The potential that practitioners will be faced with prohibited transaction excise taxes has recently increased for CPAs who act as trustees of IRA trusts. CPAs who act in this capacity can be subject to excise tax liabilities if the IRA trustee causes the IRA trust to directly or indirectly incur fees that are not reasonable in the aggregate.
Because the Department of Labor (DOL) focuses on the amount of fees incurred in rendering IRA advisory services to IRA account holders, the IRA trustee now faces increased scrutiny. The DOL released the final fiduciary rule regarding IRA advisory services on April 6, 2016, effective April 10, 2017. The DOL fiduciary rule focuses primarily on the IRA adviser, whereas this column addresses the issues facing the IRA trustee.DOL's Point of View
Although there has been a great deal of discussion involving the IRS's treatment of IRA trusts, very little has been written about the DOL's point of view when an IRA trust is the beneficiary of an IRA. Since Dec. 31, 1978, the DOL has been delegated the authority to issue interpretations regarding prohibited transactions under Sec. 4975 if IRAs are involved. Sec. 4975 covers the rules for prohibited transactions.
A detailed discussion of Sec. 4975 as it relates to an IRA trust was issued by the DOL in 2009 (see DOL Advisory Opinion 2009-02A, available at www.dol.gov). Practitioners need to be aware of Advisory Opinion 2009-02A so they do not fall into a trap that can trigger tax problems when IRA transactions are at issue.
In the facts discussed in the advisory opinion, the IRA owner established a revocable trust as the beneficiary of his IRA account. The trust terms provide that it will become irrevocable upon the IRA owner's death. (That provision is required based on Regs. Sec. 1.401(a)(9)-4, Q&A-5, when a trust is the beneficiary of an inherited IRA.) Seymour was the IRA owner and initial trustee, Jason was the successor trustee, and Cole was the trust beneficiary. Jason, as successor trustee, was granted the power to "invest and reinvest the assets in the IRA in any securities, stocks, bonds or other property, real or personal, which may be deemed advisable . . ."
Jason, the successor trustee after the IRA owner's death, is required under the terms of the trust to determine the required minimum distributions (RMDs) that must be received by the trust for each calendar year based upon the distribution calendar year, the account balance as of the appropriate valuation date, and the appropriate life-expectancy factor. The successor trustee then has to pay the RMDs each year to Cole, the trust beneficiary, or the custodian under the Uniform Transfers to Minors Act if he is under the age of 21.
The Seymour Goldberg Revocable Trust for the Benefit of Cole Goldberg was a trust created under the laws of the state of New York. Under New York law, trustee commissions for individual trustees are based on statutory rates. According to the advisory opinion, the "statutory schedule of compensation has been interpreted by New York courts as an effort to set a fixed rate schedule for the reasonable value of trustee services performed during the trust period."
The issues presented to the DOL were whether (1) the IRA distributions to the trust and (2) the payment of statutory commissions associated with the IRA distributions to the trust would constitute prohibited transactions under Sec. 4975.Prohibited Transactions
IRS Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs), for 2015 discussed the tax consequences of a prohibited transaction in general terms. The relevant portion follows:
Generally, a prohibited transaction is any improper use of your traditional IRA account or annuity by you, your beneficiary, or any disqualified person.
Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant). . .
Fiduciary. For these purposes, a fiduciary includes anyone who does any of the following:
- Exercises any discretionary authority or discretionary control in managing your IRA or exercises any authority or control in managing or disposing of its assets.
- Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so.
- Has any discretionary authority or discretionary responsibility in administering your IRA.
Effect on an IRA account. Generally, if you or your beneficiary engages in a prohibited transaction in connection with your traditional IRA account at any time during the year, the account stops being an IRA as of the first day of that year.
Effect on you or your beneficiary. If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis, you will have a taxable gain that is includible in your income. . . .
Taxes on prohibited transactions. If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction is not corrected. [Publication 590-B, pp. 22, 23]
It should be noted that Jason, in the author's opinion, is not a beneficiary of the IRA but is only a trustee. The trust beneficiary of the IRA trust is Cole. If the DOL held that Jason is a beneficiary of the IRA trust, then a prohibited transaction would trigger the loss of the IRA's tax-exempt status, and the IRA trust would be taxable on the entire value of the IRA.
According to the advisory opinion, Jason, upon becoming the successor trustee, would become a fiduciary by reason of his authority to control the management and disposition of the IRA assets. In addition, Jason and the trust are disqualified persons under Sec. 4975.
The DOL held that the trustee's decision to take a benefit distribution from the IRA in accordance with the terms of the IRA trust is an ordinary benefit distribution and is not a prohibited transaction.
Regarding the issue involving the statutory trustee commissions that Jason would receive in administering the trust, the DOL indicated that "Code section 4975(c)(1)(D) prohibits a direct or indirect transfer to, or use by or for the benefit of, a disqualified person of any assets of an IRA, and Code section 4975(c)(1)(E) makes it unlawful for a fiduciary to deal with assets of an IRA in his own interest or for his own account."
The DOL then indicated that the receipt of statutory trustee commissions by the trustee was not a prohibited transaction under Sec. 4975. Had the receipt of statutory trustee commissions by Jason been considered a prohibited transaction, then it would have resulted in prohibited transaction excise taxes for Jason. It would also mean that the trustee of an IRA trust would have to serve as a trustee without compensation to avoid a prohibited transaction.Standards of Conduct
The advisory opinion then made the following statement, which should be of concern to the trustee of an IRA trust: "Where [Jason] does act as a fiduciary of the IRA, he may not act in a manner prohibited by Code section 4975."
Thus, if Jason, for example, received his statutory trustee commissions and then hired an investment adviser who received a management fee, that could trigger a prohibited transaction under Regs. Sec. 54.4975-6(a)(5). Under state trust law, Jason's trustee compensation should include the investment management duties of a trustee. In that case, the payment of any management fees by Jason as trustee would result in excess fees being paid by the IRA trust.
According to the advisory opinion, Regs. Sec. 54.4975-6(a)(5) describes the standards of conduct that must be adhered to by a fiduciary to avoid triggering a prohibited transaction. In addition, DOL Advisory Opinion 2005-10A (available at www.dol.gov) should be examined. This advisory opinion refers to Regs. Sec. 54.4975-6(a) and emphasizes a reasonable compensation rule for a fiduciary who renders services to a plan.
Advisory Opinion 2005-10A uses an offset approach: If Jason, as successor trustee, engaged an investment adviser to manage the IRA assets, then he would have to offset the amount of his statutory trustee commissions by the amount of the fees paid to the investment adviser to satisfy the reasonable compensation standard found in Regs. Sec. 54.4975-6(a), based on the DOL's position in Advisory Opinion 2005-10A. This would be necessary to avoid prohibited transaction excise tax liabilities for any excess compensation amount.
If Jason did not offset the fees, then as a fiduciary of the IRA trust, he would cause additional fees to be paid above and beyond his statutory trustee commissions. This would violate the reasonable compensation standard discussed above.
If Jason, as successor trustee, did not have an investment adviser and handled the investment decisions on his own, then the excess fee issue would not apply.
The problem that confronts trustees of IRA trusts throughout the United States is that most states' laws do not provide for statutory trustee commissions. Most states merely have suggested guidelines as to what reasonable trustee commissions should be. In fact, Regs. Sec. 54.4975-6 does not define reasonable compensation but merely states that whether compensation is reasonable is based on the facts and circumstances (Regs. Sec. 54.4975-6(e)(2)).
Under trust law, a trustee can only receive reasonable compensation. If a prudent trustee delegates the investment authority to an investment manager, then the overall compensation to the trustee and investment manager must be reasonable. The trustee can be compensated only for what he or she does. The investment management fee will cause a reduction in the trustee's commission to the extent that the total fees paid are excessive.
If the CPA as the trustee of an IRA trust engages his or her CPA firm to prepare the fiduciary Form 1041, U.S. Income Tax Return for Estates and Trusts, for the IRA trust, then separate time records for that engagement must be maintained. The accounting fees charged to the IRA trust must be reasonable. This rule would apply to non-IRA trusts as well.Considerations for Trustees
If a CPA is asked to serve as the trustee of an IRA trust, he or she should be aware of the responsibilities of acting as a trustee. In addition, if the CPA is affiliated with a wealth advisory service that provides IRA advisory services, then his or her trustee commissions will have to be adjusted downward by the amount of the management fees paid to the investment advisory unit if the aggregate fees paid are excessive. This would also apply to an attorney who acts as a trustee of an IRA trust and is affiliated with a wealth advisory unit that renders IRA advisory services to the IRA trust.
On April 6, 2016, the DOL released the final fiduciary rule (81 Fed. Reg. 20945) that affects advisers who render investment advice to IRA account holders. These rules are effective as of April 10, 2017, and thereafter.
The fiduciary rule basically provides that in the absence of a DOL exemption, IRA advisers who render investment advice to IRA holders for a fee will be involved in a prohibited transaction. The adviser will then be subject to excise taxes. For the IRA adviser to avoid excise taxes, the IRA adviser's firm must enter into a contract with the IRA account holder to take advantage of the DOL's "best interest contract exemption."
The DOL final rule did not discuss or cover IRA trust issues.
If the CPA is the trustee of an IRA trust and is associated with a wealth advisory unit that renders IRA advisory services, then in the absence of a DOL advisory opinion, the CPA as trustee should not risk using the wealth advisory unit of his or her firm to render IRA advisory services to the trustee of the IRA trust.
In essence, the DOL needs to be consulted on this issue. This would apply as well if an attorney acts as an IRA trustee and the attorney's firm has a wealth advisory unit. In view of all the headaches involved, the CPA should consider whether to accept the responsibilities of acting as a trustee of an IRA trust.
Also the wealth advisory unit of a CPA firm in general should examine whether to render IRA advisory services to firm clients who have IRA accounts in a non-IRA trust situation. If yes, then the financial institution the wealth advisory unit works with will have to execute a best interest contract agreement with the firm's clients who have IRA accounts. This agreement would have to provide that the IRA adviser is a fiduciary.
Theodore Sarenski is president and CEO of Blue Ocean Strategic Capital LLC in Syracuse, N.Y. Seymour Goldberg is a senior partner in the law firm of Goldberg & Goldberg PC on Long Island, N.Y., and is Professor Emeritus of Law and Taxation at Long Island University. Mr. Goldberg is the author of Inherited IRAs: What Every Practitioner Must Know, 2015 edition, and the IRA Guide to IRS Compliance Issues Including IRA Trust Violations. He has previously written several manuals for the AICPA and the American Bar Association on trust accounting rules and the taxation of retirement distributions. Mr. Sarenski is chairman of the AICPA PFP Executive Committee's Elder Planning Task Force and is a member of the AICPA Advanced PFP Conference Committee and PFP Executive Committee Thought Leadership Task Force. For more information about this column, contact firstname.lastname@example.org.