IRS Allows Deduction for Payment of IRA “Wrap Fees”
IRS determines that “wrap fees” paid from a taxable investment account on behalf of IRA and Roth IRA accounts are not treated as additional contributions, thereby allowing a taxpayer to deduct the cost of IRA and Roth IRA account management fees.
In private letter ruling 201104061, the IRS determined that “wrap fees” charged to IRA and Roth IRA accounts paid out of taxable investment accounts are not treated as additional contributions to the IRA and Roth IRA accounts. In essence, the determination allows taxpayers to deduct the fees of their IRA and Roth IRA accounts on Schedule A of Form 1040 (U.S. Individual Income Tax Return), thereby increasing the overall return on the accounts and further leveraging the benefits of tax-deferred retirement investing.
Transactional Facts. ACME company is a securities broker-dealer and investment advisor that provides a variety of financial services to its clients. ACME offers three levels of account management services for clients that maintain traditional IRAs and Roth IRAs with ACME. All three levels of management service require the client to pay to ACME a quarterly fee based on the percentage of assets under management. The fee, which is not related to the number of trades executed in any account, is called a “wrap fee.” For example, in one type of non-discretionary investment advisory account, ACME offers five risk-based portfolios invested in mutual funds. An ACME advisor assists the client in selecting an appropriate portfolio based on the client’s financial goals, time horizon to invest, and risk tolerance. Each portfolio features professional risk allocation and quarterly rebalancing, including monitoring and review of the underlying funds in the account, by a research specialist focused on portfolio management. Historically, ACME was charging the wrap fees to, and paying the wrap fees from, the IRA or Roth IRA accounts on a quarterly basis.
ACME filed its private letter ruling request because it wanted to offer its clients the option of paying the wrap fee with non-IRA assets, without the payment being treated as a deemed contribution to the client’s IRA under Code §408 and/or Roth IRA under Code §408A.
The IRS Ruling. The IRS concluded that the wrap fees assessed by ACME for its investment advisory accounts are recurring administrative or overhead expenses incurred in connection with the maintenance of clients’ respective IRAs and/or Roth IRAs. The wrap fees include investment advice, performance monitoring and review, trade execution, money management and custodial services. Further, the wrap fees are based on a fee structure calculated as a percentage of the value of the assets held in the respective account. The fees do not vary with the frequency of the transactions performed and are distinct from the cost or volume of any assets purchased or sold.
As a result, the IRS determined that the payment of wrap fees by account holders that participate in the investment advisory accounts will not be treated as deemed contributions to such clients’ traditional IRAs under Code §408 and/or Roth IRAs under Code §408A, if they are paid directly from funds that are not part of the account holders’ respective IRAs and/or Roth IRAs.
Planning Point. The IRS ruling does not express an opinion on other aspects of the transactions described by ACME. Nonetheless, it appears that as investment fees, the clients’ separately-paid wrap fees should be deductible on Schedule A of Form 1040 as miscellaneous itemized deductions subject to the 2%-of-AGI floor. In essence, allowing the client to make an additional tax deductible contribution to an IRA or Roth IRA.