Risks HTVAs Pose In IRA Accounts
Before the IRS Commissioner authorizes a bank or brokerage firm to act as an IRA custodian and issue reports including Forms 5498 (used to inform the IRS and the IRA owner (among others) about the fair market value of the account) and 1099-R (used to report to the IRS (among others) the market value of assets withdrawn from the IRA, which is a taxable event), the institution commits to value the IRA’s assets annually, as set forth in Section 1.408-2(e): ‘The applicant will determine the value of the assets held by it in trust at least once each calendar year and no more than 18 months after the preceding valuation. The assets will be valued at their fair market value...’
Having the client indemnify the custodian from its valuation responsibilities (a common practice among IRA custodians) in no way alters the custodian’s promise to the IRS to abide by the Service’s requirements. This practice may (or may not) reduce the custodian’s legal exposure to action from the client, but it certainly does not afford any protection with respect to the reporting requirements imposed on the custodian by the IRS. The custodian has an obligation to value assets every December 31st in order to file IRS Form 5498; and to file IRS Form 1099-R whenever the IRA makes a distribution. An “information letter” from the Internal Revenue Service dated 2/24/1993 explicitly details the obligations facing custodians with respect to HTVAs:
Q: Must IRA HTVAs Be Valued Annually?
“Based on the fact that the IRS requires that the fair market value of the assets as of 12/31 be reported on Form 5498, an IRA is required to value its assets on an annual basis. Similarly, the requirement that fair market value be determined annually for purposes of Form 5498 necessitates the valuation of all IRA assets, including ‘hard to value’ assets.”
Q: Who Is Responsible For Proper Valuations, The Investor Or The Custodian?
“The person responsible for insuring that an IRA’s assets are properly valued is the IRA trustee or issuer, because under the Service’s reporting requirements that person is responsible for reporting the correct fair market value of assets.”
Q: Can Trustees Be Released From Valuation Responsibilities?
“The IRA trustee or issuer cannot evade valuation responsibility by having the participant sign a release, indemnification or other instrument, because the trustee’s or issuer’s responsibility for valuation derives from the Service’s reporting requirements, which cannot be waived by participant action.”
Incorrect Form 1099-Rs result in a widespread taxpayer failure to pay required taxes. The problem is compounded since Form 1099-R need not be filed “if the amount of the gross distribution paid to someone for the year is less than $1". (An unpriced HTVA would appear to have a value of $0.) Taxpayers have a vested interest in maintaining the status quo (and thus are unlikely to complain about the practice), but the Service has shown increasing interest in the problem in recent years.
Bulletin 2004-4 was issued in response to misvaluation abuses in Roth IRAs and illuminates the IRS’ view that misvalued assets in an IRA used to avoid paying taxes are ‘tax avoidance transactions’. The Bulletin alerts parties involved with these transactions of certain responsibilities that may arise from their involvement with these transactions. While 2004-4 specifically addresses a violation within a Roth IRA, the principles articulated apply as well to other types of IRAs also.
You Want To Do WHAT With Your IRA?
By John N. Singletary Jr., CFP
Published in the American Bankers Association's Trusts & Investments Magazine, May/June 2006
