Individual Retirement Accounts:

Additional IRS Actions Could Help Taxpayers Facing Challenges in Complying with Key Tax Rules

GAO-08-654: Published: Aug 14, 2008. Publicly Released: Sep 15, 2008.

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Individual retirement accounts (IRA) allow individuals to save for retirement in a tax-preferred way. Traditional IRA contributions, subject to certain limitations, can be deducted from taxable earnings and taxes on earnings are deferred until distribution. In contrast, Roth IRA contributions are made after tax and distributions are tax-free. Faced with a myriad of rules covering IRA contributions and distributions, taxpayers may fail to comply with the rules. GAO was asked to (1) provide an overview of key rules and describe how the Internal Revenue Service (IRS) educates taxpayers about these rules, (2) describe what IRS knows about the extent of noncompliance with IRA transactions reported on taxpayer returns, and (3) describe challenges taxpayers face with key rules and some options for strengthening compliance. GAO reviewed IRS documents and compliance data. To identify challenges, GAO interviewed officials from the financial industry and advisor representatives.

Taxpayers face a myriad of tax rules governing contributions to, distributions from, and rollovers between accounts for traditional and Roth IRAs. Both types of IRAs have rules governing eligibility to contribute, and all IRA contributions are subject to an annual limit. For example, eligibility to deduct (from taxable income) contributions to a traditional IRA and to contribute to a Roth IRA depends on taxpayer income and filing status, while coverage by an employer-sponsored retirement plan only affects eligibility for deductible contributions to a traditional IRA. Tax rules for distributions diverge for traditional and Roth IRAs, but both types are generally subject to a 10 percent early withdrawal penalty, with some exceptions. Further, traditional IRA owners over age 70? must take minimum distributions or face a 50 percent penalty on the required distribution amount. Rollovers, where a taxpayer moves money from one account into an IRA account, must be completed within 60 days, or the amounts are taxable and subject to penalty. To assist taxpayers in voluntarily complying with IRA rules, IRS offers special publications and telephone assistance for taxpayers with IRA questions. Even with IRS's service efforts, IRS data show that some taxpayers fail to comply with rules for reporting contribution deductions and taxable distributions from traditional IRAs. IRS's National Research Program showed that nearly 15 percent of taxpayers who took traditional IRA contribution deductions as well as 15 percent of those who took taxable distributions misreported on them on their tax returns in 2001 (the most recent data available). IRS has automated enforcement programs--matching tax returns with information reported by IRA custodians--to detect and correct these types of IRA misreporting. For tax year 2004, IRS assessed additional taxes of $23.2 million for ineligible traditional IRA contribution deductions or exceeding the deduction limits and $61.1 million in taxes and penalties for early withdrawals from traditional IRAs. As partly shown by taxpayer misreporting to IRS, taxpayers face challenges in figuring how much they can contribute, navigating the various distribution rules, and rolling over their IRAs between custodians. For example, according to representatives of financial firms and advisors GAO interviewed, taxpayers may not understand that the annual contribution limit applies across traditional IRAs and Roth IRAs in combination. On the distribution side, interviewees said that older taxpayers make mistakes in determining when they must start distributions and calculating the correct amount. Interviewees identified some options for IRS to clarify guidance, such as for the combined contribution limit rule, or develop tools to help taxpayers, such as a Webbased calculator for required minimum distributions. IRS could explore actions such as requiring additional reporting by custodians or simplifying the required minimum distribution rule to strengthen compliance with this complicated rule. Other options to reduce the complexity of IRA rules, such as eliminating income limits on eligibility, pose trade-offs and could be considered in the context of broader tax reform

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: On October 30, 2008, IRS posted on their employee plans website a chart describing information about traditional and Roth IRA combined contribution limits and the deductibility of traditional IRA contributions. The 2008 Publication 590 included a new reminder at the beginning of the publication about the combined contribution limit, which the 2009 Publication 590 also includes.

    Recommendation: To help address the challenges facing taxpayers in complying with IRA rules, the Commissioner of Internal Revenue should clarify guidance and outreach materials to help taxpayers better understand that the combined IRA contribution limit applies across all traditional and Roth IRAs.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Implemented

    Comments: IRS has taken several actions to educate taxpayers on how to comply with Required Minimum Distribution (RMD) rules for individual retirement accounts (IRA). IRS created simplified worksheets that taxpayers may use to calculate the RMD amount for IRA and retirement accounts, and posted these worksheets to their employee plans website on October 23, 2008. On October 27, 2008, IRS updated and simplified the list of Frequently Asked Questions (FAQs) about RMDs on their employee plans website. These FAQs include information on when individuals should begin to take RMDs, how to calculate the RMD amount, and refers to the Publication 590 for more information about RMDs. Since March 2008, IRS has addressed RMDs in the ongoing Question and Answer series published in of its quarterly Employee Plan Newsletters (Employee Plans News and Retirement News for Employers); IRS plans to continue to address these topics in future editions of both newsletters. In February 2012 as part of the President's fiscal year 2013 budget, the Department of the Treasury, in consultation with the IRS, proposed two legislative strategies to exempt some IRA owners from RMD rules and improve compliance for inherited IRAs. The first proposal would exempt individuals with aggregate IRA and retirement plan balances not exceeding $75,000 from RMD rules; the proposal is effective for IRA owners attaining age 70 1/2 after December 31, 2012. The second proposal would allow 60-day rollovers for all inherited IRAs. Differing rollover rules for spouse and non-spouse beneficiaries confused plan administrators and beneficiaries and had been a source of inadvertent noncompliance.

    Recommendation: To help address the challenges facing taxpayers in complying with IRA rules, the Commissioner of Internal Revenue should identify administrative options to improve compliance with the minimum required distribution rule, including additional taxpayer guidance or information reporting, and work in consultation with Treasury on regulatory or legislative strategies to strengthen compliance with the rule.

    Agency Affected: Department of the Treasury: Internal Revenue Service


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