"The Pension Specialists" Blog

IRS Issues Guidance on the New Safe Harbor Exceptions Applying to Certain 2016 1099-R Forms

IRS Issues Guidance on the New Safe Harbor Exceptions

Applying to Certain 2016 1099-R Forms

In June/July of 2015 a new tax law was enacted increasing the penalty for failing to prepare a required Form 1099-R or for preparing an incorrect Form 1 099-R (and many other reporting forms) from $100 per form to $250 per form. A $250 penalty is owed for an incorrect form furnished to the individual recipient and another $250 penalty if the IRS is furnished an incorrect Form 1 099-R. Such penalties are very costly.

There was a limited public outcry against the new $250 per form penalty as some new exceptions to the $250 penalty were enacted in December of 2015. The Protecting Americans from Tax Hikes Act of 2015 became law on December 18, 2015.

This law created new two new exceptions so an IRA custodian will not owe the $250 penalty (times two) even though a 1 099-R form has been prepared in error. For some time the law has contained what are called de minimis error exceptions and as long as there are only a very limited number of incorrect 1 099-R forms, the filer wil not owe the penalty amount. These other "older" exceptions are beyond the scope of this article.

There are two new exceptions. The IRS has issued Notice 2017-09 to issue temporary guidance until the IRS issues a regulation. The IRS probably would have preferred that these new exceptions had not become law, but they are a welcome change for IRA custodians.

First, the $250 penalty is not owed if the error relates to an incorrect dollar amount and the error differs from the correct amount by no more than $100. For example, Jane Doe's 1099-R form shows a distribution amount of $9,800 when the correct distribution amount was $9900 or alternatively it was $9700. In such case, the new general rule is that the IRA custodian is not required to prepare a corrected Form 1099-R for Jane Doe.

Second the $250 penalty is not owed if the error relates to an incorrect tax withheld amount and the error differs from the correct amount by no more than $40. For example, John Doe's 1099-R form shows a distribution with a withheld amount of $450 when the correct withheld amount was $490 or alternatively it was $410. In such case, the new general rule is that the IRA custodian is not required to prepare a corrected Form 1099-R for John Doe.

There is an exception to the exception. If Jane Doe or John Doe makes a certain election, then the IRA custodian/trustee will not be able to use this new de minimis exception and will owe the $250 penalty regardless that the error is within the $100 or the $40 range.

There is also an exception to the exception to the exception. If the IRA distributee has made the election and the IRA custodian within 30 days of the election prepares and files a corrected Form 1099-R, then the IRA custodian will not owe the $250 penalty as its error is deemed subject to the reasonable cause exception and is not willful neglect. If special rules create a longer time period, then such longer time periods will be available.

These new rules apply to 1099-R forms required to be filed with the IRS and furnished to individuals after December 31, 2016. That is, it applies to 2016 forms which must be furnished/filed in 2017.

An IRA distributee has the right to instruct (i.e. elect) the IRA custodian/trustee that it will not be able to use the de minimis exception and that it must prepare a corrected Form 1099-R. The IRA custodian has the right to create the method(s) the IRA distributee must use to notify the IRA custodian that it will not be able to use the de minimis exception and that it must prepare a corrected Form 1099-R. Such method(s) must be reasonable. It can be required that the election be in writing, it can be required that the instruction be made by making a telephone call or it can be made on-line. The IRA custodian only needs to establish one method. If so, the IRA distributee must use this method and the individual can't use another method even if his/her method is reasonable. Exception, if the IRA custodian establishes an on-line method, the individual must be allowed to use another method of his or her election.

The IRA custodian does not have the right to limit in any way the IRA distributee's right to request a corrected Form 1099-R such as imposing a time limit or any preconditions.

The IRA custodian must inform an IRA distribution of the election procedures before a person makes his or her election. If an IRA custodian fails to establish an election method, then the IRA distributee may furnish his or her written election to the IRA custodian's address as set forth on the incorrect Form 1099-R or as directed by the IRA custodian after he or she has inquired. An IRA distributee in his or her election must furnish the following information -

(1) that he or she is making the election;

(2) his or her name, address and TIN;

(3) that a Form 1099-R was prepared with an error with applicable account number, if applicable; and

(4) the year or years the IRA distributee wants the election to apply to. It might be the current year or the current year and certain future years.

An IRA custodian is ineligible to use this de minimis error safe harbor rule if it has failed to file or furnish a correct Form 1099-R or if it has intentionally misreported an incorrect dollar amount. This is true even for distributions less than $100 or withheld amounts less than $25.

The IRA custodian must retain records of an IRA distributee's election or a revocation of an election for as long as that information may be relevant to the administration of any tax law.

The IRS will be writing regulations discussing these new rules and procedures for use of the de minimis errors safe harbor rules. It is expected that an IRA custodian will be required to notify an IRA distributee of the new safe harbor and that he or she may request to be furnished a corrected Form 1099-R and that the IRA custodian will not have the right to not prepare a corrected Form 1099-R as is possible under the new safe harbor. A good way to meet this requirement will be to discuss these new rules in the IRA plan agreement and disclosure statement booklet. An explanation could also be furnished along with the Form 1099-R. The IRS most likely will add a discussion to the instructions furnished to the IRA distributee.

As under pre-2016 laws, an IRA custodian may still choose to always prepare corrected Forms 1099-R when one has been prepared incorrectly even though the law no longer requires it and if the IRA distributee has not required it. This is obviously what the IRS prefers.

Although this article has discussed the new rules applying to the Form 1099-R, in fact these new rules apply to many IRS reporting forms as set forth in Code 6724. However, these new rules do not apply to Form 5498, IRA FMV statements, RMD Notices, Form 1099-SA and Form 5498-SA.