The Internal Revenue Service plans to take further steps to discourage taxpayers from exceeding the limits on contributions to individual retirement accounts within a single year.
According to a new report from the Treasury Inspector General for Tax Administration, the IRS needs to take action to address the problem of excess contributions to IRAs. The report cites research from the Government Accountability Office estimating that 43 million individuals had IRAs in tax year 2011 with a fair market value of $5.2 trillion.
“IRAs are a key tax preferred way for individuals to save for retirement; however, there are rules that limit the amount individuals can contribute to IRAs in a tax year,” said the report. “Individual noncompliance with excess IRA contribution rules results in revenue loss to the federal government.”
Back in fiscal years 2008 and 2010, TIGTA recommended that the IRS develop a strategy to address retirement provision noncompliance. In response to those recommendations, the IRS developed and implemented a broad strategy focusing on educating tax preparers and individuals about IRA rules and notifying individuals when they have potentially exceeded contribution limits.
The new report acknowledges that the IRS has taken positive steps toward testing its strategy by adding controls to identify and address excess IRA contributions. However, while the IRS has addressed many of TIGTA’s earlier recommendations, TIGTA found that more improvements could be made. For example, the IRS developed education materials for individuals and tax preparers but did not consider developing education materials for IRA custodians. The new report identified a significant number of inaccurate IRA information documents submitted by IRA custodians, and TIGTA believes including outreach to IRA custodians would improve the accuracy of information documents sent to the IRS.
The IRS has also tested a way to identify and notify individuals who have made potentially excessive IRA contributions. While IRS officials said the agency only intended to identify a suitable sample population for its test, TIGTA identified a significant number of potentially noncompliant individuals who were not included in the universe from which the IRS selected its sample.
If the IRS decides to continue its compliance efforts based on its test, TIGTA noted that having a more complete and accurate population of potentially noncompliant taxpayers would help IRS management select the most productive cases to pursue with limited compliance resources. Improved methods of identifying noncompliance could also protect revenue and reduce taxpayer burden, the report pointed out.
TIGTA recommended that, when evaluating future efforts related to the IRA strategy, the commissioner in charge of the IRS’s Wage and Investment Division, should consider developing education materials for IRA custodians informing them of common mistakes made on information documents and the importance of submitting accurate information documents, and identifying a more complete and accurate universe of individuals who potentially made excess contributions from which to select potentially productive cases.
In response to the report, IRS officials said they plan to continue to inform IRA custodians of issues and errors affecting the administration of IRAs from a taxation perspective. In addition, the IRS agreed to identify a more complete and accurate universe of individuals who potentially made excess contributions as it is a logical next step in expanding the IRA soft notice program from its current pilot state.
“One of the most significant challenges faced by the IRS in administering provisions of the tax code governing IRAs is the level of complexity that may be present with various taxpayer situations, preventing the formulation of a generic approach that would adequately and accurately address all situations,” wrote Debra Holland, commissioner of the IRS’s Wage and Investment Division.
“Traditionally, these issues have been addressed through the examination process, which is the most costly and time consuming treatment for addressing compliance issues. Because our limited compliance resources must also address other issues of equal or higher priority than excess IRA contributions, we are exploring the viability of improving compliance through the use of soft notices.”
She noted that the average potential excise tax deficiency reported by TIGTA associated with excess IRA contributions is only $131 per taxpayer.
“Such a comparatively low yield, when considering the cost of resources needed to address the issue, supports shifting compliance activities to a more economical education and outreach approach afforded by the soft notice process,” said Holland.
She pointed out that the IRS has had success with using soft notices for alerting taxpayers to potential errors in their treatment of specific issues and in achieving improved compliance rates in subsequent periods. However, Holland observed that success depends on developing effective messaging and supplemental materials to inform and educate the intended recipients.
“Because poorly designed soft notices could generate increased telephone and correspondence contacts by taxpayers, it is critical that the message conveyed by them is appropriately tested and refined prior to widespread deployment,” she wrote.