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DOL Proposes Class Exemption To Resolve PT Problems with IRAs for Security Firms and Others

Posted by James M. Carlson
Jul 18 2013

Securities and brokerage firms have written many of their account opening documents so that an individual opening a new investment account agrees that if he or she owes money with respect to anyone of his or her accounts that the security company has the right to withdraw the amount owed from a different account. This is generally called a cross-collateralization agreement. In order for a person (or an IRA) to be able to engaged in short sales, margin transactions, options and futures the securities firm wants to be assured of getting paid and so imposes a cross-collateralization agreement or an indemnification agreement.

The securities and brokerage firms have rightfully concluded that there needs to be a prohibited transaction class exemption granted by the DOL/EBSA or many firms will suffer adverse tax and financial consequences because of their account agreements. One does wonder why the securities firms have been so stubborn and so stubborn for so long in requiring individuals setting up an IRA to furnish a cross-collateralization.

As discussed in the previous article, this is a prohibited transaction. The securities industry has been brazen to think it is not a prohibited transaction or try to argue it is not. IRA custodians have known since the 1970’sand 1980’s that they could not have a person’s IRA serve as collateral for any personal loan or investment. Nevertheless, it is 2013 and the securities industry wants to keep doing what they have been doing. The securities industry has requested of the DOL/EBSA that prohibited class exemption (PTE) 80-26 be amended on a prospective basis to allow an individual in the future to be able to use his or her IRA to cover debts of other non-IRA accounts.

In general, the DOL/EBSA is not granting the request on a prospective basis, but is granting limited relief on a retroactive basis if certain conditions are met. The securities industry should be ecstatic as they have ignored a basic tax rule for over 30 years.

In October of 2009, the DOL/EBSA in Advisory Opinion 2009-03A made clear that the grant by an IRA owner to a broker of a security interest in the IRA owner’s non-IRA accounts in order to cover indebtedness of, or arising from, the IRA would be an impermissible extension of credit under Code section 4975. In October of 2011, the DOL issued Advisory Opinion 2011-09A and made clear the exemption provided by PTE 80-26 granting class PTE exemption for certain interest free credit would not apply to the cross-collateralization situations.

Independent auditors are apparently discussing this cross-collaterization topic in their public audit reports. In some situations the financial consequences could be so adverse as to materially impact the securities firm’s financial condition.

Remember when a prohibited transaction (PT) occurs as a result of an individual with respect to an IRA, that the IRA is either considered totally taxable since a deemed distribution takes place on the first day of the tax year, or if the PT occurs as a result of the IRA custodian, then the financial institution will need to pay a tax equal to 15% times the total value of the involved IRAs.

The possible adverse tax consequences are very large.

The DOL/EBSA has concluded that its proposed regulatory action of amending PTE 80-26 is not so “significant” that the Office of Budget and Management(OBM) must first review the proposal before it was submitted to the general public. The OBM is supposed to review a regulatory proposal if on an annual basis the proposal will have an impact on the economy of $100 million or more. Considering that IRAs have a value of4.7 trillion and that over 75% of IRAs are with Securities firms, it is almost a certainty that taxing such IRAs would amount to more than $100 million. And there certainly would be lawsuits by individuals against the security and brokerage firms.

Consequently, the Securities Industry and Financial Markets Association (SIFMA) has requested the DOL/EBSA issue the proposed amendment to PTE 80-26 and code section 4975. The proposed amendment, if adopted, would give temporary and retroactive exemptive relief for certain guarantees of the payment of debts to plan investment accounts (including IRAs) by parties in interest to such plans as well as certain loans and loan repayments made pursuant to such guarantees. If adopted, the proposed amendment will be effective from January 1, 1975, until the date that is 6months after the date on which an adopted amendment is published in the Federal Register.

That is, the prohibited transaction exemption (PTE) is to be retroactive. It may be that a person who has had to pay the income tax penalties associated with a PT will be able to seek a refund. It will certainly mean that large tax amounts currently owed will not need to be paid. This is a nice “settlement” for the securities industry. The DOL/EBSA does not discuss whether it has considered or could consider having the security industry pay a monetary penalty.

At the present time, the DOL/EBSA proposal is to forgive any tax amount owing as long as the conditions set forth in the proposed exemption are satisfied.

Even though SIMFA did not request any relief where a business and its 401(k) plan might have executed across-collateralization agreement, the DOL/EBSA on its own has pointed that such agreements may also need to be revised and that retroactive relief is also available by the same deadline.

The DOL/EBSA has proposed a 6 month time period during which the securities and brokerage firms must replace all of the existing account opening agreements. Any cross-collateralization or indemnification provisions must be removed from the account opening form. In some cases there may need to be refunds of various fees.

The DOL/EBSA did not adopt a 12 month correction period as requested by SIFMA. The DOL/EBSA said that 12 months was unreasonable considering the DOL/EBSA had put the industry on notice in 2009 that such provisions result in a prohibited transaction.

And the DOL/EBSA is unwilling to grant the UNLIMITED exemption requested by SIFMA on a prospective basis. However, if the new conditions of the revised exemption are satisfied, then there will be exemptive relief.The DOL/EBSA has set July 23, 2013, as the deadline to submit a request for a public hearing and to submit written comments.

The DOL/EBSA must receive such on or before July 23, 2013 (i.e. 60 days after the proposal on May 23, 2013).

To read sections IV-VI of the proposed class exemption, go to www.pension-specialists/dolebsa.pdf. Once the 6 month period has expired (sometime in 2014) the general exemption will apply if the general prospective requirements are met.

Categories: Pension Alerts

Can a Grandparent be the Responsible Individual of a CESA?

Posted by James M. Carlson
Jul 18 2013

Yes, but the IRS model CESA forms must be revised.

Such a revision is permissible. The IRS has written in Article V of its Model Coverdell ESA (CESA) plan agreement form (5305-E and 5305-EA) to require that the individual must be a parent or guardian beneficiary and that there shall only be one responsible individual at any time.

Collin W. Fritz and Associates, Ltd. has chosen to write its current version of the Coverdell ESA plan agreement forms to allow a grandparent or a great grandparent to be the responsible individual. Many grandparents today make contributions to CESAs for their grandchildren. However, many grandparents are frustrated because they would prefer to control the funds by being the depositor and the responsible individual, but they lose this control to their son, daughter-in-law, daughter or son-in-law if the standard IRS Coverdell ESA form is used. Many financial institutions don’t understand that there are CESA forms available allowing a grandparent or a great grandparent to serve as the custodian.

The authority for Coverdell Education Savings Accounts is section 530. Nowhere in this tax code section is the term, “responsible individual,” mentioned let alone defined. The IRS settled on the approach that an adult needed to act on behalf of the child (i.e. the designated beneficiary) and so wrote the model Coverdell ESA forms to require that a parent or guardian be the responsible individual. He or she is to act on the behalf of the designated child and in some cases on behalf of other family members of the designated beneficiary. Articles V and VI on set forth on the following page.

Article VIII sets forth the procedure that other articles may be added or incorporated into the Coverdell ESA. However, if the additional article would conflict with any of the provision in Article I-III, then the provisions of Articles I through III will control. This means Article V may be revised. Authorizing a grandparent or a great grandparent will not cause problems with the IRS. Nowhere has the IRS ever stated that a grandparent may not serve as the responsible individual. In Chapter 7 of Publication 970, in numerous places the IRS states that a parent or guardian is “generally” the responsible individual. The CESA plan document must authorize a grandparent or a great grandparent to be eligible to be a responsible individual – either in the original document or by adopting an amendment.

Categories: Coverdell ESAs, Pension Alerts

IRA Amendments Being Required

Posted by James M. Carlson
Jul 18 2013

The IRS last revised the model IRA Forms 5305, 5305- A, 5305-R and 5305-RA in March of 2002. Since then there have been numerous tax laws enacted with IRA changes. The IRS has given no written explanation as to why the IRA forms have not been amended. We have asked a number of times when the IRS would be revising their IRA forms, but to no avail. It is not a good thing that the IRS has not updated their forms.

When is it necessary for an IRA custodian/trustee to furnish an IRA amendment? Is it necessary or required to furnish one in 2013?

Each institution must make its own determination because one needs to understand when was the IRA agreement last amended and how is it being amended. A primary question is, “when is the last time the financial institution furnished an amendment?” What do the current IRA plan agreements provide? Are there some IRAs set up with one certain plan agreement and others with a different plan agreement?

One may learn a tax lesson the hard way, if he or she adopts the position that an amendment is not required because the IRS has not said one is required. One must remember that the IRS has already stated in its governing IRA regulation(1.408- 6 (d) (4) (ii) (C) ) when an IRA amendment is required. The regulation must be followed until the IRS revises it.

There are two types of amendments – one which amends the IRA plan agreement and one which amends the IRA disclosure statement. Regulation 1.408- 6(4)(ii)(C) requires that an IRA amendment be furnished no later than the 30th day after the amendment is adopted or becomes effective.

The general rule in the governing IRA regulation is - a law change is enacted which impacts a provision found in the IRA plan agreement; the provision will be amended to implement the law change and the amendment will need to be communicated to the IRA accountholder or inheriting beneficiary.

When the IRS revises its model IRA forms, the amendment is considered to be mandatory or required. When a non-IRS change is made in the plan agreement by the financial institution (or the IRA vendor), the change may either be mandatory or not.

Mandatory changes deal with the tax code changes. For example, CWF has amended the Roth IRA plan agreement so that any person with funds in a traditional IRA is eligible to convert some or all of these funds to a traditional IRA even though he or she may have MAGI of more than $100,000.

The IRS has not yet amended its model Roth IRAs (Forms 5305-R and 5305-RA) to remove the $100,000 restriction. And the IRS has not given any guidance as to whether or not a conversion done in 2010 or later qualifies or doesn’t qualify since Form 5305-R and 5305-RA state that the custodian/ trustee may not accept a conversion contribution if the person has a MAGI greater than the $100,000.

The standard IRS rule for IRAs/pensions has always been - the plan document must authorize the action. For this reason, even though the IRS has not amended the Roth forms, CWF has. And CWF has added provisions authorizing new rollovers from 401(k) plans and other employer plans. And CWF has made other changes or amendments to adopt law changes. Other vendors have taken the approach, we don’t need to amend our form because the IRS has not done so. Similar changes have been made by CWF in the traditional plan agreement forms.

Non-mandatory amendments would be made by a financial institutions for its own administrative reasons. If an institution would want such a change or changes to apply to all existing IRA accountholders or some of them, the amendment would be furnished to those accountholders which the financial institution wanted the new provision to apply. An example, in 2011/2012 CWF added special provisions covering the topics of when a power of attorney is designated by the IRA accountholder, when a non-IRS creditor may impose a claim against an IRA, or when a trust beneficiary or an estate beneficiary will have special pass-through requests.

A long time ago (1986/1987) the IRS acknowledged that there are times that even though the IRA plan agreement has not been changed, a disclosure statement amendment must still be furnished. Example, when the deductible/non-deductible rules were first authorized in 1986/1987, such rules did not require the IRA form to be rewritten because the IRA form discusses the maximum contribution amount limit, but does not discuss the deductible/non-deductible rules. The IRS stated there needed to be a disclosure statement amendment discussing or explaining the deductible/non-deductible rules.

In summary, answering a question whether or not an amendment is required is not all that simple. Sometimes the caller will furnish some additional information, but many times not. Each financial institution will need to make its own decision if there is a requirement to furnish one or both amendments or if it will furnish the amendments so there is no question.

It is true that the IRS has not been very active in auditing whether or not IRA custodian/trustees are furnishing IRA amendments as required by the IRA regulation. We at CWF believe it is in the best interest of a financial institution to furnish the amendments. The governing IRA regulation provides that a $50 fine may be assessed an institution for each time it fails to furnish the IRA plan agreement and $50 each time it fails to furnish the IRA disclosure amendment.

Categories: Amendments, Pension Alerts

Will the IRS Revise the IRA/Pension Life Expectancy Tables in the Near Future?

Posted by James M. Carlson
Jul 18 2013

We are awaiting an answer from the IRS. The IRS has recently updated various morality tables for defined benefit pension plan purposes. More Americans are living longer. This fact certainly affects pension plans and it also affects to IRAs. The IRS will inform the public in the near future whether the IRA/pension life expectancy tables have been or will be revised to reflect individuals living longer. If so, the RMDs of most individual RMDs would decrease slightly. This would be true for both accountholders and also inheriting beneficiaries.

Since smaller distributions means less tax dollars collected, it may be the IRS will not adjust the IRA life expectancy tables. As discussed below, there is no tax law requiring the IRS to make such an adjustment in 2013, but public policy would seem to support the adjustment. Most IRA accountholders age 70½ and older want to take only their required distribution and not a penny more.

Section 634 of EGTRRA (2001) instructed the Secretary of the Treasury to modify the life expectancy tables for purposes of the minimum distribution rules to reflect current life expectancies. In 2002-2003 the IRS in its final regulation adjusted these tables to reflect improvements in mortality from 2000-2003. The Uniform Lifetime table, the Joint Life Expectancy table, and the Single Life table were changed to reflect mortality improvement from 2000 to 2003. Earlier the IRS had adjusted various tables to create the Annuity 2000 mortality table. And such revised tables were created by combining on a basis of 50% male and 50% female. The mortality of females is superior to that of males as the tables demonstrate.

These mortality tables are of critical importance for administering defined benefit pension plans. An employer sponsoring a defined benefit plan will be required to make larger contributions if mortality improves. The plan benefit (i.e. amount) an employee is entitled to be paid at his or her normal retirement date will be larger if mortality has improved. The IRS has recently released Notice 2013-49. This Notice provides updated static mortality tables for the years 2014 and 2015.

Code section 430 does contain a provision providing that periodically (at least every 10 years) these mortality tables shall be revised to reflect the actual experiences of pension plans.

What about IRAs? 10 years or more have passed since the IRS last updated the IRA/pension life expectancy tables.

We expect the IRS will respond to CWF’s question within the next 2-6 weeks. We will let you know what we are told in a future newsletter. We hope the IRS will revise the life expectancy tales thereby allowing accountholders and inheriting beneficiaries to take slightly smaller required distributions.

Categories: Pension Alerts, RMDs, Traditional IRAs