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Reducing unnecessary IRS tax notices on IRA conversions

Often we write about audits of IRS policies and processes completed by the Treasury Inspector General for Tax Administration (TIGTA). This agency plays an important oversight role in assessing how well the IRS is doing.

A recent review looked at retirement account rollovers – specifically traditional to Roth Individual Retirement Arrangements (IRA) conversions. The Automated Underreporter (AUR) program matched third-party documents against the tax returns of about 400,000 taxpayers as more than $10 billion in assets were converted in 2011. Underreported taxes on these conversions have been an agency priority, but they often involve complex issues.

Why convert in the first place?

Often conversions are part of the estate planning process. Aging parents might convert IRA funds into a Roth and pay the tax bill, since their income and effective tax rate is lower than that of their children. An expectation of a jump in pay (graduating from a professional program and landing a career position) is another reason to convert.

IRS notices and the burden they pose

The IRS has a process in place to assess conversion compliance. The TIGTA audit found that in general these procedures were followed. But an error rate of 13 percent in the sample reviewed was higher than estimates on other types of cases handled by the AUR Program. The reasons were related to unclear guidance and the complex issues associated with Roth IRA conversions.

In some cases, the IRS worker could have researched information within IRS systems to find that minimal or no taxes were due. But because the manual did not require this step, unnecessary notices were sometimes sent to taxpayers.

Recommendations

These audits can bring about changes that benefit taxpayers. In this case, there will be clarifications and additional education for those working in the AUR Program. How best to limit the number of notices is still being debated between the TIGTA and the IRS. If asked for more information or assessed a tax penalty related to an IRA conversion, get guidance from an experienced tax attorney prior to responding.

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