Publication 590 |
2000 Tax Year |
What Acts Result in Penalties?
The tax advantages of using traditional IRAs for retirement savings
can be offset by additional taxes and penalties if you do not follow
the rules. For example, there are additions to the regular tax for
using your IRA funds in prohibited transactions. There are also
additional taxes for the following activities.
- Investing in collectibles.
- Making excess contributions.
- Taking early distributions.
- Allowing excess amounts to accumulate (failing to take
required distributions).
There are penalties for overstating the amount of nondeductible
contributions and for failure to file Form 8606, if required.
This chapter discusses those acts that you should avoid and the
additional taxes and other costs, including loss of IRA status, that
apply if you do not avoid those acts.
Prohibited Transactions
Generally, a prohibited transaction is any improper use of your
traditional IRA account or annuity by you, your beneficiary, or any
disqualified person.
Disqualified persons include your fiduciary and members of your
family (spouse, ancestor, lineal descendant, and any spouse of a
lineal descendant).
The following are examples of prohibited transactions with a
traditional IRA.
- Borrowing money from it.
- Selling property to it.
- Receiving unreasonable compensation for managing it.
- Using it as security for a loan.
- Buying property for personal use (present or future) with
IRA funds.
Fiduciary.
For these purposes, a fiduciary includes anyone who does any
of the following.
- Exercises any discretionary authority or discretionary
control in managing your IRA or exercises any authority or control in
managing or disposing of its assets.
- Charges to provide investment advice with respect to your
IRA, or has any authority or responsibility to do so.
- Has any discretionary authority or discretionary
responsibility in administering your IRA.
Effect on an IRA account.
Generally, if you or your beneficiary engage in a prohibited
transaction in connection with your traditional IRA account at any
time during the year, the account stops being an IRA as of the first
day of the year.
Effect on you or your beneficiary.
If you or your beneficiary engage in a prohibited transaction in
connection with your traditional IRA account at any time during the
year, you (or your beneficiary) must include the fair market value of
all or part, in certain cases of the IRA assets in your gross income
for that year. The fair market value is the price at which the IRA
assets would change hands between a willing buyer and a willing
seller, when neither has any need to buy or sell, and both have
reasonable knowledge of the relevant facts.
You must use the fair market value of the assets as of the first
day of the year you engaged in the prohibited transaction. You may
have to pay the 10% tax on early distributions, discussed later.
Borrowing on an annuity contract.
If you borrow money against your traditional IRA annuity contract,
you must include in your gross income the fair market value of the
annuity contract as of the first day of your tax year. You may have to
pay the 10% additional tax on early distributions, discussed later.
Pledging an account as security.
If you use a part of your traditional IRA account as security for a
loan, that part is treated as a distribution and is included in your
gross income. You may have to pay the 10% additional tax on early
distributions, discussed later.
Trust account set up by an employer or an employee
association.
Your account or annuity does not lose its IRA treatment if your
employer or the employee association with whom you have your
traditional IRA engages in a prohibited transaction.
Owner participation.
If you participate in the prohibited transaction with your employer
or the association, your account is no longer treated as an IRA.
Taxes on prohibited transactions.
If someone other than the owner or beneficiary of a traditional IRA
engages in a prohibited transaction, that person may be liable for
certain taxes. In general, there is a 15% tax on the amount of the
prohibited transaction and a 100% additional tax if the transaction is
not corrected.
Loss of IRA status.
If the traditional IRA ceases to be an IRA because of a prohibited
transaction by you or your beneficiary, you or your beneficiary are
not liable for these excise taxes. However, you or your beneficiary
may have to pay other taxes as discussed under Effect on you or
your beneficiary, earlier.
Exemptions
Exemption from prohibited transaction penalties has been granted
for the following two transactions, if they meet the requirements
listed later under Payments of cash, property, or other
consideration and Services received at reduced or no
cost.
- Payments of cash, property, or other consideration by the
sponsor of your traditional IRA to you (or members of your
family).
- Your receipt of services at reduced or no cost from the bank
where your traditional IRA is established or maintained.
Payments of cash, property, or other consideration.
All of the following requirements must be satisfied for this
exemption to apply.
- The payments must be for establishing a traditional IRA or
for making additional contributions to it.
- The IRA must be established solely to benefit you, your
spouse, and beneficiaries (yours and your spouse's).
- During the year, the total fair market value of the payments
you receive cannot be more than:
- $10 for IRA deposits of less than $5,000, or
- $20 for IRA deposits of $5,000 or more.
- If the consideration is group term life insurance, then
requirements (a) and (b) do not apply if no more than $5,000 of the
face value of the insurance is based on a dollar-for-dollar basis on
the assets in your IRA.
Services received at reduced or no cost.
All of the following conditions must be satisfied for this
exemption to apply.
- The traditional IRA qualifying you to receive the services
must be established and maintained for the benefit of you, your
spouse, or beneficiaries (yours and your spouse's).
- The services must be services the bank itself can legally
offer.
- The services must be provided in the ordinary course of
business by the bank (or a bank affiliate) to customers who qualify
but do not maintain an IRA (or a Keogh plan).
- For a traditional IRA, the determination of who qualifies
for these services must be based on an IRA (or a Keogh plan) deposit
balance equal to the lowest qualifying balance for any other type of
account.
- The rate of return on a traditional IRA investment that
qualifies cannot be less than the return on an identical investment
that could have been made at the same time at the same branch of the
bank by a customer who is not eligible for (or does not receive) these
services.
Investment in Collectibles
If your traditional IRA invests in collectibles, the amount
invested is considered distributed to you in the year invested. You
may have to pay the 10% tax on early distributions, discussed later.
Collectibles.
These include art works, rugs, antiques, metals, gems, stamps,
coins, alcoholic beverages, and certain other tangible personal
property.
Exception.
Your IRA can invest in one, one-half, one-quarter, or one-tenth
ounce U.S. gold coins, or one-ounce silver coins minted by the
Treasury Department. It can also invest in certain platinum coins and
certain gold, silver, palladium, and platinum bullion.
Excess Contributions
Generally, an excess contribution is the amount contributed to your
traditional IRAs for the year that is more than the smaller of:
- Your taxable compensation for the year, or
- $2,000.
The taxable compensation limit applies whether your
contributions are deductible or nondeductible.
Contributions for the year you reach age 70 1/2 and any
later year are also excess contributions.
An excess contribution could be the result of your contribution,
your spouse's contribution, your employer's contribution, or an
improper rollover contribution. If your employer makes contributions
on your behalf to a SEP-IRA, see chapter 4,
later.
Tax on Excess Contributions
In general, if the excess contribution for a year and any earnings
on it are not withdrawn by the date your return for the year is due
(including extensions), you are subject to a 6% tax. You must pay the
6% tax each year on excess amounts that remain in your traditional IRA
at the end of your tax year. The tax cannot be more than 6% of the
value of your IRA as of the end of your tax year.
The excise tax is figured on Form 5329. For information on filing
Form 5329, see Reporting Additional Taxes, later.
Example.
For 2000, Paul Jones is single, his compensation is $31,000, and he
contributed $2,500 to his IRA. Paul has made an excess contribution to
his IRA of $500 ($2,500 minus the $2,000 limit). The contribution
earned $5 interest in 2000 and $6 interest in 2001 before the due date
of the return, including extensions. He does not withdraw the $500 or
the interest it earned by the due date of his return, including
extensions.
Paul figures his excess contribution tax for 2000 by multiplying
the excess contribution ($500) shown on line 16, Form 5329, by .06,
giving him an additional tax liability of $30. He enters the tax on
line 17, Form 5329, and on line 54, Form 1040. See Paul's filled-in
Form 5329 in Appendix C, later.
Excess Contributions Withdrawn by Due Date of Return
You will not have to pay the 6% tax if you withdraw an excess
contribution made during a tax year and you also withdraw
any interest or other income earned on the excess contribution. You
must complete your withdrawal by the date your tax return for that
year is due, including extensions.
How to treat withdrawn contributions.
Do not include in your gross income an excess contribution that you
withdraw from your traditional IRA before your tax return is due if
both of the following conditions are met.
- No deduction was allowed for the excess contribution.
- You withdraw the interest or other income earned on the
excess contribution. Beginning in 2000, you can take into account any
loss on the contribution while it was in the IRA when calculating the
amount that must be withdrawn. If there was a loss, the net income you
must withdraw may be a negative amount.
Note.
If the trustee of your IRA is for any reason unable to calculate
the amount you must withdraw, get IRS Notice 2000-39. The notice
explains the IRS-approved method of calculating the amount you must
withdraw.
How to treat withdrawn interest or other income.
You must include in your gross income the interest or other income
that was earned on the excess contribution. Report it on your return
for the year in which the excess contribution was made. Your
withdrawal of interest or other income may be subject to an additional
10% tax on early distributions, discussed later.
Form 1099-R.
You will receive Form 1099-R indicating the amount of the
withdrawal. If the excess contribution was made in a previous tax
year, the form will indicate the year in which the earnings are
taxable.
Excess Contributions Withdrawn After Due Date of Return
In general, you must include all distributions (withdrawals) from
your traditional IRA in your gross income. However, if the following
three conditions are met, you can withdraw excess contributions from
your IRA and not include the amount withdrawn in your gross income.
- Total contributions (other than rollover contributions) for
the year to your IRA were not more than $2,000.
- There were no employer contributions for the year.
- You did not take a deduction for the excess contribution
being withdrawn.
The withdrawal can take place at any time, even after the due
date, including extensions, for filing your tax return for the year.
Excess contribution deducted in an earlier year.
If you deducted an excess contribution in an earlier year for which
the total contributions were $2,000 or less and for which there were
no employer contributions, you can still remove the excess from your
traditional IRA and not include it in your gross income. To do this,
file Form 1040X, Amended U.S. Individual Income Tax Return,
for that year and do not deduct the excess contribution on the
amended return. Generally, you can file an amended return within 3
years after you filed your return, or 2 years from the time the tax
was paid, whichever is later.
Excess due to incorrect rollover information.
If an excess contribution in your traditional IRA is the result of
a rollover and the excess occurred because the information the plan
was required to give you was incorrect, you can withdraw the excess
contribution. The limits, mentioned above, are increased by the amount
of the excess that is due to the incorrect information. You will have
to amend your return for the year in which the excess occurred to
correct the reporting of the rollover amounts in that year. Do not
include in your gross income the part of the excess contribution
caused by the incorrect information.
Deducting an Excess Contribution in a Later Year
You cannot apply an excess contribution to an earlier year even if
you contributed less than the maximum amount allowable for the earlier
year. However, you may be able to apply it to a later year if the
contributions for that later year are less than the maximum allowed
for that year.
You can deduct excess contributions for previous years that are
still in your traditional IRA. The amount you can deduct is the excess
contribution up to the maximum amount deductible for the current year
minus any amounts contributed to the IRA for the current year.
This method lets you avoid making a withdrawal. It does not,
however, let you avoid the 6% tax on any excess contributions
remaining at the end of a tax year.
Example.
Terry was entitled to contribute to her traditional IRA and deduct
$1,000 in 1999 and $1,500 in 2000 (the amounts of her taxable
compensation for these years). For 1999, she actually contributed
$1,400 but could deduct only $1,000. In 1999, $400 is an excess
contribution subject to the 6% tax. However, she would not have to pay
the 6% tax if she withdrew the excess (including any earnings) before
the due date of her 1999 return. Since Terry did not withdraw the
excess, she owes excise tax of $24 for 1999. To avoid the excise tax
for 2000, she can correct the $400 excess amount from 1999 in 2000 if
her actual contributions are only $1,100 for 2000 (the allowable
deductible contribution of $1,500 minus the $400 excess from 1999 she
wants to treat as a deductible contribution in 2000). Terry can deduct
$1,500 in 2000 (the $1,100 actually contributed plus the $400 excess
contribution from 1999).
Closed tax year.
A special rule applies if you incorrectly deducted part of the
excess contribution in a closed tax year (one for which the period to
assess a tax deficiency has expired). The amount allowable as a
traditional IRA deduction for a later correction year (the year you
contribute less than the allowable amount) must be reduced by the
amount of the excess contribution deducted in the closed year.
Early Distributions
You must include early distributions of taxable amounts from your
traditional IRA in your gross income. Early distributions are also
subject to an additional 10% tax, as discussed later.
Early distributions defined.
Early distributions are amounts distributed from your traditional
IRA account or annuity before you are age 59 1/2, or
amounts you receive when you cash in retirement bonds before you are
age 59 1/2.
Exceptions.
There are several exceptions to the age 59 1/2 rule.
You may qualify for an exception if you are in one of the following
situations.
- You have unreimbursed medical expenses that are
more than 7.5% of your adjusted gross income.
- The distributions are not more than the cost of your
medical insurance.
- You are disabled.
- You are the beneficiary of a deceased IRA
owner.
- You are receiving distributions in the form of an
annuity.
- The distributions are not more than your qualified
higher education expenses.
- You use the distributions to buy, build, or rebuild a
first home.
- The distribution is due to an IRS levy of the
qualified plan.
Most of these exceptions are explained earlier at
Exceptions under Age 59 1/2 Rule.
Note.
Distributions that are timely and properly rolled over, as
discussed earlier, are not subject to either regular income tax or the
10% additional tax. Certain withdrawals of excess contributions are
also tax free and not subject to the 10% additional tax. (See
Excess Contributions, earlier.) This also applies to
transfers incident to divorce, as discussed under Can I Move
Retirement Plan Assets?, earlier.
Receivership distributions.
Early distributions (with or without your consent) from savings
institutions placed in receivership are subject to this tax unless one
of the above exceptions applies. This is true even if the distribution
is from a receiver that is a state agency.
Additional tax.
The additional tax on early distributions is 10% of the amount of
the early distribution that you must include in your gross income.
This tax is in addition to any regular income tax resulting from
including the distribution in income.
Use Form 5329
to figure the tax. See the discussion
of Form 5329, later, under Reporting Additional Taxes for
information on filing the form.
Example.
Tom Jones, who is 35 years old, receives a $3,000 distribution from
his traditional IRA account. Tom does not meet any of the exceptions
to the age 59 1/2 rule, so the $3,000 is an early
distribution. Tom never made any nondeductible contributions to his
IRA. He must include the $3,000 in his gross income for the year of
the distribution and pay income tax on it. Tom must also pay an
additional tax of $300 (10% x $3,000). He chooses to file Form
5329. See the filled-in Form 5329 in Appendix C.
Early distributions of funds from a SIMPLE retirement account made
within 2 years of beginning participation in the SIMPLE are subject to
a 25%, rather than 10%, early distributions tax.
Nondeductible contributions.
The tax on early distributions does not apply to the part of a
distribution that represents a return of your nondeductible
contributions (basis).
Excess Accumulations (Insufficient Distributions)
You cannot keep amounts in your traditional IRA indefinitely.
Generally, you must begin receiving distributions by April 1 of the
year following the year in which you reach age 70 1/2
(your 70 1/2 year). The required minimum distribution for
any year after your 70 1/2 year must be made by December
31 of that later year.
Tax on excess.
If distributions are less than the required minimum distribution
for the year, discussed earlier under When Must I Withdraw IRA
Assets? (Required Distributions), you may have to pay a 50%
excise tax for that year on the amount not distributed as required.
Reporting the tax.
Use Form 5329 to report the tax on excess accumulations. See the
discussion of Form 5329, later, under Reporting Additional Taxes,
for more information on filing the form.
Request to excuse the tax.
If the excess accumulation is due to reasonable error, and you have
taken, or are taking, steps to remedy the insufficient distribution,
you can request that the tax be excused.
How to file the request.
File Form 5329 with your Form 1040 and pay any tax you owe on
excess accumulations. Attach an explanation for the excess
accumulation and show when you removed the excess or what you have
done that will result in its distribution.
If the IRS approves your request, it will refund the excess
accumulations tax you paid.
Exemption from tax.
If you are unable to make required distributions because you have a
traditional IRA invested in a contract issued by an insurance company
that is in state insurer delinquency proceedings, the 50% excise tax
does not apply if the conditions and requirements of Revenue Procedure
92-10 are satisfied. Those conditions and requirements are
summarized below. You can read the full text of the revenue procedure
at most IRS offices and at many public libraries. Revenue Procedure
92-10 is in Cumulative Bulletin 1992-1.
Conditions.
To qualify for exemption from the tax, the assets in your
traditional IRA must include an affected investment. Also, the amount
of your required distribution must be determined as discussed earlier.
Affected investment defined.
Affected investment means an annuity contract or a guaranteed
investment contract (with an insurance company) for which payments
under the terms of the contract have been reduced or suspended because
of state insurer delinquency proceedings against the contracting
insurance company.
Requirements.
If your traditional IRA (or IRAs) includes other assets in addition
to your affected investment, all traditional IRA assets, including the
available portion of your affected investment, must be used to satisfy
as much as possible your IRA distribution requirement. If the affected
investment is the only asset in your IRA, as much as possible of the
required distribution must come from the available portion, if any, of
your affected investment.
Available portion.
The available portion of your affected investment is the amount of
payments remaining after they have been reduced or suspended because
of state insurer delinquency proceedings.
Make up of shortfall in distribution.
If the payments to you under the contract increase because all or
part of the reduction or suspension is canceled, you must make up the
amount of any shortfall in a prior distribution because of the
proceedings. You make up (reduce or eliminate) the shortfall with the
increased payments you receive.
You must make up the shortfall by December 31 of the calendar year
following the year that you receive increased payments.
Table 2.1 You Can Contribute to a Roth IRA
Reporting Additional Taxes
Generally, you must use Form 5329 to report the tax on excess
contributions, early (premature) distributions, and excess
accumulations.
Filing Form 1040.
If you file Form 1040, complete Form 5329 and attach it to your
Form 1040. Enter the total amount of IRA tax due on line 54, Form
1040.
Note.
If you have to file an individual income tax return and Form 5329,
you must use Form 1040.
Not filing Form 1040.
If you do not have to file a Form 1040 but do have to pay one of
the IRA taxes mentioned earlier, file the completed Form 5329 with IRS
at the time and place you would have filed Form 1040. Be sure to
include your address on page 1 and your signature and date on page 2.
Enclose, but do not attach a check or money order payable to the
United States Treasury for the tax you owe, as shown on Form 5329.
Write your social security number and "2000 Form 5329" on your
check or money order.
Form 5329 not required.
You do not have to use Form 5329 if any of the following conditions
exist.
- Distribution code 1 (early distribution) is shown in box 7
of Form 1099-R. Instead, multiply the taxable part of the early
distribution by 10% and enter the result on line 54 of Form 1040.
Write "No" next to line 54 to indicate that you do not have to
file Form 5329. However, if you owe this tax and also owe
any other additional tax on a distribution, do not enter this 10%
additional tax directly on your Form 1040. You must file Form 5329 to
report your additional taxes.
- You qualify for an exception to the additional tax on early
distributions. You need not report the exception if distribution code
2, 3, or 4 is shown in box 7 of Form 1099-R. However,
if one of those codes is not shown, or the code shown is
incorrect, you must file Form 5329 to report the exception.
- You properly rolled over all distributions you received
during the year.
Previous| First | Next
Publication Index | IRS-Forms Main | Home
|