Today, the federal Government Accountability Office (GAO) released its report on “large balance IRAs”. The full report is 99 pages long, but a summary can be found here. For me personally, the report is important in multiple ways:
- I was interviewed by a GAO officer during their preparation for writing the report.
- Almost all of my clients will be affected by any changes that Congress makes to the rules governing IRA investing (particularly with regards to investments into “non-traditional” assets); and
- Although increased IRS scrutiny of self-directed IRAs might be warranted (in the sense that some IRA investors intentionally try and skirt the rules), a heavy-handed approach by the federal government could be dangerous even for well-intentioned investors – because the current legal framework is vague in many ways.
“Recommendations” of the GAO are listed below. Depending on how Congress and the Internal Revenue Service (IRS) responds, these suggested changes could have very significant impacts on self-directed IRA investors going forward.
Matter for Congressional Consideration
- To promote retirement savings without creating permanent tax-favored accounts for a small segment of the population, Congress should consider revisiting the use of IRAs to accumulate large balances and consider ways to improve the equity of the existing tax expenditure on IRAs. Options could include limits on (1) the types of assets permitted in IRAs, (2) the minimum valuation for an asset purchased by an IRA, or (3) the amount of assets that can be accumulated in IRAs and employer-sponsored plans that get preferential tax treatment.
Recommendations for Executive Action
- To improve IRS’s ability to detect and pursue noncompliance associated with undervalued assets sheltered in IRAs and prohibited transactions, the Commissioner of Internal Revenue should approve plans to fully compile and digitize the new data from electronic and paper-filed Form 5498s to ensure the efficient use of the information on non-publicly traded IRA assets.
- To improve IRS’s ability to detect and pursue noncompliance associated with undervalued assets sheltered in IRAs and prohibited transactions, the Commissioner of Internal Revenue should conduct research using the new Form 5498 data to identify IRAs holding nonpublic asset types, such as profits interests in private equity firms and hedge funds, and use that information for an IRSwide strategy to target enforcement efforts.
- To improve IRS’s ability to detect and pursue noncompliance associated with undervalued assets sheltered in IRAs and prohibited transactions, the Commissioner of Internal Revenue should work in consultation with the Department of the Treasury on a legislative proposal to expand the statute of limitations on IRA noncompliance to help IRS pursue valuation-related misreporting and prohibited transactions that may have originated outside the current statute’s 3-year window.
- To help taxpayers better understand compliance risks associated with certain IRA choices and improve compliance, the Commissioner of Revenue should, building on research data on IRAs holding nonpublic assets, identify options to provide outreach targeting taxpayers with nonpublic IRA assets and their custodians, such as reminder notices that engaging in prohibited transactions can result in loss of the IRA’s tax-favored status.
- To help taxpayers better understand compliance risks associated with certain IRA choices and improve compliance, the Commissioner of Revenue should add an explicit caution in Publication 590 Individual Retirement Arrangements (IRAs) for taxpayers about the potential risk of committing a prohibited transaction when investing in non-publicly traded assets or directly controlling IRA assets.