Individual Retirement Accounts: IRS Could Better Inform Taxpayers about and Detect Noncompliance Related to Unconventional Assets
Released: 2020-02-26T00:00:00

Letter

Background

Created as part of the Employee Retirement Income Security Act of 1974, as amended (ERISA), traditional IRAs provide tax advantages to help individuals—including small business owners, independent contractors, and other workers not covered by employer-sponsored retirement plans— save for retirement. Employees who have employer-sponsored retirement plans, such as a 401(k), can also roll over these assets into an IRA when they retire or change jobs.

Since the enactment of ERISA, different types of IRAs with different features for individuals and small businesses have been created. The two IRA types with federal income tax benefits for individuals are traditional IRAs (which allow eligible individuals to make tax-deductible contributions and accumulate tax-deferred investment earnings) and Roth IRAs (which allow eligible individuals to make after-tax contributions and accumulate investment earnings tax free).

IRA owners are able to invest their IRA savings in a wide variety of asset types. IRA owners generally make tax-favored contributions to their accounts to purchase assets from investment options offered through banks or other IRS-qualified firms acting as custodians of the IRA assets. Most IRA custodians limit holdings in IRA accounts to firm- approved stocks, bonds, mutual funds, and CDs.

Some custodians offer so-called “self-directed IRAs” that allow investments in a broader set of unconventional assets—such as real estate, certain precious metals, private equity, and virtual currency—than is permitted by most IRA custodians. As we previously reported, custodial agreements for these accounts often require IRA account owners to be responsible for directing their investments, and to oversee the selection, management, monitoring, and retention of all investments in the account. The account owners bear the consequences of any mistakes made in managing their accounts, such as being noncompliant with IRA rules.

Through our prior work, we identified the following four areas where complex rules are likely to apply to IRA owners investing in unconventional assets:

Barred investments. Investments in life insurance contracts and collectibles, such as artwork and antiques, are prohibited. Although precious metals are generally prohibited collectibles, certain types of coins and bullion are permitted provided that they meet specific purity and custody requirements.

Prohibited transactions. IRA owners are not permitted to engage in prohibited transactions that personally benefit the owner or other disqualified persons in a way other than as a vehicle to save for retirement. Examples of such prohibited transactions include IRA owners selling their own property to an IRA, or taking a salary from an IRA-funded business. IRA owners who believe that an otherwise prohibited transaction should be permitted, may apply to the Department of Labor (DOL) to request an exemption for a specific transaction.

Unrelated business income. Earnings and profits made in tax- deferred savings vehicles like IRAs generally are reinvested in the account without generating current federal tax liability, but investments in certain unconventional assets can generate ongoing tax liability for IRA owners. Any IRA that earns $1,000 or more of gross income from an unrelated business must file Form 990-T Exempt Organization Business Income Tax Return with IRS and pay related taxes.

Fair market value (FMV). When IRA owners invest in less conventional and nonpublicly traded assets, custodians may find it challenging to properly report the FMV of those assets. Starting with tax year 2015, IRS began requiring IRA custodians to report selected information on unconventional assets in their clients’ accounts. For some hard-to-value unconventional assets, IRA owners may need to supply custodians with independent appraisals or other evidence to substantiate an asset’s current FMV.

Failure to abide by the rules governing IRAs with unconventional assets can have significant consequences for IRA owners. For example, if an IRA owner engages in a prohibited transaction that has not been exempted by DOL, the IRA will lose its tax-favored status, and the account is treated as distributing all of its assets to the owner at the FMV on the first day of the year in which the prohibited transaction occurred. Noncompliance with IRA rules—if not detected—can also lead to millions of dollars in uncollected tax revenue for the government.

Individuals who invest in certain unconventional assets using Roth IRAs can avoid taxation on investment gains. For example, founders of companies (or key initial investors) who use IRAs to invest in nonpublicly traded shares of their newly formed companies can realize many millions of dollars in tax-favored gains on their investment if the company is successful.

IRS is responsible for enforcing IRA tax laws, including rules that apply when IRA owners invest in unconventional assets. Within IRS, four business operating divisions have responsibilities for enforcing compliance with IRA rules. Table 1 provides an overview of each division’s IRA enforcement activities.

Third-party reporting by IRA custodians provides information that taxpayers can use in preparing their tax returns and that IRS can use to identify noncompliant taxpayers and help close the tax gap. In 2015, IRS began requiring custodians to report new information to help identify IRAs with hard-to-value unconventional assets. IRS Form 5498 IRA Contribution Information has a new box 15a for custodians to report the portion of the IRA FMV attributable to nonmarket assets as well as a box 15b with codes describing the type of nonmarket assets. Custodians are to report similar information on IRS Form 1099-R identifying distributions of IRA assets that do not have a readily available FMV.

Primary IRS Publication Could Better Help IRA Owners with Unconventional Assets Understand Complex Rules

The first article in the Taxpayer Bill of Rights is the right to be informed which means that taxpayers have the right to know what they need to do to comply with tax laws. IRS’s Publication 1, Your Rights as a Taxpayer, further states that taxpayers are entitled to clear explanations of the laws and IRS procedures in all forms, instructions, publications, notices, and correspondence.

To help taxpayers and their advisors better understand tax rules, such as those governing IRAs with unconventional assets, IRS produces several types of resources. Taxpayers (or their advisers and paid tax preparers) with complicated returns or transactions may require detailed and technical resources, such as guidance published in a weekly IRS publication called the Internal Revenue Bulletin (IRB). Tax regulations— issued by the Department of the Treasury (Treasury)—are published in the IRB together with technical IRS guidance such as revenue rulings and revenue procedures. IRS has stated that only guidance published in the IRB contains IRS’s authoritative interpretation of the law.

IRS also produces resources that are less technical and intended to be more easily understood by most taxpayers. IRS issues hundreds of publications on a variety of tax topics, and many are updated annually. IRS also produces a variety of information on its website (IRS.gov) such as online tools, instructions, and FAQs.

IRS’s Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs), and Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), serve as a general IRA handbook for IRA owners and a logical starting point for all IRA owners with tax questions, including those with unconventional assets. At more than 120 pages combined, Publications 590-A and 590-B comprise one of IRS’s longest publications on retirement related topics. Publications 590-A and 590-B provide some limited information on the four compliance topics that we identified through prior work as likely to affect IRA owners with unconventional assets. However, the two-part publication lacks additional information that IRA owners with unconventional assets need to comply.

Publications 590-A and 590-B recommend that taxpayers research IRS’s website (IRS.gov) for additional information. We found some additional information on IRS’s website about three of the four compliance topics. This information was typically in the form of FAQs in a section of IRS’s website about retirement plans (https://www.irs.gov/retirement-plans).

Table 2 summarizes: what information for IRA owners with unconventional assets can be found in Publications 590-A and 590-B; what other IRS sources provide relevant information; and what information was not readily available on the IRS website for the four compliance areas likely to affect IRA owners with unconventional assets. Appendix II describes in more detail the information available and the information lacking in Publications 590-A and 590-B and other IRS sources.

Given the complexity of the four compliance topics we identified as well as the relatively few numbers of taxpayers affected and the already large publication size, it may not be feasible to provide complete information on these topics within Publications 590-A and 590-B. IRS publications (like 590-A and 590-B) are intended to explain the law in plain language for taxpayers and their advisors. They generally summarize and translate into layperson’s terms more complex and technical information from authoritative sources like the Internal Revenue Code and more authoritative guidance like tax regulations, revenue procedures, and revenue rulings.

IRS analysis indicates that perhaps only about 2 percent of IRAs have invested in hard-to-value unconventional assets. However, even small numbers of taxpayers with particular circumstances have the right to know what they need to do to comply with tax laws. IRA owners with unconventional assets who turn to Publications 590-A and 590-B are unlikely to fully understand how certain IRA investment decisions can increase their risks for noncompliance. Misunderstanding the rules governing IRAs could result in increased tax liability for taxpayers making unintentional errors and jeopardize their retirement savings.

Given the serious consequences that could result for a taxpayer found to be noncompliant, IRS’s current publications are not clearly providing information for IRA owners with unconventional assets. Adding information to Publications 590-A and 590-B would be one solution that IRS could explore, but we recognize that it may not be practical for IRS to add substantially more information to Publications 590-A and 590-B for a relatively small percentage of IRA owners. Alternatives to adding more pages to Publications 590-A and 590-B could include directing readers with questions about rules affecting unconventional IRA assets to other IRS resources, such as IRS web pages or tax regulations that contain more technical and specialized information. As shown in table 2 above, we found some additional information on IRS web pages that would be helpful to IRA owners with unconventional assets. Adding language in Publication 590-A or 590-B directing taxpayers to specific web page URL addresses for additional information could help taxpayers more easily locate this information. For more technical or specialized information, IRS could direct readers of Publications 590-A and 590-B to the relevant sections of the Internal Revenue Code and related tax regulations. This additional information could help IRA owners better understand and navigate the potential compliance challenges associated with certain types of unconventional assets.

Insufficient Data and Fragmented Expertise across IRS Organizational Units Complicate Enforcement of IRA Rules Involving Unconventional Assets

IRS Cross-Divisional Team Identified Risks of IRA Noncompliance Based on Different Asset Types

In October 2017, the Deputy Commissioner for Service and Enforcement commissioned a cross-divisional team comprised of representatives from all four IRS operating divisions to identify, assess, and mitigate risks of IRA noncompliance. In its February 2018 interim presentation, the IRS cross-divisional team categorized potential noncompliance risks over an IRA life cycle into two mitigation strategies, which are summarized below. 1. Noncompliance risks for most contribution and distribution IRA rules can be mitigated systemically through automated enforcement. For example, IRS can detect excess IRA contribution deductions and unreported IRA distributions by matching information from taxpayer returns with information reported by custodians. For the large population of IRA owners investing in conventional assets held by custodians, IRS relies on automated enforcement. 2. Noncompliance risks associated with the small population of IRAs with hard-to-value unconventional assets or under direct control of the IRA owner are generally mitigated through case-by-case audits. For example, noncompliance with the complex rules governing prohibited transactions and unrelated business income is generally not reflected on individual tax returns. Some custodians rely on IRA owners to provide asset value information and may not have complete and accurate data to report to IRS. Undervaluing IRA assets hampers automated enforcement, for example, to detect excess contributions and taxable distributions.

Noncompliance involving IRAs with unconventional assets is generally detected through labor-intensive audits of individual taxpayers. IRS’s SB/SE division uses field audits to pursue complex individual tax return cases, including those that could involve IRAs with unconventional assets. In February 2018, an IRS cross-divisional team that studied the risks of IRA noncompliance reported that, from fiscal years 2012 to 2016, IRS audited about 26,000 tax returns with IRA issues.

IRS officials provided us examples of SB/SE job aides and training materials designed to help examiners recognize different types of noncompliance associated with IRAs invested in unconventional assets. For example, the job aides provide instructions on prohibited transactions, barred collectibles, and FMV issues involving IRAs. When interviewing taxpayers, examiners are instructed to ask a series of questions covering subjects such as: what kind of advice the taxpayer received from promoters or custodians of self-directed IRAs, whether the taxpayer had direct involvement in purchasing unconventional assets through a control feature known as “checkbook access,” whether the taxpayer has a limited liability company (LLC) tied to the how the taxpayer determined the FMV of unconventional assets.

IRS officials told us that enforcing rules associated with IRAs investing in unconventional assets can be particularly challenging for investments involving LLCs or special partnership arrangements. An IRA owner may establish an LLC that is owned by the IRA. Once the LLC is set up, a business checking account is linked to the IRA funds and the account owner is named the manager of the LLC with control over the checkbook. This allows IRA owners to purchase assets directly from investment sponsors without having to wait for custodians to execute a purchase or sale.

The LLC may be used to invest in businesses that could generate unrelated business income. According to IRS officials, prohibited transactions may also be more likely to occur when custodians allow “checkbook” access to IRAs, in part because the marketing of this IRA structure is appealing to individuals who want less oversight of their IRA transactions and are more likely to intentionally engage in self-dealing transactions.

IRS examination officials told us that the 3-year statute of limitations for assessing taxes owed remains an obstacle in pursuing noncompliance that may span the many years of an IRA investment. For example, abuses involving prohibited transactions frequently are not reflected on any filed tax return and may be difficult to detect within the general 3-year statute of limitations period. IRS agreed with our October 2014 recommendation for the Commissioner to work in consultation with the Department of the Treasury (Treasury) on a legislative proposal to expand the statute of limitations on IRA noncompliance. IRS said Treasury is aware of IRS’ support for changing the limitation period for IRA noncompliance. Treasury reviews and presents the administration’s tax proposals and has not released a legislative proposal as of October 2019.

Data Collection Has Improved, but Opportunities Exist to Further Strengthen Identification of Potentially Abusive IRAs

With electronically compiled data for tax year 2016 filed in 2017, IRS was positioned for the first time to quantify the number of IRAs with specified types of hard-to-value assets. IRS officials said that even with the new custodian reporting, the broad IRA asset type data alone may be inadequate for improving audit selection criteria and identifying potentially abusive IRAs in a timely manner. In February 2018, using the newly available data, an IRS cross-divisional team identified that about 2 million IRAs included one or more types of hard-to-value assets for tax year 2016. However, custodians reported an FMV dollar amount for hard-to- value assets for only 1.6 million of those IRAs, as shown in table 3. The combined FMV was approximately $137 billion.

As shown in table 3, about 400,000 (about 20 percent) of the Form 5498s reporting that the IRA held investments in one or more of the specified unconventional categories were missing the 2016 FMV dollar amount for those assets. The cross-divisional team identified that undervaluation risk affects custodian reporting. IRS officials said that the team did not review the custodian reporting patterns as part of its initial analysis of the 2016 Form 5498 data. Forthcoming tax regulations on IRAs may help to improve custodian reporting of FMVs on Form 5498. IRS officials told us that the new IRA regulations would address FMV for certain categories of hard-to-value unconventional assets. IRS officials also told us that it would be premature to publish new guidance for IRA owners and custodians on the FMV of unconventional assets until the new regulations are issued.

The tax year 2016 Form 5498 information indicated about 141,000 IRAs invested in LLCs—an asset type which IRS has determined presents greater noncompliance risk. Prior to the newly available asset type data, SB/SE conducted an interim Compliance Initiative Project (CIP) using external state government information to identify businesses, including LLCs and partnerships, owned by IRAs as a way to select IRA owners for audit. Completed in October 2019, the interim compliance research revealed that audits detecting prohibited transactions can result in substantial tax adjustments.

In September 2018, SB/SE approved a new CIP using the asset type data from Form 5498s for tax year 2017 to select a sample of traditional and Roth IRAs that had an ownership in an LLC or real estate. The latest compliance research field work began in February 2019 and is to be completed in January 2021. IRS officials told us they plan to use this research in combination with the interim research results to improve criteria for selecting tax returns with IRAs at greater risk of noncompliance for audit.

To detect abusive transactions, IRS can require taxpayers to self-report certain transactions that have been used by other taxpayers to avoid taxes. Transactions become “reportable” (meaning a taxpayer must report it to IRS) when IRS designates them as a “listed transaction” or “transactions of interest.”

Listed Transaction. A listed transaction is reportable when it is the same or substantially similar to one of the types of transactions that IRS has determined to be an avoidance transaction. In 2004, IRS determined that Roth IRA “stuffing” is an abusive tax avoidance transaction that taxpayers must report to IRS as a listed transaction. “Stuffing” involves shifting value through transactions that disguise Roth IRA contributions exceeding annual IRA limits, such as selling receivables at less than FMV to a Roth IRA, or other transactions between a closely-held business in which the Roth IRA invests and another closely-held business of the Roth IRA owner.

Transaction of Interest. A transaction of interest is one that IRS and Treasury believe to have the potential for tax avoidance or evasion, but which lacks enough information for IRS and Treasury to determine whether the transaction should be identified as a tax avoidance transaction. As of December 2019, IRS has not identified or classified any IRA asset types or investment transactions as reportable transactions of interest.

Taxpayers are required to disclose all types of reportable transactions on Form 8886, Reportable Transaction Disclosure Statement. Similarly, advisers helping taxpayers conduct reportable transactions are required to file Form 8918, Material Advisor Disclosure Statement.

Results from the ongoing IRS compliance research may yield insights about existing and emerging abusive schemes involving IRAs. This information could be useful for evaluating the feasibility of requiring greater disclosure by IRA owners and their custodians and advisors. For example, IRS could consider requiring reporting of known abusive IRA arrangements and prohibited transactions as listed transactions. Also, IRS could explore disclosure of high-risk IRA asset types susceptible to gross valuation misstatements, such as LLCs, as transactions of interest. We recently found that IRS’s Research, Analysis and Statistics office had developed the capability to analyze the narrative fields of tax forms. Additional disclosure of potentially abusive IRA transactions coupled with greater use of tax form’s narrative fields may help IRS to select IRA owner tax returns for more detailed review. The cases identified by such detailed review would help IRS better allocate limited audit resources.

Enforcing IRA Rules for Unconventional Assets Draws on Expertise and Roles of Multiple IRS Organizational Units

Responsibility for addressing IRA noncompliance detected through case- by-case audits is fragmented among multiple IRS organizational units. This fragmentation creates challenges for IRS examiners from different units that may need to share expertise and collaborate on enforcement of complex rules applicable to IRAs that invest in unconventional assets. In February 2018, the IRS cross-divisional team concluded that no one IRS operating division alone can effectively identify and penalize IRA noncompliance regarding unrelated business income and undervaluation of unconventional assets.

Unrelated business income. SB/SE and TE/GE officials told us that detecting unrelated business income unreported by an IRA can also require the involvement of multiple IRS divisions. IRS responsibility and expertise in detecting noncompliance with the rules for unrelated business income resides in IRS’s TE/GE division. TE/GE is responsible for enforcing the unrelated business income taxation rules across tax-exempt organizations. Its Exempt Organizations group audits Form 990-T filed by tax- exempt charities and its examiners are required to check if tax exempt charities have reported unrelated business income. Examiners in TE/GE’s Employee Plans group have been trained on how to determine if a tax-exempt employee retirement plan has engaged in activities that constitute unrelated trade or business.

SB/SE has primary responsibility for auditing individuals owning IRAs, and its examiners are to verify that all returns within the taxpayer’s sphere of influence are filed. IRS officials told us that when SB/SE examiners discover potential unrelated business income issues when reviewing an individual taxpayer’s IRAs, those examiners can seek assistance from TE/GE examiners via an internal Specialist Referral System used to refer cases to other divisions.

Although IRS officials described to us how SB/SE examiners, at their own initiative, can seek out expertise on unrelated business income, the topic is not addressed in SB/SE examiner training materials and job aids on auditing IRAs with unconventional assets. SB/SE officials provided us training slides used to teach examiners how to recognize excess contributions, prohibited transactions, barred collectibles, and valuation issues involving IRAs. While the slides instruct examiners to contact a Senior Program Analyst or Counsel for assistance with complicated issues or cases, there is no information educating SB/SE examiners about unrelated business income or informing examiners that specialized knowledge about this topic resides in the TE/GE division. Without resources, such as training materials or job aides, that provide such information, SB/SE examiners carrying out the ongoing compliance initiative project are not positioned to surface unrelated business income tax issues for referral to TE/GE. Given that IRS plans to use those research results to refine its audit selection criteria, IRS is missing an opportunity to learn more about IRA noncompliance with unrelated business income taxation.

Undervaluation of unconventional assets. In February 2018, the cross-divisional IRA team cited undervaluation of unconventional assets as another compliance risk that involves the expertise and enforcement responses from multiple IRS units. If SB/SE examiners determine in auditing an IRA owner that the IRA custodian had inaccurately reported IRA asset values, other IRS divisions can take action against the custodian. LB&I can penalize a large financial institution custodian, although the cross-divisional IRA team reported the $50 penalty for filing an incorrect Form 5498 poses little deterrent effect. For the approximately 75 non-bank IRA trustees approved by IRS, TE/GE can revoke a non-bank’s trustee status for violating any fiduciary, accounting, or financial requirements.

The cross-divisional IRA team explored an approach for joint examination to more effectively identify and penalize noncompliance associated with prohibited transactions, unreported unrelated business income, and undervaluation of IRA assets. Based on knowledge from prior examinations, the team identified a small subset of non-bank trustees publicly marketing alternative investments that held IRAs more than $5 million in reported FMV as of tax year 2016.

As of February 2018, the team reported that it had been premature for the separate divisions to commit examination resources. As of October 2019, IRS officials said they plan to reconvene the cross-divisional IRA team after the ongoing SB/SE compliance initiative project is complete in 2021. IRS officials said the plan is for the team to use the compliance research results to refine audit selection. Also, the team could continue work on establishing a joint examination approach for IRA noncompliance associated with hard-to-value unconventional assets.

Conclusions

IRA owners that invest in unconventional assets—such as real estate, certain precious metals, virtual currency, or private equity—assume greater responsibility for navigating complex rules that govern tax-favored retirement investments. To understand these rules, taxpayers are likely to consult IRS Publications 590-A and 590-B. While this two-part publication provides some information on compliance issues likely to affect IRA owners with unconventional assets, the information in the publication as well as on IRS web pages is limited. By assessing options for making such information clearer, IRS could better inform taxpayers and help them comply. This is particularly important because misunderstanding the rules governing IRAs can result in increased tax liability for these taxpayers and jeopardize their retirement savings.

Noncompliance associated with nonpublicly traded IRA assets has been difficult for IRS to detect and time consuming to pursue. In contrast to automated enforcement for IRAs with conventional investments, noncompliance involving IRAs with unconventional assets is generally detected on a case-by-case basis through labor-intensive audits of individual taxpayers. In recent years, IRS has begun collect information from IRA custodians that IRS can use to quantify the dollar amounts of specified types of hard-to-value assets held by IRAs.

However, the broad IRA asset type data alone may not be sufficient for audit selection and identifying potentially abusive IRAs in a timely manner. When IRS lacks sufficient data to detect abusive transactions, IRS can require taxpayers to self-report certain transactions that have been used by other taxpayers to avoid taxes. Additional disclosure of certain IRA transactions coupled with mining the narrative fields of tax forms could help IRS to efficiently identify potentially abusive IRA activity and better allocate limited audit resources.

Fragmented responsibility among IRS operating divisions creates additional challenges for IRA enforcement. The division responsible for tax-exempt entities trains its examiners on how to determine if an employee retirement plan has unrelated business activities subject to taxation. Yet, examiners in the division that audits complex individual tax returns, including those involving IRAs, do not receive similar training. Training for those examiners on unrelated business income tax issues, and how examiners can refer those cases to other divisions for assistance, could help improve collaboration on IRA enforcement.

Recommendations for Executive Action

We are making the following three recommendations to IRS: The Commissioner of Internal Revenue should assess options for updating Publications 590-A and 590-B to either include more information or direct taxpayers to other resources for IRA owners with investments in unconventional assets. Such information could include: storage requirements for IRA investments in certain precious metals; valuation methods for hard-to-value IRA assets; the Department of Labor’s process for granting exemptions to IRA prohibited transactions rules; and IRA investments with the potential to create unrelated business income tax liabilities. (Recommendation 1)

The Commissioner of Internal Revenue, building on forthcoming compliance research using new IRA asset data, should evaluate the feasibility of requiring disclosure for high-risk IRA asset types associated with abusive schemes as transactions of interest. (Recommendation 2)

The Commissioner of Internal Revenue should develop resources (such as training materials or job aids) for Small Business/Self-Employed examiners conducting IRA owner audits that explain how IRAs with unconventional assets can generate unrelated business income tax liability, and how examiners can refer cases to unrelated business income experts in IRS for assistance. (Recommendation 3)

Agency Comments

We provided a draft of this report to the Treasury and IRS for review and comment.

In its comments, reproduced in appendix III, IRS generally agreed with our recommendations. For recommendation 1, IRS said it will review its educational publications and web pages for appropriate updates within the scope of the tax code. For recommendation 2, IRS said that it will determine whether there are abusive schemes associated with certain IRA asset types, and if the data indicate such a correlation, it will evaluate the feasibility of requiring disclosure of such arrangements as transactions of interest. For recommendation 3, IRS said it will review and update resources for examiners conducting IRA owner audits, including guidance on how to address unrelated business income tax (UBIT). It will incorporate guidance for agents on how to refer such cases to UBIT experts when assistance is needed. IRS also said that it will renew its efforts at ensuring collaboration with relevant subject matter experts.

IRS in consultation with Treasury also provided technical comments which we incorporated as appropriate.

As agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies to the Secretary of the Treasury, the Commissioner of Internal Revenue, the Secretary of Labor, and other interested parties. In addition, the report will be available at no charge on the GAO website at http://www.gao.gov.

If you or your staff have any questions about this report, please contact James R. McTigue, Jr. at (202) 512-9110 or Charles A. Jeszeck at (202) 512-7215. You may also reach us by email at jeszeckc@gao.gov or mctiguej@gao.gov. Contact points for our Office of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff making key contributions to this report are listed in appendix IV.

Appendix I: Status of GAO Recommendations

Appendix II: IRS Information for IRA Owners Investing in Unconventional Assets

This appendix describes: what information for individual retirement account (IRA) owners with unconventional assets can be found in Publications 590-A and 590-B, what other Internal Revenue Service (IRS) sources provide relevant information, and what information was not readily available on the IRS website for the four compliance areas we identified through prior work as likely to affect IRA owners with unconventional assets. The information below does not include the Internal Revenue Code or detailed and technical resources published in the weekly Internal Revenue Bulletin, such as tax regulations, revenue rulings, and revenue procedures.

Barred investments

Publications 590-A and 590-B explain what types of IRA investments are barred, such as collectibles, but the publication does not have additional information that could be useful to IRA owners with allowable investments in coins and bullion. The publications define collectibles as including artworks, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages, and certain other tangible personal property. The publications explain that if a traditional IRA invests in collectibles, the amount invested is considered distributed, and that the IRA owner could be subject to an additional tax on early distributions. Publications 590-A and 590-B further explain that an exception exists for IRA investments in certain types of coins and bullion. However, the two-part publication does not indicate that certain types of bullion must be stored by a bank or an IRS-approved non-bank trustee. The two-part publication also does not mention that IRA investments in life insurance contracts are not permitted.

Two IRS web pages listing frequently asked questions (FAQs) about retirement plans contain additional information about bullion storage requirements and IRA investments in life insurance contracts. Both web pages state that investing IRA funds in life insurance contracts and collectibles are prohibited, and they also note the exception for certain precious metals. One of the web pages further explains that allowable bullion must be stored with a bank or an IRS-approved non-bank trustee.

Prohibited transactions

Publications 590-A and 590-B define prohibited transactions in general terms, list examples, and explain the consequences of engaging in a prohibited transaction. The two-part publication also cautions that the risk of engaging in a prohibited transaction in connection with an IRA account may be increased when an IRA owner invests in nonpublicly traded assets or assets that an IRA owner directly controls. However, the publication does not provide any information about applying for an exception to the prohibited transaction rules.

We found some limited information about exemptions to the prohibited transaction rules on an IRS web page entitled “Retirement Plan Investments FAQs.” The web page explains that the Department of Labor (DOL) has granted class exemptions for certain types of investments under specific conditions, and that a plan sponsor may apply to DOL to obtain an administrative exemption for a particular proposed transaction that would otherwise be prohibited. However, the web page does not provide any links to DOL information such as a DOL publication that explains the prohibited transactions exemption process.

Unrelated business income

In February 2018, IRS updated Publications 590-A and 590-B to include information about IRAs with unrelated business income. Publications 590- A and 590-B now explain that an IRA is subject to tax on unrelated business income if the IRA carries on an unrelated trade or business. Publications 590-A and 590-B state that the IRA trustee is required to file a Form 990-T if an IRA has $1,000 or more of unrelated trade or business gross income. For more information, Publications 590-A and 590-B direct taxpayers to consult Publication 598, Tax on Unrelated Business Income of Exempt Organizations.

Publication 598 lists IRAs as one of many exempt entities subject to taxes on unrelated business income, and the requirement to file Form 990-T for gross income of $1,000 or more. Publication 598 describes dozens of activities by tax-exempt organizations that would be considered an unrelated business; but the publication does not include any examples specific to IRA investments that could also be considered unrelated business activities and subject to taxes. Our search did not find additional information on IRS.gov relating to IRAs and unrelated business income taxes.

Fair market value (FMV)

Publications 590-A and 590-B do not provide guidance about how to accurately determine the FMV of hard-to-value unconventional assets. IRS requires custodians to report (on Form 5498) an IRA’s FMV at year’s end as well as some additional information for IRAs with unconventional assets. The instructions for completing Form 5498 explain that IRA custodians are responsible for ensuring that “all IRA assets (including those not traded on established markets or not having a readily determinable market value) are valued annually at their FMV.” However, neither the form’s instructions nor Publications 590-A and 590-B provide guidance or tips on how to determine the FMV of non-publicly traded or other hard-to-value assets. As we previously reported, some unconventional assets may require a third-party appraisal to determine their FMV.

One IRS web page titled, “Valuation of Plan Assets at Fair Market Value,” provides some additional FMV information but it is intended more for the valuing assets in employer-provided retirement benefits like traditional pensions and 401(k) plans. The web page states that an accurate assessment of the FMV of retirement plan assets is essential for complying with Internal Revenue Code requirements and avoiding prohibited transactions. The web page also states that for defined contribution plans like a 401(k) plan, investments must be valued at least once per year in accordance with a consistent and uniform method. For traditional pensions (defined benefit plans), tax regulations define FMV for purposes of valuing plan assets as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”

The Department of the Treasury (Treasury) plans to issue regulations on IRAs. IRS officials told us that these new regulations would address FMV for certain categories of hard-to-value unconventional assets. IRS officials also told us that it would be premature to publish new guidance for IRA owners and custodians on the FMV of unconventional assets until the new regulations are issued. In their October 2019 update of planned guidance projects, Treasury’s Office of Tax Policy and IRS listed planned IRA regulations.

Appendix III: Comments from the Internal Revenue Service

Appendix IV: GAO Contacts and Staff Acknowledgments

GAO Contacts

Staff Acknowledgments

In addition to the contacts named above, MaryLynn Sergent and David Lehrer (Assistant Directors), Ted Burik, Susan Chin, Steven Flint, Emily Gruenwald, Mark Kehoe, Jungjin Park, and David Reed made key contributions to this report. James Bennett, Amy Bowser, Jacqueline Chapin, Edward J. Nannenhorn, Andrew J. Stephens, Walter Vance, and Adam Wendel also provided support.