IRS pushed to crack down on ‘mega IRAs’

In 2014, the GAO said the federal government will forgo an estimated $17.45 billion in tax revenue from IRAs, which Congress created to ensure equitable tax treatment for those not covered by employer-sponsored retirement plans. “Congress limited annual contributions to IRAs to prevent the tax-favored accumulation of unduly large balances,” GAO said. “But concerns have been raised about whether the tax incentives encourage new or additional saving.” Congress is re-examining retirement tax incentives as part of tax reform.

Wyden commended the IRS for better enforcing IRA rules regarding hard-to-value assets with its Form 5498, which, starting in tax year 2014, will require IRA custodians to include the fair market value of nonpublicly traded assets and information on the type of asset.

Form 5498 is effective now, Slott says, but is optional. The new reporting rules under Form 5498 “will be mandatory in 2015,” Slott says, and the “IRS will require valuations on these assets. Hard-to-value IRA assets are generally non-traditional investments (alternative IRA investments), such as non-publicly traded stock, partnership and LLC interests, real estate, options and similar items that are not traditionally offered by your average bank or IRA custodian. These assets are usually held in self-directed IRA accounts.”

The “better move for these undervaluation schemes, which some investors are doing, is to use the Roth IRA, where the true value will escape income taxation forever,” Slott continues. “We’ll have to see whether these new hard-to-value IRA investment reporting rules will really catch the mega IRA owners undervaluing their holdings.”

While valuations of these assets will soon be required, Slott says, “these high-end IRA investors can still obtain valuations to their favor. The question is whether the IRS will be able to pursue theses cases and prevent further abuse of the retirement tax rules. IRS does have a few tools at their disposal that could heavily penalize these undervaluations.”

To improve IRS’s ability to detect and pursue noncompliance associated with undervalued assets sheltered in IRAs and prohibited transactions, GAO recommended that the IRS commissioner:

• 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 nonpublicly traded IRA assets;

• 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 IRS-wide strategy to target enforcement efforts.

• 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 three-year window.

• 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.

• 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 nonpublicly traded assets or directly controlling IRA assets.