The IRS Sets Its Sights on IRA Abuses

Kelly Greene for the Wall St. Journal writes: The Internal Revenue Service is gearing up for a major "compliance effort" targeting individual retirement accounts. The agency "will begin a careful and data driven approach" for getting IRA owners to avoid making excess contributions or missing withdrawals required after age 70½, according to a March 25 letter sent by an IRS official to Rep. Steve Israel (D., N.Y.).

The initiative will begin between now and the end of the federal government's fiscal year on Sept. 30, according to the letter, signed by Peggy Bogadi, commissioner of the IRS Wage and Investment Division.

The IRS also said it planned to issue "soft notices" to taxpayers before the filing season began to remind them they "may have to take certain actions when they file their returns" and that they could face consequences if they fail to take those actions. It doesn't specify which IRA owners would get the notices. An IRS spokesman declined to comment further.

Contributing more than the maximum $5,500 allowed in 2013, or $6,500 for people who are 50 or older, can result in a tax of 6% of the amount above the limit. And missing a "required minimum distribution," usually starting at age 70½, could result in a tax of 50% of the amount that the account holder should have taken out.

The IRS's compliance effort was prompted by a 2010 audit report by the Treasury Inspector General for Tax Administration, the federal tax watchdog. In 2006 and 2007 alone, an estimated $286 million in taxes went uncollected due to missed withdrawals and excess contributions, the report says.

Mr. Israel asked the IRS for an update on its plans after constituents brought the issue to his attention. With two in five U.S. households holding IRAs, "I am concerned that countless Americans may make innocent IRA mistakes and incur penalties they can't afford to pay," he says.

The IRS is trying to increase public awareness of IRA contribution and distribution requirements in a number of ways. It sent a mass email to tax practitioners, published an article in a government newsletter for "businesses and payroll professionals" and plans to submit another article to AARP, the membership group for older Americans, it said in its letter to Mr. Israel.

The letter also says the IRS can waive the extra tax owed for "reasonable error," noting that taxpayers who believe they qualify for relief can submit Form 5329, available at IRS.gov, and attach an explanation.

IRA owners must start taking their required withdrawals from traditional IRAs by April 1 of the year after they turn 70½. Those withdrawals are calculated by dividing the total IRA balance as of Dec. 31 of the year before the owner reached that age by life expectancy, found in a table in IRS Publication 590.

IRA owners can't contribute more than their "earned income" each year, which includes wages, commissions and alimony but not rental-property income, a pension or deferred compensation.