IMGCAP(1)]Last month, the U.S. Department of Labor issued the final fiduciary rule, which significantly affects advisors who render investment advice to Individual Retirement Account owners.
This article discusses the pitfalls that IRA advisors now face when giving advice to IRA owners. It clarifies an issue regarding whether the final DOL fiduciary rule is applicable when an IRA advisor recommends to IRA owners that they withdraw funds from an IRA account to invest in a product that results in direct and/or indirect compensation for the IRA advisor and the advisor’s firm after the funds are taken out of the IRA. This is a post-distribution transaction.
The DOL held in essence that the “follow the money rule” is applicable. Regulation Section §2510.3-21(a)(1)(ii) provides in part:
(ii) “… or recommendations [by an IRA advisor makes the IRA advisor a fiduciary] with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amounts in what form, and to what destination such a rollover transfer or distribution should be made ….”
Thus, a post-distribution transaction is covered by this fiduciary rule effective as of April 10, 2017 and thereafter.
In the absence of a DOL exemption from the prohibited transaction rules, the IRA advisor who receives any compensation, direct or indirect, as a result of a product transaction that is triggered from a post-distribution transaction is subject to a 15 percent excise tax under Section 4975 of the tax code.
The prohibited transaction excise tax is generally equal to 15 percent of the amount involved. The amount involved is based on the amount of compensation, direct and indirect, that the IRA advisor and the advisor’s firm receives. The excise tax applies for each year thereafter until the transaction is reversed in the manner required under the IRS rules.
The DOL has issued an exemption from the prohibited transaction rules that may avoid the excise tax issue provided that the IRA advisor’s fees (direct and indirect) are reasonable. The exemption is discussed below.
This exemption is a DOL class exemption called the “Best Interest Contract Exemption.” It is a detailed agreement that must be entered into between the IRA advisor’s firm and the IRA owner. Assume for a moment that the agreement is entered into by the parties. According to the DOL any breach of an agreement can result in excise taxes to the extent that the compensation (direct or indirect) of the IRA advisor and the advisor’s firm obtains fees that are in excess of reasonable fees. Civil litigation is available in the event of a breach of the agreement as well. The DOL does not define what is meant by the term “reasonable compensation” but indicates that it is based on facts and circumstances. This is an issue that may be a headache if, for example, the product is a high-commission product such as a permanent life insurance policy.
There is no statute of limitations on an excise tax liability if Forms 5330 are not filed with the IRS reflecting the amount of the excise tax liabilities. Delinquency penalties and interest also accrue if there is an untimely filing of Forms 5330.
CPAs who are IRA advisors either directly or indirectly through their wealth advisory units should be extremely careful if they are involved in the IRA advisory area. Their malpractice liability in this area may become a significant issue for the CPA and the CPA firm that has a wealth advisory unit that is involved in IRA advisory services.
Seymour Goldberg, CPA, MBA, JD, a senior partner in the law firm of Goldberg & Goldberg, P.C., Long Island, New York, is Professor Emeritus of Law and Taxation at Long Island University. He has taught many CLE and CPE programs at the state and national level as well as CLE courses for the New York State Bar Association, City Bar Center for Continuing Legal Education, NJICLE, local bar associations and law schools. He has been quoted in major publications including The New York Times, Forbes and The Wall Street Journal and has been interviewed on CNN, CNBC and CBS. Mr. Goldberg is a member of the IRS Long Island Tax Practitioner Liaison Committee and the Northeast Pension Liaison Group. He was formerly associated with the Internal Revenue Service and has been involved in conducting continuing education outreach programs with the IRS. He is the chairman of the Estate & Financial Planning Committee of the Suffolk Chapter of the New York State Society of CPAs. He is the author of "
