by: Dennis Zuehlke, Compliance Manager, Ascensus
The Treasury Inspector General for Tax Administration (TIGTA) has recommended changes to
Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., to reduce taxpayer confusion and improve the accuracy in reporting retirement plan and IRA distributions.
The TIGTA issued a report on January 30, 2012, titled “Opportunities Exist to Identify More Taxpayers Who Underreport Retirement Income.” The report states that in the Tax Gap for Tax Year 2001 study, the IRS estimated that as much as $4.2 billion can be attributed to underreported retirement income. Given the enormity of the tax gap, even small improvements in the accuracy of reporting retirement plan distributions could increase compliance, generate substantial revenue, and reduce the tax gap. The TIGTA’s review was to determine whether the IRS has effective controls and processes in place to ensure that taxpayers and retirement plan providers are correctly computing and reporting the taxable portion of retirement distributions.
The IRS uses its Automated Underreporter (AUR) Program to ensure taxpayer compliance with reporting retirement income. The AUR Program matches amounts reported by taxpayers on Form 1040, U.S. Individual Income Tax Return, to what was reported as paid to taxpayers by financial organization on Form 1099-R. If a mismatch is identified, the IRS issues a “Computer Paragraph 2000” notice to inform the taxpayer that he or she may have underreported retirement income.
The TIGTA’s report determined that the AUR Program is very effective in determining the proper reporting of retirement income when Form 1099-R discloses the taxable amount of the retirement distribution. However, under current IRS reporting guidelines, the taxable amount is not reported on Form 1099-R for IRA distributions, and from a sample of returns for Tax Year 2007, TIGTA was not able to determine whether taxpayers reported the taxable amounts correctly on their tax returns. TIGTA believes that taxpayers who receive Forms 1099-R with Box 2a, Taxable amount, either blank or with a dollar amount listed, and Box 2b, Taxable amount not determined, checked, may be confused and may not report a correct taxable amount on their returns.
TIGTA Forms 1099-R and 5498 Recommendations
The TIGTA recommended that the IRS revise Form 1099-R to clarify the meaning of Box 2b to reduce taxpayer confusion when a payer, such as an IRA trustee or custodian, is unable to calculate the taxable amount of the distribution. The report indicates that the box should clearly communicate that the taxpayer is responsible for calculating the taxable amount of the distribution.
The TIGTA also recommended that the IRS revise the Instructions for Forms 1099-R and 5498 to require filers of Forms 1099-R to include the date of the retirement plan or IRA distribution or transfer (e.g., distribution for rollover) on Form 1099-R, and filers of Form 5498, IRA Contribution Information, to include the date the taxpayer rolled over the distribution into a retirement plan or IRA. The TIGTA report suggests that this would help the IRS identify distributions not rolled over within 60 days as required.
IRS response to TIGTA Recommendations
In responding to TIGTA’s recommendations, the IRS agreed to revise the instructions for Form 1099-R to clarify taxpayer responsibility and amounts to report. The IRS also will study the feasibility of capturing additional information on a form to be filed with the tax return. Currently, taxpayers use the Simplified Method Worksheet found in the Form 1040 instructions to compute the taxable amount of retirement income, but do not file the worksheet with their federal tax returns.
The IRS acknowledged that it would be useful in some instances to have the dates of distributions rolled over or transferred to another retirement plan or IRA, but they indicated that they do not believe that it would result in significant improvements to taxpayer compliance or make it easier for the IRS to detect noncompliance. The IRS noted that there currently are statutory requirements in place to ensure accurate reporting and deter acceptance of nonqualified contributions. The IRS did agree to consider whether it would be feasible and beneficial to require the reporting of the dates of distributions and subsequent contributions of distributions rolled over or transferred on Forms 1099-R and 5498.
It remains to be seen if the IRS determines that additional reporting of retirement plan and IRA transactions would be useful in identifying underreporting of retirement income. Any new reporting requirement would add complexity and require retirement plan and IRA providers to make costly system changes to comply with the requirements. What is certain is that policymakers are focused on closing the tax gap as one way to shrink the budget deficit. IRS Commissioner Doug Shulman, speaking to the Tax Executives Institute in late 2008, acknowledged that the IRS cannot audit its way to full compliance, and that information reporting will be the key to future success in reducing the tax gap. Since then, new regulations require brokerage firms to report basis on stock sales, credit card companies to report payments to merchants, and most recently, financial organizations to report deposit interest to nonresident aliens.
With billions of dollars of underreported retirement income, is additional reporting of retirement plan and IRA transactions on the horizon? Stay tuned.
Dennis Zuehlke is Compliance Manager for Ascensus in Middleton, Wisconsin. Mr. Zuehlke provides clients with technical support on tax-advantaged accounts (including individual retirement accounts, health savings accounts, simplified employee pension plans, and Coverdell education savings accounts), and information reporting and tax withholding issues. Mr. Zuehlke is a frequent national speaker on compliance-related issues and retirement savings trends within the financial services industry. Mr. Zuehlke attended Marquette University and graduated from the University of Wisconsin. Prior to joining Ascensus, he held a similar position with the Credit Union National Association.
Ascensus delivers a full range of retirement plan services—including plan administration, plan design and maintenance, consulting, web-based tools and content, software solutions, education and training, forms and documents, and technical resources—to approximately 9,000 financial organizations nationwide. www.ascensus.com