw funds from the inherited IRA for personal consumption reasons. In essence the debtor would have a free pass which is not the intent of the Bankruptcy laws. The court was unwilling to give this free pass.

Additional Litigation

There will be additional litigation by bankruptcy trustees as a result of his case. The U.S. Supreme Court has made clear it is receptive to consider cases involving whether or not - the exemption of Code section 522(b)(3)(C) is available to a bankruptcy filing.

This case settles the issue with respect to an inherited traditional IRA.

The case of In Rousey v. Jacoway, settled that a traditional IRA was a retirement account within the meaning of Bankruptcy code section 522(b) (3) (C) and was entitled to be exempted from the individual’s bankruptcy estate.

When one reads this case, one certainly has the idea that an inherited Roth IRA would also be found to not be retirement funds for bankruptcy Code section 522(b)(3)(C) purposes.

What about standard Roth IRA funds? Although we expect that the rules of Rousey would apply to a Roth IRA and the exemption would apply, this issue has not been firmly settled. One can expect that a bankruptcy trustee will make the argument that Roth IRA funds are not retirement funds since the Roth IRA accountholder never has to take a distribution while alive.

What about inherited 401(k) funds still within the 401(k) plan? One can expect a bankruptcy trustee to argue that inherited 401(k) funds also are not retirement funds within the meaning of Bankruptcy Code section 522(b)(3)(C). ERISA protects such funds from creditors, including a bankruptcy trustee, as long as such funds are within the 401(k) or other pension plan. Many 401(k) plans have been written to require an inheriting beneficiary to withdraw or direct rollover his or her inherited funds within a short time period.

This bankruptcy ruling is going to result in more IRA accountholders seeking legal and tax advice regarding whether a trust should be the IRA’s designated beneficiary rather than directly naming family members and other individuals.

Additional Legislation.

This case is going to make people nervous. Congressional representatives will hear from their constituents that a person who has inherited an IRA should be able to exempt a reasonable amount from his or her bankruptcy estate. If the definition of retirement funds needs to be changed, then it should be changed. What amount is reasonable will need to be discussed and settled.

In summary, the unanimous decision by the U.S. Supreme Court in Clark v. Rameker was surprising. Although an inherited IRA is certainly a retirement account for tax purposes, it is notNo Bankruptcy Exemption For Funds Within an Inherited Individual Retirement Account retirement funds within the meaning of the Bankruptcy Code. Code section 522(b)(3)(C) did not seem so unclear that it needed to be rewritten by the Court, but that is what the Court did. The Court simply could not condone a bankruptcy debtor claiming an exemption for funds within an inherited IRA and then once the bankruptcy filing was finalized (and debts extinguished) to be able to take immediate distributions from the inherited IRA for any personal consumption purpose. Time will tell if Congress will choose to define more specially what funds qualify as retirement funds for purposes of the exemption. We expect there will be new legislation in 2014-2015.

Categories: Pension Alerts, Traditional IRAs

What is the status of myRA ?

Posted by James M. Carlson
Jul 21 2014

Presumably, the IRS on behalf of the U.S. Department of the Treasury is in the process of developing what is needed to implement and administer the myRA program. There will need to be created myRA plan agreements, investments and computer software.

In January of 2014 the U.S. Department of Treasury announced that it was developing the myRA (“My Retirement Account”) program. This was discussed in the February 2014 newsletter. You may find this article at www.pension-specialists. com/myra.pdf

The U.S. Treasury stated that it will begin rolling out the myRA forms and procedures in late 2014. This means after the November 4th elections. It will be possible for eligible employees of participating employers to enroll by signing up for a myRA account online.

It is presently unclear if an individual’s contributions would be invested in an investment created and administered by the U.S. Treasury or whether the U.S. Treasury would select various financial institutions to serve as the myRA custodian or trustee. An employer’s duties under this program would be limited to sending by direct deposit the contribution amounts withheld from employee paychecks to each employee’s on-line myRA. Once the U.S. Department of the Treasury furnishes the promised guidance, we will inform you.

Categories: Pension Alerts, Traditional IRAs

U.S. Government Enters the Roth IRA Business with myRA !

Posted by James M. Carlson
Jun 12 2014

The Obama administration has done many things to expand the role of the federal government in the lives of ordinary Americans, but it has recently taken a giant step forward so that the federal government can take a more active role with respect to retirement savings and investments.

The United States is going into the IRA business, more specifically the Roth IRA business. myRA is a Roth IRA, nothing more and nothing less. The Treasury Department does not make this fact as clear or as transparent as it should. There is no discussion that the maximum contribution amount for a person younger than age 50 is $5,500, for a person age 50 or older is $6,500 and that these limits are reduced by other IRA contributions. There is no discussion of the fact that an individual’s maximum contribution amount is reduced when his or her MAGI is in the range of $114,000-$129,000 and $181,000 to $191,000. There is no discussion that a person must have compensation in order to make a contribution to a myRA just as if he or she must have when making a contribution to a Roth IRA.

Rather than investing a person’s Roth IRA contributions in a time deposit, certificate of deposit, or savings accounts as offered by an FDIC insured financial institution or other non-insured investments as offered by investment firms, the myRA contributions will be invested in a special investment or deposit account that “will earn interest at the same variable rate as the Government Securities Investment Fund in the Thrift Savings Plan for federal employees.“ myRA’s will be backed by the full faith and credit of the United States.

The U.S. Department of the Treasury will either administer the myRA Program itself or hire a financial institution to serve as the Roth IRA custodian/trustee and administer these accounts. Under current law, the governing IRA regulation does not authorize the U.S. government to serve as an IRA custodian/trustee. Late 2014 is the tentative goal of the Treasury to implement the myRA program. Most likely this program will not be implemented until after the November 2014 elections. Many new forms will need to be written for the myRA and computer software will need to be developed and tested.

The main features of the myRA program are:

  1. Small contributions may be made. An initial contribution of $25 is required and subsequent contributions would need to be $5.
  2. No administrative fees would be charged – opening, closing, transferring, distributions, investing, etc. A guarantee is given that there may be no investment loss.
  3. myRA is initially to be a payroll deduction program. That is, the individual cannot make his or her contributions via the web. Rather, the individual’s employer must withdraw the contribution amount from each individual’s payroll and that day the employer will send a direct deposit to each participating employee’s myRA. The employer’s role is limited to providing information to its employees as to how the myRA program works, having the employee complete a form as to how much is to be withheld and then transmitting such myRA contributions. An individual would sign-up online.
  4. Distributions may be taken at any time. It will be interesting to see if a person will be able to withdraw funds online. Rollovers will also be permitted. Additional guidance will need to be furnished by the IRS. An individual will be able to voluntarily roll over his or her myRA to another eligible retirement. Under current law, the only plan to which Roth IRA funds may be rolled over to is another Roth IRA. Presumably, the only plan that myRA funds may be rolled over to is a Roth IRA. Once the balance in the myRA reaches $15,000 or after 30 years, the balance in the myRA must be rolled over to a Roth IRA as authorized by current law. The Treasury Department seems to give the impression that there might be other private sector retirement accounts that could accept such a rollover. There is no discussion of transferring funds from a myRA to a Roth IRA.

What is the Obama administration and the current Treasury Department leaders trying to accomplish by creating this myRA program?

The Obama administration does want more individuals to save for retirement. This is an important public purpose. The reality is, however, too many individuals are not making the IRA contributions one would expect or hope would be made. Not everyone participates in a 401(k) plan. Due to the complexity of the federal tax laws applying to pension plans, many small employers don’t sponsor pension plans for their employees. Once the economy improves, it may be that such employees would make IRA contributions.

The myRA program is a trial program. It may be an unspoken trial program, but that is what it is. Many in the Obama administration would like to see the U.S. government do much more than is presently being done to assure the majority of low and moderate income individuals will have retirement funds in addition to Social Security.

After seeing how the myRA program works or doesn’t work, the Obama administration may try to seek to have all employers, even small employers, sponsor and make contributions to federally run profit sharing/pension plans or federally run employees’ IRAs. That is contributions by employers become mandatory rather than voluntary as under existing law. And the government makes the investments rather than the individuals, as too many individuals tend to make poor investments.

Time will tell if sufficient employers will voluntarily participate in the myRA program to make it a success. We have doubts. Certainly the goal to increase retirement savings is worthwhile, but a simpler approach has a better chance of accomplishing this. The simplest approach is that the individual makes a contribution into his or her own IRA without involving the employer.

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Helping A father Who Has Inherited His Daughter’s 401(k) Account

Posted by James M. Carlson
Jun 12 2014

Raul, age 58, has been a bank customer since 1998. He presently does not have an IRA. He does have a 401(k) account at his employer. His daughter Laura, age 31, died March 2014, in a car accident. Laura had designated her father to be the beneficiary of her 401(k) account. The 401(k) plan administrator had contacted Raul to inform him that he was Laura's beneficiary and that her account balance was approximately $60,000. He has come into the bank seeking some help.

Raul is fairly sure that he will decide to establish an inherited IRA with your financial institution.

Raul will want to ask the 401(k) administrator to provide him the following information: a copy of the plan's summary plan description, a copy of plan's distribution form and a copy of Laura's most recent participant statement showing her various investment account balances.

The summary plan description will provide a discussion of the rights of a non-spouse beneficiary once he has inherited the 401(k) balance of a deceased beneficiary. The plan could be written to allow him to keep the funds within the 401(k) and then withdraw annual required distributions from such plan. Most likely the plan will be written to require Raul as a non-spouse beneficiary to withdraw the inherited IRA funds within a 3-5 year period. One of his options will be to instruct to directly rollover the inherited 401(k) funds into an inherited traditional IRA and/or an inherited Roth IRA. He then could withdraw annual required distributions from the inherited IRA using the life distribution rule. The 401(k) distribution form must present Raul with the following three options. Sometimes the distribution form does a poor job of explaining that there is the third option.

Option #1. He could elect to withdraw the entire balance of $60,000. Since he, as any non-spouse beneficiary, does not have the right to rollover this $60,000, the rule requiring mandatory withholding at the rate of 20% does not apply. The tax rules would require that 10% of the distribution be withheld, but he would have the right to instruct to have no withholding. If he chose to withdraw the $60,000, it would be prudent for him to have 15-25% withheld since he will need to include the $60,000 in his income and pay the applicable tax liability. As a beneficiary he is does not owe the 10% penalty tax even though he is younger than age 59½.

Option #2. He could elect to directly rollover the $60,000. He has three (3) sub-options. First, he could elect to directly rollover the $60,000 into an inherited traditional IRA. Although he is required to commence taking required distributions, he will be deferring taxation on most of the funds until later. Second, he could elect to directly rollover the $60,000 into an inherited Roth IRA. Such a distribution will require him to include the $60,000 in his income and pay the applicable taxes. He will also be required to commence annual required distributions from the Roth IRA. Once the 5-year rule has been met all such distributions will be tax-free. Third, he could directly rollover a portion to an inherited traditional IRA and then he could directly rollover the remaining portion into an inherited Roth IRA.

Although the law provides a general rule that if the five-year rule applied to the distributions under the 401(k) plan then this rule is to continue to apply to the inherited IRA, there is a major exception which allows the beneficiary to elect to use the life distribution rule. Two requirements must be met. First, the funds must be directly rolled over before the end of the year following the year of death. Secondly, the life distribution rule must be determined using the same non-spouse beneficiary.

Option # 3, He would withdraw some of the $60,000 and then he would directly rollover the remaining balance. For example, he could instruct to withdraw $10,000 and then he would directly rollover the remaining $50,000 into an inherited traditional IRA and/or inherited Roth IRA. The withholding rules as discussed under Option #1 would also apply to the withdrawal of the $10,000.

Raul will complete this 401(k) distribution form and furnish it to the 401(k) administrator. Raul should also furnish a copy of this form to you as the IRA custodian of his new inherited IRA. He will need to execute the inherited IRA plan agreement and instruct you how he wishes to have such funds invested. When the funds are sent to your bank, you will be able to process the direct rollover check as he and the 401(k) administrator have instructed.

The right of a non-spouse beneficiary to set up an inherited IRA for funds arising from decedent with a 401(k) account did not exist until January 1, 2007. There will be mothers, fathers, brothers, sisters, and friends who will wish to establish an inherited IRA. You want to be ready to service these individuals. Almost always, they will be long-term customers, as they will be taking partial distributions over their life expectancy.

Categories: Pension Alerts, Traditional IRAs

IRS Grants Temporary Relief to Sponsors of One-Person Plans Who Failed to File One or More 5500-EZ Forms, Including For a Terminated Plan

Posted by James M. Carlson
May 23 2014

The IRS is beginning a one-year pilot program on June 2, 2014, to help individuals and partnerships that failed to file one or more 5500-EZ forms. Such filers will be able to be relieved from paying the maximum penalty of $15,000 per year for failing to file a Form 5500-EZ by filing such non-filed form or forms. The IRS announced this special program in Revenue Procedure 2014-32 as published on May 16. This relief will apply to 5500-EZ forms filed during the period of June 2, 2014 until June 2, 2015. Forms filed after June 2, 2015 will not be entitled to the relief.

Since 1995 the Department of Labor (DOL) has had a correction program available to employers of plans covering multiple participants. It is called the Delinquent Filer Voluntary Compliance (DFVC) program. Sponsors of multiple participant plans use the DFVC correction program to come into compliance with the law on a voluntary basis by filing the missed forms and by paying a correction fee much less than the amount owed if the DOL and/or the IRS discovered the failure to file the 5500 forms.

In 2002, the IRS adopted the administrative practice that it would not impose applicable tax penalties (in addition to the DOL penalties) on an employer for it not filing the Form 5500 as long as the filer was eligible to use the DOL’s DFVC program and satisfied the requirements of such program by filing the non-filed 5500 forms.

Until now, the IRS has not had a correction program for One-Person plans. The DOL has no authority over One-Person plans except for the prohibited transaction topic.

Under this special IRS relief program, an individual with a One-Person plan will not be required to pay any fee for participating in the IRS pilot program. The IRS is asking the public if this pilot program should be adopted on a permanent basis, and, if so, how the correction amount or fees, should be determined.

Individuals who are not in compliance will generally want to take advantage of this special opportunity. The IRS has said that the pilot program will end on June 2,2015. CWF will prepare such a filing for $150 per plan.

For discussion purposes, assume that Sarah Andrews, a sponsor of a One-Person profit sharing plan failed to file a 2011 Form 5500-EZ even though her profit sharing plan had a balance of $280,000 as of December 31, 2011. Sarah forgot that a filing was required when the plan balance exceeded $250,000 as of any December 31st. She did file the 2012 Form 5500-EZ showing a year-end balance of $325,000 and the 2013 Form 5500-EZ showing a year-end balance of $365,00. Sarah will wish to use this special pilot program to file her missed 2011 Form 5500-EZ and avoid the penalty amount due of $15,000.

The tax penalty is $25 per day to a maximum of $15,000 per return. The $15,000 is reached when a filer is 600 days late. Many times this 600th day is reached as many times the IRS has not yet determined that the employer had not filed a required form. For example, in the Sarah example, since her plan had never exceeded the $250,000 limit, the IRS did not know that she had missed a required filing.

When is a filing required for a One-Person plan which was terminated during the year? Always is the IRS position. However, the IRS has done a poor job of communicating this position.

The IRS discusses in Revenue Procedure 2014-32 that not withstanding the PPA 2006 provision that a One-Person plan with assets of $250,000 or less at the end of the year are not required to file Form 5500-EZ, the IRS has “determined” that a filing is required when a plan is terminated and all of the assets have been distributed. The IRS does not cite any legal authority for its position. An individual who has failed to file a Form 5500-EZ has two courses of action. He or she may file under this pilot program or may use the general rule that such penalty is to be waived if the IRS finds the individual had a reasonable cause as to why the form was not filed. A request for relief for reasonable cause may be attached to the delinquent return or it maybe filed separately. A reason must be given explaining why the return is late. It is not be filed with the IRS office where the most current Form 5500-EZ is to be mailed

Categories:

IRS Issues 2015 HSA Indexed Amounts

Posted by James M. Carlson
Apr 14 2014

The Treasury Department and Internal Revenue Service issued new guidance on the maximum contribution levels for Health Savings Accounts (HSAs) and out-of-pocket spending and deductible limits for High Deductible Health Plans (HDHPs) that must be used in conjunction with HSAs. The HSA contribution limits for 2015 have increased by a small amount and a small percentage over the 2014 limits. The2015 limits are set forth in Revenue Procedure 2014-30. The catch-up contribution amount of $1,000 is not subject to being adjusted by the COLA adjustment of Code section 223(g) and so it remains at $1,000 for 2015. The minimum annual deductible limits and the maximum annual out-of-pocket expense limits for 2015 have also increased

The IRS normally announces these changes in May each year so that employers and individuals will have sufficient time to plan for HDHP insurance coverage and HSA contributions for 2015 and so that insurance companies may revise their HDHP policies. This year the IRS announced the new limits on April 25.

CWF will be updating our HSA brochures and our HSA Amendments immediately so they could be furnished with the mailing of 5498-SA forms.

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IRS Postpones New Rollover Rule to January 1, 2015

Posted by James M. Carlson
Mar 10 2014

IRS Postpones New Rollover Rule to January 1, 2015

The IRS is beginning a one-year pilot program on June 2, 2014, to help individuals and partnerships that failed to file one or more 5500-EZ forms. Such filers will be able to be relieved from paying the maximum penalty of $15,000 per year for failing to file a Form 5500-EZ by filing such non-filed form or forms. The IRS announced this special program in Revenue Procedure 2014-32 as published on May 16. This relief will apply to 5500-EZ forms filed during the period of June 2, 2014 until June 2, 2015. Forms filed after June 2, 2015 will not be entitled to the relief.

Since 1995 the Department of Labor (DOL) has had a correction program available to employers of plans covering multiple participants. It is called the Delinquent Filer Voluntary Compliance (DFVC) program. Sponsors of multiple participant plans use the DFVC correction program to come into compliance with the law on a voluntary basis by filing the missed forms and by paying a correction fee much less than the amount owed if the DOL and/or the IRS discovered the failure to file the 5500 forms.

In 2002, the IRS adopted the administrative practice that it would not impose applicable tax penalties (in addition to the DOL penalties) on an employer for it not filing the Form 5500 as long as the filer was eligible to use the DOL’s DFVC program and satisfied the requirements of such program by filing the non-filed 5500 forms.

Until now, the IRS has not had a correction program for One-Person plans. The DOL has no authority over One-Person plans except for the prohibited transaction topic.

Under this special IRS relief program, an individual with a One-Person plan will not be required to pay any fee for participating in the IRS pilot program. The IRS is asking the public if this pilot program should be adopted on a permanent basis, and, if so, how the correction amount or fees, should be determined.

Individuals who are not in compliance will generally want to take advantage of this special opportunity. The IRS has said that the pilot program will end on June 2,2015. CWF will prepare such a filing for $150 per plan.

For discussion purposes, assume that Sarah Andrews, a sponsor of a One-Person profit sharing plan failed to file a 2011 Form 5500-EZ even though her profit sharing plan had a balance of $280,000 as of December 31, 2011. Sarah forgot that a filing was required when the plan balance exceeded $250,000 as of any December 31st. She did file the 2012 Form 5500-EZ showing a year-end balance of $325,000 and the 2013 Form 5500-EZ showing a year-end balance of $365,00. Sarah will wish to use this special pilot program to file her missed 2011 Form 5500-EZ and avoid the penalty amount due of $15,000.

The tax penalty is $25 per day to a maximum of $15,000 per return. The $15,000 is reached when a filer is 600 days late. Many times this 600th day is reached as many times the IRS has not yet determined that the employer had not filed a required form. For example, in the Sarah example, since her plan had never exceeded the $250,000 limit, the IRS did not know that she had missed a required filing.

When is a filing required for a One-Person plan which was terminated during the year? Always is the IRS position. However, the IRS has done a poor job of communicating this position.

The IRS discusses in Revenue Procedure 2014-32 that not withstanding the PPA 2006 provision that a One-Person plan with assets of $250,000 or less at the end of the year are not required to file Form 5500-EZ, the IRS has “determined” that a filing is required when a plan is terminated and all of the assets have been distributed. The IRS does not cite any legal authority for its position. An individual who has failed to file a Form 5500-EZ has two courses of action. He or she may file under this pilot program or may use the general rule that such penalty is to be waived if the IRS finds the individual had a reasonable cause as to why the form was not filed. A request for relief for reasonable cause may be attached to the delinquent return or it maybe filed separately. A reason must be given explaining why the return is late. It is not be filed with the IRS office where the most current Form 5500-EZ is to be mailed

Categories: Pension Alerts, Traditional IRAs

Warning: U.S. Tax Court Rejects IRS Policy on the One Rollover Per 12-Month Rule

Posted by James M. Carlson
Feb 26 2014

Commencing immediately, an IRA custodian/trustee will need to start applying a new rule for when it is receiving an IRA rollover contribution.

Since at least 1989 the IRS has stated in Publication 590 that the once per year rollover rule applies on a per IRA plan agreement basis and not to all of a person’s IRAs. That is, if two distributions are taken from the same IRA, then only one of them could be rolled over. A distribution taken from a different IRA could be rolled over even though a person had taken a distribution from another IRA and rolled it over within the 12-month period. The 2013 version states the following on page 25.

Waiting period between rollovers. Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover.

The 1-year period begins on the date you receive the IRA distribution, not on the date you roll it over into an IRA.

Example. You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA.

However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.

A recent U.S. Tax Court case is a classic illustration that there are times the IRS wants to collect taxes so strongly from a particular taxpayer that the IRS personnel in charge is willing to have the decision cause the general public large tax administrative problems. Such is the result of a recent U.S. Tax Court case, A.L. Brobrow and E.S. Brobrow v. Internal Revenue Commissioner, T.C. Memo 2014-21 as decided on January 28, 2014.

The court expressly holds that the one-year restriction between rollovers applies to all distributions from all IRAs and is not limited to the same IRA. The court found the applicable statute expressly authorizes just one rollover during the 12-month period commencing on the date of distribution when such distribution is rollover. The court did not discuss the subject if the IRS had the authority to modify this provision. The court wrote,

Section 408(d)(3)(B) limits a taxpayer from performing more than one nontaxable rollover in a one-year period with regard to IRS and individual retirement annuities. Specifically, section 408(d)(3)(B) provides:

This paragraph [regarding tax-free rollovers] does not apply to any amount described in subparagraph (A)(i) received by an individual from an individual retirement account or individual retirement annuity if at any time during the 1-year period ending on the day of such receipt such individual received any other amount described in that subparagraph from an individual retirement account or an individual retirement annuity which was not includible in his gross income, because of the application of this paragraph.

The reference to “any amount described in subparagraph (A)(i)” refers to any amount characterized as a non-taxable rollover contribution by virtue of that amount's being repaid into a qualified plan within 60 days of distribution from [*9] IRA or individual retirement annuity. The one-year limitation period begins on the date on which a taxpayer withdraws funds from an IRA or individual retirement annuity and has no relation to the calendar year.

The plain language of section 408(d)(3)(B) limits the frequency with which a taxpayer may elect to make a non-taxable rollover contribution. By its terms, the one-year limitation laid out in section 408(d)(3)(B) is not specific to any single IRA maintained by an individual but instead applies to all IRAs maintained by a taxpayer. Section 408(d)(3)(B) speaks in general terms: An individual may not receive a non-taxable rollover from ''an individual retirement account or individual retirement annuity" if that individual has already received a tax-free rollover within the past year from ''an individual retirement account or individual retirement annuity." (Emphasis added.) In other words, a taxpayer who maintains [*13] multiple IRAs may not make a rollover contribution from each IRA within one year.

What were the facts of this case?

Mr. Brobrow maintained two traditional IRAs at Fidelity Investments. One was a rollover IRA. His wife maintained her own traditional IRA. The couple must have had cash flow problems. Fidelity's advisers apparently told him he could to do the following.

  1. On April 14, 2008, he withdrew $65,064 from his IRA #l. He did take two distributions. It may be he needed these funds to pay tax liabilities, which had to be paid by the April 15th.
  2. On June 6, 2008, he withdrew $65,064 from his IRA #2
  3. On June 10, 2008, he made a rollover contribution of $65,064 into IRA #l. The funds had come from his personal checking or investment account
  4. On July 31, 2008, she withdrew $65,064 from her personal traditional IRA. These funds were deposited into a joint account
  5. On August 4, 2008, Mrs. Brobrow made a rollover contribution of $65,064 into his IRA #2. The funds for this rollover came from their joint account
  6. On September 30, 2008, she made a rollover contribution of $40,000 into her traditional IRA. The funds came from their joint account. Note her withdrawal of $65,064, however, was taxable as she made her rollover contribution on day 61 and not on day 60.

If the court had followed the IRS statement set forth in the 2007 or the 2008 Publication 590, Mr. Brobrow’s two withdrawals of $65,064 would not have been taxable. He rolled over both within the 60-day time period. He had not rolled over a previous distribution from the two IRAs within the preceding 12 months.

Actions by an IRA Custodian/Trustee.

CWF is in the process of revising its rollover certification forms to state the 12-month rule is no longer a one per plan agreement. The Disclosure Statement of the IRA Plan Agreement booklet will also be revised. An IRA custodian/trustee will want to send an amendment to its IRA accountholders informing them of this change. It must be remembered that any distribution after the one which is rolled over is now taxable. One way to inform the existing accountholders would to furnish the 2013-2014 Comprehensive IRA Amendment, which discusses this change.

Categories: Pension Alerts, Traditional IRAs

Excess HSA Contributions - The HSA Custodian Must Not Shirk its Responsibilities

Posted by James M. Carlson
Feb 06 2014

An HSA custodian is required to prepare and furnish Form 1099-SA (Distributions from an HSA, Archer MSA,or Medicare Advantage MSA) to report distributions received by the HSA owner or an inheriting HSA beneficiary. The individual will use the information from the Form 1099-SA to complete their federal income tax return, including Form 8889 (Health Savings Accounts).The individual explains on this form whether all distributions were used for qualified medical reasons and so they are tax-free, whether some of the distributions are taxable since they were not used to pay a qualified medical expense, or whether some distributions are not taxable since they were the withdrawal of an excess contribution.

The IRS takes the reporting of the withdrawal of excess HSA contributions very seriously. Reason code 2 is to be inserted in box 3 of Form 1099-SA when an HSA owner withdraws an excess contribution. The amount of the earnings, if any, associated with the excess contributionis to be reported in box 2. The IRS procedures applying to the withdrawal of HSA excess contributions are very similar to the rules applying to the withdrawal of excess IRA contributions, but there are some significant differences.

Excess HSA contributions can cause tax problems for an HSA owner, but they also cause administrative problems for the HSA custodian/trustee. The purpose of this article is to discuss the tax rules applying to excess HSA contributions so that an HSA custodian will properly perform its IRS reporting duties and also help its HSA owners. The HSA custodian/trustee may well want to have the authority to charge an administrative fee for the additional work which will need to be performed on account of the excess HSA contribution(s).

Based on a number of consulting calls, some financial institutions are adopting the approach that the institution will report all HSA distributions as normal distributions and then instruct the HSA owner that it is up to him or her (and the accountant) to explain things on the Form 8889

This approach is imprudent as it relies on wishful thinking. This approach is contrary to IRS guidance. The IRS may assess a fine of $50 for each Form 1099-SA prepared in error . If the IRS concludes that an HSA custodian has failed to provide a correct Form 1099-SA due to its intentional disregard of the requirement to furnish a correct Form 1099-SA, then the penalty is at least $250 per form with no maximum penalty. The $250 perform penalty may be assessed twice – once with respect to the copy required to be filed with the IRS and also with respect to the copy to be furnished the HSA owner.

Who is primarily responsible for correcting an excess HSA contribution?

The HSA owner is, but in some situations the HSA custodian must be proactive in making sure the excess contribution is corrected. It is the HSA owner who must pay the 6% excise tax if excess contributions have been made to his or her HSA and they have not been with-drawn by the tax filing deadline. Normally, this is April 15 of the following year. A special tax rules modifies the deadline to October 15 if the individual filed his or her tax return byApril 15 and paid any taxes owing. The 6% tax applies for each year the excess remains in the HSA.

The HSA plan agreement provides that the HSA custodian is NOT authorized to accept annual contributions totaling more than $7,450 for 2013 and $7,550 for2014. This amount is the family HDHP limit plus$1,000. This provision means the HSA custodian must be proactive in correcting excess contributions which have arisen because the individual and the employer contributed more than this limit. Both the individual and the institution have done something they should not have done. The individual made the excess contribution and the institution should not have accepted it. HSA custodians must have a procedure to monitor (and enforce) the $7,450/$7,550 limit.

In order to illustrate some of the administrative issues which may arise from an excess HSA contribution situation, two situations will be discussed.

Situation #1. Sue Taxpayer, age 39, contributed $6,450 to her HSA on April 1, 2013 for 2013. At that time she thought she had family HDHP coverage for allof 2013. However on July 1, 2013, she went to work for a new employer which covered her immediately under a non-HDHP. Thus, she was eligible to contribute only $3,125 to their HSA and so she needs to withdraw her excess contribution of $3,125 plus the related income, if any.

In January of 2014, Sue visits the HSA custodian and states she needs to withdraw $3,125 as an excess HSA contribution plus the related income. The HSA custodian must assist her. The withdrawal cannot be coded as the withdrawal of a normal HSA distribution. Note that even though this distribution relates to a 2013 distribution, it will be reported on a 2014 Form 1099-SA. The rule is – the income, if any, withdrawn and shown inbox 2 is taxable for the year withdrawn (2014) and not 2013 which is the IRA rule.

Situation #2. John Taxpayer contributes $14,000 to his HSA in 2013 for 2013. He says he was unaware of any contribution limit. His beginning balance as of January1, 2013 was $600. He made monthly contributions of$1,000. His HSA’sending balance as of December 31,2013 was $200. His distributions for the year totalled $14,400. Of this $12,400, John knows that $8,800 was used to pay qualified medical expenses and the remaining $5,600 was used to pay the premiums for the HDHP. The institution does not know how John used the funds.

The HSA custodian has initially coded all of the HSA distributions as being normal HSA distributions and a code “1” would be inserted in box 3 on the 2013 Form1099-SA. The HSA custodian, however, knows that John made excess contributions of at least $6,950 ($14,000-$7,450). This amount is no longer in the HSA as it only has a balance of $200 at year end. Whether John knew it or not, when he took a distribution he was withdrawing an excess contribution. The HSA custodian cannot continue to report this amount as the withdrawal of a normal distribution. It must change some of withdrawals to show that he withdrew $7,950 as an excess contribution, plus the earnings, if any.

Be aware that the IRS has not furnished specific guidance on Situation #2. The IRS should do so. Note that John used the funds to pay the premiums for the HDHP. As discussed in a previous newsletter article, if he had taken a normal distribution he would have had to include the $5,600 in income and also pay the 20% penalty tax as the funds were not used to pay a qualified medical expense. But he does not have such adverse tax consequences as he withdrew an excess contribution.

An HSA custodian must adopt procedures to properly report the withdrawal of an excess HSA contribution(s). Such withdrawals must not be reported as normal distributions.

Categories: Health Savings Accounts, Pension Alerts