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What does the DOL rule mean for your future?

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The entire financial industry is quickly becoming more and more familiar with the three letters “DOL,” but the question at the end of the day is, “What does this mean for the future of giving advice.”

With more than 1,000 pages in the new rule and exemptions, it may be really hard for one to fully understand all the ramifications and how to position your business so you can thrive in the future. I recently came across a gentleman by the name of Peter Gulia, a lawyer who advises fiduciaries, including investment advisors. In our first conversation, I presented the case of wanting to help advisors increase their knowledge around this topic so they can help protect their businesses and execute their fiduciary oath. As our conversation progressed, he explained a point that shocked me and I felt it was critical to pass along this information.

If an advisor recommends a prospect move his or her retirement plan money to a commissioned-based IRA, the advisor and broker-dealer or other financial institution must, beginning April 10, 2017, meet all the many conditions of the new Best Interest Contract exemption (BICE), including a written contract or obligation that binds the advisor and the firm to the exemption’s best-interest standards. Got it!

This is where it gets interesting. If the IRS audits the investor, they might be required to produce a completed and accurate BICE form. If this form is not complete or is inaccurate, the IRS can make the entire IRA a taxable event to your client. YES!!! That’s right. Your client could be happy with your advice and the investment results, but now he has a major taxable event on his hands. So I think we can all guess what will happen next. They call an attorney and you are personally liable for the situation.

Thinking about this, I asked Peter to explain what law imposes tax consequence on an IRA if the BICE or another prohibited-transaction exemption is not met. Rather than try to describe, I quote (with Peter Gulia’s permission) the response he emailed me:

“Most practitioners are not surprised that Congress granted the Labor Department authority to interpret ERISA’s non-tax fiduciary-responsibility provisions concerning employment-based employee-benefit plans. But some are surprised that the Labor Department has authority also to interpret tax code provisions, even as those provisions apply to an individual retirement account or individual retirement annuity that has no connection to an employment-based retirement plan. Here’s how.

In legislating the Employee Retirement Income Security Act of 1974, Congress granted powers to several government agencies, including the Labor and Treasury departments. Congress enacted ERISA’s participation, vesting, funding, and some fiduciary-responsibility provisions in two sets of provisions — in ERISA’s title I for non-tax provisions, and in ERISA’s title II for provisions that amended the Internal Revenue Code. Further, in ERISA’s title III Congress directed the agencies to coordinate their interpretations and enforcement. Many rules required collaborations between or among two or more agencies, and required executive approval from every agency involved.

The Labor and Treasury departments’ people found this cumbersome. They designed a plan under which authority to interpret specified statute sections rests with one department, even if this means that the tax agency interprets a labor statute, or that the labor agency interprets a tax statute. President Carter adopted this plan, and transmitted it to both bodies of Congress. The plan’s name carries little political symbolism; rather, it is Reorganization Plan No. 4 of 1978.

The Reorganization Plan’s § 102 transfers to the Secretary of Labor the Secretary of the Treasury’s authority to interpret Internal Revenue Code § 4975, with some exceptions (none of which constrains what the investment-advice fiduciary rule does).

Internal Revenue Code § 4975 defines a prohibited transaction, and imposes an excise tax on each prohibited transaction. Internal Revenue Code § 408(e)(2)(A) provides: ‘If, during any taxable year of the individual for whose benefit any individual retirement account is established, that individual or his beneficiary engages in any transaction prohibited by section 4975 with respect to such account, such account ceases to be an individual retirement account as of the first day of such taxable year.’ Internal Revenue Code § 408(e)(2)(B) provides: ‘In any case in which any account ceases to be an individual retirement account by reason of subparagraph (A) as of the first day of any taxable year, paragraph (1) of subsection (d) applies as if there were a distribution on such first day in an amount equal to the fair market value (on such first day) of all assets in the account (on such first day).’ Internal Revenue Code § 408(d)(1) includes in a taxpayer’s gross income previously untaxed amounts paid or distributed from an IRA.

Although the Treasury department’s Internal Revenue Service administers the Federal excise and income taxes, the Labor Department’s new rule governs whether a person is a fiduciary, which affects whether a transaction is a prohibited transaction.”

If you would like to reach out to Peter directly for his thoughts and counsel, he can be reached at [email protected].

As always, I look forward to continuing to share different strategies and knowledge that will help you grow and protect your practice!

See also:

Wall Street splits with smaller firms over broker-rule lawsuit

Partner or practice? How to comply with the fiduciary rule

3 exciting unintended consequences of the DOL rule

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