Individual retirement account (IRA) penalties are put in place to minimize account abuse and fraud. It is important to understand the tax laws regarding these accounts since penalties can offset any tax advantages that an IRA may offer. Penalties can range from additional taxes to loss of IRA status.
Excess Accumulations Penalty
If you inherited your IRA, you need to be concerned about what the IRS calls "excess accumulations." When you inherit your IRA, you are responsible for meeting the required minimum distribution rule. This rule states you must withdraw a certain amount each year from your account. If you do not make these minimum withdrawals from your IRA, your account balance keeps getting larger and larger. The IRS will consider your IRA as having "insufficient distributions" and penalize you. There usually is a 50-percent excise tax, otherwise known as a penalty, placed on the amount not distributed.
Even if you were over the age of 70-1/2 when you received the distribution, you still will face this steep penalty. You can have this penalty waived if you can show the IRS that you are aware of the issue and are currently making corrections. The insufficient distributions must have been "due to reasonable error" says IRS Publication 590.
Prohibited Transactions Penalty
You may face a penalty if you or your beneficiary engage in transactions that are prohibited under tax laws. These transactions involve using the funds of your IRA account in an improper manner. Examples of prohibited transactions include selling property to it, using it as collateral for obtaining a loan, buying property for personal use (either now or in the future) or borrowing money from it.
You also are not allowed to receive any unreasonable compensation for managing your IRA account. If you are found to have engaged in any prohibited transaction, your IRA will lose its status as an IRA. All of your IRA account assets will be treated as a distribution to you. The assets will be valued at their fair market value at the date of distribution, states IRS Publication 590. If the market value is more than your current basis, you need to include the taxable gain in your income.
Nonqualified Distribution Penalty
You may be assessed a penalty if you receive any distributions from your individual retirement account that are not considered qualified. The penalty is in the form of an additional 10 percent tax on the distribution. The nonqualified distribution will be considered an early distribution if you receive it prior to reaching the age of 59-1/2. Also, if five years have not elapsed since you made your first contribution into your Roth IRA, any distribution you receive will be nonqualified. Other examples of nonqualified distributions include not using the funds to purchase your first house, or not being disabled when you receive the funds.
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