Tax Notes Newsletter

Individual Retirement Accounts (IRAs) Face New IRS Scrutiny

By Louis LiBrandi, Doug Ruttenberg and Garrett Higgins
According to a report by the US Treasury Inspector General for Tax Administration, the government [i.e., the Internal Revenue Service (IRS)] has not collected millions of dollars in tax and penalties for the failure of IRA owners to properly comply with the many complex tax rules applicable to these types of retirement accounts. Because of the findings in the Inspector Generals Report, it appears the IRS is turning its attention to IRA account owners. Recently the IRS has issued a change (discussed below) to one of the reporting forms that must be provided to an IRA account holder. The IRS is also considering what other guidance and/or additional reporting requirements it will issue or impose on custodians of IRAs and to IRA account holders to ensure that the proper amount of contributions, valuing of the IRA, and distribution requirements are being met. The main areas that the IRS is expected to be looking at are:

Louis LiBrandi Principal 212.286.2600 llibrandi@odpkf.com

1. Non-Traditional Investments (NTIs) held in self-directed IRAs 2. Beneficiary designations and distribution calculations 3. Unrelated Business Income Tax (UBIT) being generated by investments in
IRAs
Doug Ruttenberg Partner 914.381.8900 druttenberg@odpkf.com

The IRS has indicated they initially will be sending notices to custodians of IRA accounts beginning in 2014. This will be followed with an examination program of identified IRA account holders who meet the specific examination characteristics. Lets take a closer look at the areas of scrutiny being considered by the IRS. Non-Traditional Investments (NTIs) Most individuals invest their IRA assets in taxable equities, mutual funds and taxable bonds. More recently, non- traditional assets, such as investments in Master Limited Partnerships, Real Estate and Closely-Held Businesses, have gained increasing popularity as effective IRA Investments. Beginning with the 2014 filing year, the IRS has issued a draft of a revised Form 5498. The Form reports, among other information, the value of your assets in the IRA as of the prior December 31. The draft form requests, for the first time, values for NTIs. Subsequent versions of the Form will likely require identifying the type of asset held by the IRA.

Garrett Higgins Partner 914.381.8900 ghiggins@odpkf.com

Contact: New York, NY 212.286.2600 Harrison, NY 914.381.8900 Stamford, CT 203.323.2400 Paramus, NJ 201.712.9800 New Windsor, NY 845.220.2400 Wethersfield, CT 860.257.1870

The question will be how these NTIs will be valued and what is the cost of valuing these assets. The prior value and the age of the IRA beneficiary are the factors for determining the Required Minimum Distribution (RMD). If the value of the NTIs is not included or not calculated correctly, then the RMD will not be calculated correctly. The taxpayer could be subject to an additional tax for failing to take the proper amount as a distribution. The additional tax is 50% of the amount that should have been distributed. These NTIs must also have the proper custodial structure. For example, you cannot own the NTI in your own name. If not held properly, the NTI would not be an eligible IRA asset and would have to be distributed from the IRA. The taxpayer would be subject to income tax and potential penalties on this distribution. Beneficiary Designations and Distribution Calculations The issues here are whether your IRA is being distributed to the proper beneficiary and in the proper amount. The rules for distribution can be complex and depend on who the beneficiary is and the age of the beneficiary. There are different rules for spousal beneficiaries, non-spousal beneficiaries and where there are multiple beneficiaries of the same IRA. You also want to pay careful attention to your IRA beneficiaries. Do you want the full amount of your IRA to go outright to a second spouse or to a minor child or grandchild? You should review your beneficiary designations annually to make sure they are in order and meet your wishes. Unrelated Business Income Tax (UBIT) In an effort to generate greater rates of return in a slowly recovering economy, IRA owners have begun to invest in alternative type investments, such as oil and gas, private equity, real estate and hedge funds. An IRA owners venture into these types of investments can generate trade or business or debt-financed income which could subject the IRA to UBIT and require the IRA to file federal and state income tax returns when gross unrelated business income from all investments is greater than $1,000. This income is separately reported on a Schedule K-1, Part III line item 20V or the supplemental statements attached to it and is easily identifiable to an IRS agent. Failure to file such returns can result in penalties and interest being imposed upon the IRA. Since the UBIT rules are complex, it is recommended that IRA owners identify all alternative investments they have invested IRA assets in and consult with their tax advisors as to the IRAs exposure to UBIT. For more information, please contact Lou LiBrandi (llibrandi@odpkf.com), Doug Ruttenberg (druttenberg@odpkf.com) or Garrett Higgins (ghiggins@odpkf.com).
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