What to do if you failed to take a Required Minimum Distribution from and IRA, how to unwind a contribution to an IRA you thought would be deductible but isn't.

Dan Moisand for MarketWatch.com writes:  Q. I didn't take a required distribution from my IRA last year. What do I do and how bad an oversight is this? — B.T.

A. Bad. This might hurt quite a bit. The penalty is a whopping 50% of any shortfall. To rectify the situation, you should take whatever amount you were supposed to have withdrawn as soon possible and file a Form 5329 for 2012.

You might be able to get the penalty waived but you'll have to present a good cause for your failure to make the distribution. Be sure you have taken the distribution before you file Form 5329. When you file Form 5329, omit the penalty but include a letter to the IRS that explains why the distribution was not made and requests a waiver. If you do not hear from them within three years, you should be in the clear. If they respond that you still owe the penalty within that three year window, they will want the 50% penalty plus additional penalty for not paying as well as interest on the unpaid 50%.

Q. Last year, I made contributions to IRAs for my wife and I intending to deduct them on my 2012 income taxes. My tax program says that because my income (she is a stay at home mom) was $125,000, no deductions are allowed. What do I do now? — C.J.

A. Don't worry. It's just paperwork and you aren't the first to run into this.

Let's start with what is deductible and what isn't. Your income qualifies you to contribute any amount you choose up to the 2012 limit of $5,000 each ($6,000 if you are over age 50). If neither you nor your wife is "covered" by a qualified retirement plan at work, both of you can deduct your IRA contributions. When neither spouse is covered, the deductibility of contributions is not limited. If you see a check mark in the small box labeled "Retirement Plan" in section 13 of your W-2, you are "covered.” If your tax program is denying the deduction, you probably told it that box was checked.

If it is checked, your wife can still deduct the contribution to her IRA even though she doesn't have any traditional employment income. This is referred to as a "spousal IRA" and contributions to it can be deducted in full when the Modified Adjusted Gross Income (MAGI) for a married couple filing jointly is $173,000 or less. Over $183,000, no deduction is allowed. Partial deductions are allowed for MAGI between $173,000 and $183,000. For 2013, the corresponding MAGI numbers are $178,000-$188,000.

Your contribution, if covered by a retirement plan, would not be deductible because you exceed the limit for covered persons. Covered persons who are married and filing joint returns can take a full deduction with a MAGI under $92,000. Partial deductibility is available from $92,000 - $112,000. Above $112,000, no deduction is allowed. For 2013, the range is $95,000 - $115,000.

You are allowed to make nondeductible contributions to a traditional IRA up to the $5,000/$6,000 maximum regardless of how high your income may be. All earnings will grow tax deferred until withdrawn at which time it will be taxed.

My preference, however, would be for you to put this non-deductible contribution into a Roth IRA instead. There will be no difference on your 2012 return. Your contribution to either the traditional IRA or a Roth IRA results in no tax deduction. Neither one results in any taxes on earnings as the accounts grow. The Roth is better because eventually when the money is withdrawn, it should be tax free. With a traditional IRA, the tax on earnings is only deferred.

To change from the traditional IRA to the Roth IRA you must "recharacterize" the contribution. The company holding your IRA should help you do this. Open a Roth IRA account. Submit the IRA company's rechacterization form and have them transfer the contribution from the first IRA to the second IRA in a trustee-to-trustee transfer. When you recharacterize, you must include in the transfer any net income or loss allocable to the contribution, treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA, and report the recharacterization on your tax return for the year during which the contribution was made.

This last requirement means you should file for an extension to file your 2012. See the next question for some of those particulars. I would also consider getting some professional assistance to keep this all straight.