by Chris SwiecickiSonny Did Not Rollover: Some Perils of Holding and Transferring Nontraditional Assets in IRAs
I was delighted when asked to be co-author with Richard Wise on this article, which first appear in the St. Louis Bar Journal. Richard is a wealth of information on many topics, and I was happy to contribute my two cents on this particular case. Readers who want the full version, complete with footnotes, should check out the edition published by the Bar Journal.
With the popularity of using Individual Retirement Accounts (IRAs) to hold non-traditional assets such as precious metals, partnership interests, real estate, and other property, a recent case involving James Caan, the actor who played Santino Corleone (better known as Sonny) in the movie The Godfather, illustrates some of the perils of using IRAs to hold non-traditional assets.
What is an IRA?
Section 408 of the Internal Revenue Code is the main Code provision governing IRAs. It was enacted as part of the Employee Retirement Income Security Act of 1974, in furtherance of Congress’s goal “to create a system whereby employees not covered by qualified retirement plans would have the opportunity to set aside at least some retirement savings on a tax-sheltered basis.”
Section 408(a) provides that an IRA is “a trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries, but only if the written governing instrument creating the trust meets the [requirements enumerated in paragraphs (1) through (6)].” Section 408(h) further provides that for purposes of section 408:
a custodial account shall be treated as a trust if the assets of such account are held by a bank (as defined in subsection (n)) or another person who demonstrates, to the satisfaction of the Secretary, that the manner in which he will administer the account will be consistent with the requirements of this section, and if the custodial account would, except for the fact that it is not a trust, constitute an individual retirement account described in subsection (a). For purposes of this title, in the case of a custodial account treated as a trust by reason of the preceding sentence, the custodian of such account shall be treated as the trustee thereof.
To form a custodial IRA, the taxpayer executes a written custodial agreement that meets the requirements specified in section 408(a)(1) through (6). Once the custodial agreement is executed, section 408(h) treats the custodial agreement as a trust instrument and the custodian as a trustee, which allows for section 408(a) to apply, thereby creating a custodial IRA.
If the IRA is a custodial account, the institution’s duty is to hold and safeguard the investment; there is no duty with respect to investment decisions. The practical distinction is that a custodial account’s investment decisions can be dictated by the IRA owner/beneficiary.
Trust IRAs and custodial IRAs have the same three tax attributes, which together constitute the tax- deferral system that Congress created: (1) cash contributions are generally deductible; (2) accretions from the IRA’s assets are not taxable (except for Section 511 unrelated business income); and (3) distributions are taxable.
Alternative/Nontraditional Asset
IRAs are not limited to holding traditional assets such as cash, bonds, and publicly traded securities; they can still qualify for tax advantages while holding alternative assets.
When an IRA holds alternative assets, however, the IRS requires that the IRA’s trustee or custodian report the fair market value of the alternative assets yearly, valued as of December 31 of the preceding year, i.e. year-end fair market value.
Distributions from an IRA
In addition to creating a tax-deferral system through IRAs, Congress provided for nontaxable rollovers of IRA distributions, by which taxpayers can transfer investments from one IRA to another without incurring tax liability.
When a taxpayer requests an IRA distribution, that distribution is nontaxable if the entire amount received, including money and any other property is paid into an IRA for the benefit of such individual not later than the 60th day after the day on which he receives the distribution.
A taxpayer may also choose to roll over only a portion of the distribution, in which case only the portion that is contributed to another IRA within the 60-day rollover period qualifies as a nontaxable rollover contribution, and the non-contributed portion must be included in income.
Taxpayers are limited to one nontaxable rollover of an IRA distribution per one-year period, whether it be a full or partial rollover.
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Distributions of Noncash Property
If the distribution consists of noncash property, the taxpayer must contribute the exact same property in order for the distribution to be considered a nontaxable rollover contribution under section 408(d)(3)(A)(i). In other words, the taxpayer cannot change the character of the noncash property.
Sonny’s Predicament
Caan held a partnership interest in an IRA with UBS serving as the IRA custodian. As part of the UBS custodial agreement, UBS placed the responsibility with Caan to provide a year-end fair market value of the partnership. In 2015, Caan failed to provide UBS with the partnership’s 2014 year-end fair market value. As a result, UBS refused to continue serving as the custodian of the partnership interest, and sent a letter to Caan notifying him of a distribution of the partnership Interest. UBS then issued Caan a Form 1099–R – Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., which reported to the IRS a distribution of the partnership Interest using the 2013 year-end value as the value of the distribution.
Also in 2015, Caan’s financial advisor moved to Merrill Lynch and Caan transferred his IRAs to Merrill Lynch. The partnership interest, however, was not eligible for electronic transfer, so Caan’s investment advisor at Merrill Lynch directed that the partnership be liquidated, and the cash sent to Caan’s Merrill Lynch IRA account. Said liquidation and cash transfer did not occur until approximately a year from the time that UBS notified Caan of UBS’s distribution of the partnership interest.
On his federal income tax return for tax year 2015, Caan reported a nontaxable distribution of his IRA. The IRS Commissioner disagreed with Caan’s position and determined an income tax deficiency of $779,915.00 for tax year 2015. He filed a petition with the U.S. Tax Court for redetermination of his 2015 income tax deficiency.
Shortly before filing the Tax Court petition, Caan requested a private letter ruling from the IRS granting him a waiver of the 60-day period for rollovers of IRA distributions. The IRS denied that request on the grounds that Caan did not meet the “same property” requirement. In other words, regardless of the timing of the rollover, Caan’s liquidation of the partnership interest and contribution of the cash to the Merrill Lynch IRA did not comply with the “same property” requirement. As such, it was not a nontaxable rollover.
The Tax Court sided with the IRS, holding that the partnership interest was distributed in 2015 to Caan, and that Caan did not contribute the partnership interest in a manner that would qualify as a nontaxable rollover contribution under section 408(d)(3) because he changed the character of the property when the partnership interest was liquidated prior to rolling over the property to his new IRA.
Takeaway
When a client holds nontraditional or alternative assets in an IRA, the IRA should be reviewed yearly, and any actions involving rolling over such assets to a different custodian must be taken with care.
This piece originally appeared in the St. Louis Bar Journal blog.
by Chris SwiecickiHow to Find a Corporate Tax Lawyer
Creating a tax strategy takes teamwork among legal, finance, and accounting professionals. Many companies trust an independent corporate tax lawyer as an advisor to the tax strategy team. When you are ready to add a corporate tax lawyer to your team, how do you find one? The search starts the old-fashioned way and ends with a list of interview questions.
Ask for a Referral to a Corporate Tax Lawyer
This is a case when “Googling it” is not a good first step. You will not see many listings for “corporate tax lawyer.” You probably will have better success by asking your professional network if they will refer you to a corporate tax lawyer. Inquire with your banker and accountant, and the lawyers you work with on other matters. Most of us trust recommendations from respected colleagues, which is why this is the best way to find a lawyer you will trust from day one.
If you do not get a referral from someone you know, check with the bar associations in your area; for Missouri, those include the Federal Bar Association and the Eighth Circuit Bar Association, the bar for the St. Louis area. (You can also learn about our own Taxation Law capabilities here at Swiecicki & Muskett.)
Check Their Credentials for Practicing Taxation Law
The practice of taxation law requires a minimum of a Juris Doctor degree, known as a J.D. The attorney also must be licensed by the state bar. Many corporate tax lawyers expand their expertise and earn a Master of Laws in Taxation degree, known as an L.L.M.. Some are certified public accountants and others have served in corporate finance positions.
Christopher Swiecicki, founder and managing attorney at Swiecicki & Muskett, L.L.C., practices taxation law with the insight of decades of experience in law, finance, and accounting. During his career he has:
- Earned a J.D. in 1990 and an L.L.M. in 2005, both from the Washington University School of Law, one of the top law schools in the nation.
- Taught a course in Business Acquisitions as an adjunct professor at the Washington University School of Law since 2011.
- Worked as a tax accountant at one of the Big Four accounting firms.
- Served as inside tax counsel to a Fortune 500 Company.
- Worked as inside tax counsel to a regional financial institution.
- Served as a chief financial officer and general counsel for a $40 million private company.
- Been recognized as an expert in the field by the Association of Corporate Counsel and the American Bar Association.
Today, Christopher Swiecicki provides personalized service to business owners and executives at major corporations. He keeps his client roster small enough to respond quickly to every client. When he meets with clients, he has in-depth knowledge of their needs. (To begin a conversation, you can find his contact information here.)
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Ask If the Corporate Tax Lawyer Has Applicable Experience
A corporate tax lawyer might have impressive credentials but lack experience related to your situation. Ask them about it before signing a contract with them. In some cases, you may need to meet with them to explain your situation. If you learn they are not experienced in the area you need help with, ask them for a referral to another corporate tax lawyer.
Learn What the Corporate Tax Attorney Will Do for You
When hiring a corporate tax attorney, find out what they will do for you. Christopher Swiecicki has decades of experience advising companies on the federal tax-related aspects of acquisitions and dispositions, mergers and financial structures and products, and corporate governance. If you are seeking counsel in one of these areas, contact Swiecicki to discuss your situation and see if there is a good fit.
In other situations, consider asking the following questions, or variations of them, depending upon your business:
- What is your experience with a business like ours?
- How do you see our business interests intersecting with tax law?
- How will you apply your knowledge of taxation law to help us manage our business functions more effectively?
- Will you help us decide whether to set up a C-Corp or an LLC?
- What skills and resources do you have to help our company manage tax exposure and risk?
- How does your team stay current on IRS rulings and government programs affecting business taxes?
- Will you advise us on the tax ramifications of current operational and business decisions?
- Do you provide counsel related to e-commerce and cloud-based services?
- Do you have experience litigating cases before the IRS?
At Swiecicki & Muskett, we serve businesses in many industries with varied structures and sizes. We are constantly gaining new insights, thanks to the diversity of our clientele.
When you are ready to increase profits with a sophisticated tax strategy, contact us. We will serve you with the strength of our experience combined with constant attention to changes in taxation law. Contact Christopher Swiecicki at 636-778-0209 or email Chris@SwiecickiLaw.com.
by Chris SwiecickiC-Corps vs. LLCs: Which One is Right for My Business?
When deciding the best way to structure their business, owners are often inundated with advice. And while friends , colleagues, and even accountants can mean well, they can inadvertently steer them into a choice that is problematic and expensive.