Treasury Responds to Claims of Undervaluation in Contributed Retirement Plan Assets

Treasury has answered a letter from Democratic Representatives voicing suspicions that the contribution limits for tax-deferred retirement accounts are being avoided by undervaluing the contributed assets.   Treasury highlighted the IRS’s enforcement efforts, opined that current tax rules provide little incentive to shift investment gains to IRAs and SEP-IRAs by using undervalued assets, and highlighted current law’s fair market value standard for valuing assets contributed to IRAs.

Background.  Annual contributions to defined contribution plans are limited to an inflation adjusted figure ($50,000 for 2012), and contributions to IRAs are limited to $5,000 for 2012, plus a $1,000 catch-up contribution for those age 50 or older.  Taxpayers generally may roll over their defined contribution plans to IRAs on a tax-free basis.

Question of valuation.  In an August 2, 2012, letter to the Treasury Department and Employee Benefits Security Administration, Reps. George Miller (D-CA), Sander Levin (D-MI), and Chris Van Hollen (D-MD), expressed concern that taxpayers may be getting around the above contribution limits for tax-deferred retirement accounts by assigning low values to property contributed to the account.  They cited, as an example, Republican presidential candidate Mitt Romney’s high-value IRAs, which reportedly hold stakes in businesses relating to his employment at Bain Capital.

The Democratic Congressmen requested answers to specific questions, such as: the current standards related to the valuation of assets that are purchased by tax-deferred retirement accounts; the proof taxpayers must submit if they are examined as to the value of assets held by retirement accounts when those assets are not publicly traded or their value cannot be established by reference to an established market; and the number of audits the IRS has recently conducted on the valuation of assets held in tax-deferred retirement accounts.

Treasury’s response.  In identical letters responding to Reps. Levin, Miller, and Van Hollen, Treasury Assistant Secretary for Tax Policy Mark Mazur said IRS was aware of potential valuation problems for IRAs (as well as SEP IRAs), and had raised the issue in Notice 2004-8, 2004-4 IRB 333, which listed the undervaluation of IRA assets as a listed transaction that must be disclosed to IRS.  Specifically targeted were transactions attempting to bypass contribution limits that involved a business owned by a taxpayer and a corporation owned by the taxpayer’s Roth IRA (the Roth IRA corporation).

Although IRS has gone after listed transactions identified by Notice 2004-8, and instances where assets of traditional IRAs and qualified plans have been abusively undervalued, Mazur maintained that under current tax rules, there is relatively little incentive to shift investment gains into traditional IRAs or SEP IRAs through the use of undervalued assets.  While sales or other dispositions of assets within an IRA are not taxable, any appreciation (or other earnings) on assets distributed from traditional IRAs and SEP IRAs are taxed at ordinary income tax rates when distributions occur and are not eligible for favorable capital gains treatment that might apply to the sale of capital assets held directly by the taxpayer.  Mazur said that although value-shifting strategies involving traditional IRAs and SEP IRAs may have offered greater advantages in the early ‘90s when the tax treatment of long-term capital gains was closer to that for ordinary income, these advantages appear to be much smaller given the spread in ordinary versus long-term capital gains tax rates.

Mazur pointed out that IRS rules generally require all IRA assets, including those not publicly traded, to be valued using a FMV standard (as opposed to liquidation or other value), and that FMV of IRA and qualified plan assets must be reported on Form 5498 (IRA Contribution Information) and Form 5500 (Annual Return/Report of Employee Benefit Plan), as applicable.  Responding to the Representatives’ request for audit information, Mazur said the IRS is currently working to obtain a reliable estimate of the number of audits that specifically involve IRA asset valuation issues and an estimate of the size of associated tax compliance problems.  He also said IRS has assembled a working group to study ways of improving compliance and enforcement in the IRA/SEP IRA valuation area.

Click here to read Treasury’s complete response.