[IMGCAP(1)]The U.S. Department of Labor proposed new fiduciary rules in April that significantly affect IRA advisors, including accountants who render advice to holders of individual retirement accounts.
Many accountants have affiliations with wealth advisory units, either directly or indirectly, and act as financial planners for their clients. In that capacity, they should become familiar with the DOL’s proposed IRA fiduciary rule and the liabilities in connection with it.
According to the DOL, although many IRA advisors place the IRA holder’s best interest first, there may be instances where IRA holders may not necessarily receive the best advice since the IRA advisor may be conflicted.
The DOL is proposing to expand the definition of “fiduciary” to include persons who provide investment advice or recommendations to an IRA holder and meet certain tests described below. In effect this rule, if finalized, will have a significant impact on IRA advisors and subject them to stringent compliance rules, fiduciary breach of trust issues and excise tax liabilities.
At this point there is a strong possibility that the rule will be finalized within the next 18 months or so. According to the DOL, an advisor includes an individual or entity who can be a representative of a registered investment advisor, a bank or similar institution, an insurance company or a broker dealer.
If the rule is finalized and the IRA advisor is deemed to be a fiduciary, then transactions the advisor has with respect to an IRA may be prohibited transactions unless the IRA advisor adheres to the DOL’s exemptions. An exemption is in essence the ability of an IRA advisor to be involved in a transaction with the IRA holder and his or her IRA account that is exempt from being treated as a prohibited transaction.
No IRA advisor should enter into a potential prohibited transaction with an IRA holder in the absence of a DOL exemption.
Under the proposed rule, in general an IRA advisor is a fiduciary if he or she renders investment advice to an IRA holder for a fee or other compensation, whether direct or indirect, pursuant to an agreement or understanding that such advice is specifically directed to the recipient for consideration in making investments or management decisions regarding securities or property of the IRA. Investment advice includes “a [r]ecommendation as to the advisability of acquiring, holding, disposing or exchanging securities or other property, including a recommendation to take a distribution of benefits or a recommendation as to the investment of securities or other property to be rolled over or otherwise distributed from the plan or IRA.”
Under the definition of “recommendation” in the proposed rules, “a [r]ecommendation means a communication that, based on its content, context and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.”
In the event an IRA advisor is considered to be a fiduciary, then in the absence of a DOL exemption the advisor will be subject to a pyramiding prohibited transaction excise tax with respect to certain transactions involving the IRA that is considered to be a prohibited transaction. This can be a significant excise tax liability for the IRA advisor.
According to the DOL, “[a]dvisors and Financial Institutions that engage in prohibited transactions under the Code are subject to an excise tax. The excise tax is generally equal to 15% of the amount involved. Parties who have participated in a prohibited transaction for which an exemption is not available must pay the excise tax and file Form 5330 with the Internal Revenue Service.”
This excise tax with respect to prohibited transaction involving retirement accounts is Section 4975 of the tax code. This is a pyramiding excise tax. There is no statute of limitations that is triggered if the Form 5330 is not filed. A delinquent Form 5330 is subject to failure to file penalties and interest. I know of situations where the prohibited transaction excise taxes involving qualified plans were well in excess of $100,000. There is no reasonable cause exception with respect to this type of excise tax.
The DOL plans to issue exemptions to protect IRA advisors from prohibited transaction issues if certain conditions are satisfied. One of the key exemptions being considered is a proposed class exemption called the “Best Interest Contract Exemption.” It would allow IRA advisors to receive direct and indirect compensation with respect to transactions with IRA holders that would otherwise be prohibited, provided that certain contractual arrangements are made. According to the DOL, a written contract would have to be entered into by the IRA advisor and his or her firm with the IRA holder prior to making any recommendations.
The contractual representations are quite detailed but in essence require that the IRA advisor and his or her firm must agree to place the client’s interest first when giving investment advice to an IRA holder. Detailed disclosure rules must be satisfied as well.
Any breach of contract would subject the IRA advisor to litigation and excise tax liabilities.
In the event that such detailed agreements are not entered into, then the IRA advisor would not be protected by the proposed class exemption. The key to the proposed fiduciary rule is to give the IRA holder advice that is not conflicted. In addition, the IRA advisor must be transparent with respect to direct and indirect fees.
What is not clear is whether or not the proposed fiduciary rule is applicable when an IRA advisor recommends that an IRA holder withdraw funds from their IRA account to invest in a product that results in direct and/or indirect compensation for the IRA advisor after the IRA funds are taken out of the IRA. This is a post-distribution transaction.
Is this type of transaction covered by the proposed fiduciary rule or not? Once the distribution is taken out of the IRA account, one might say the DOL has no jurisdiction over this type of transaction. Alternatively, one can argue that this is a step transaction that leads to a product sale and that it is subject to the DOL-proposed fiduciary rule.
According to the proposed regulation, a “recommendation as to the advisability of acquiring, holding, disposing or exchanging securities or other property, including a recommendation to take a distribution of benefits or a recommendation as to the investment of securities or other property to be rolled or otherwise distributed from the plan or IRA,” pursuant to an agreement or understanding with the IRA holder that such advice be considered in making investment or management decisions with respect to securities or other property of the IRA would make the IRA advisor a fiduciary. The phrase “otherwise distributed from the plan or IRA” is interesting since it leaves open the issue as to whether or not the DOL has jurisdiction over a post-distribution product transaction.
If an IRA advisor, for example, tells the IRA owner to withdraw $100,000 from his or her IRA and purchase life insurance, then regardless of whether or not the IRA advisor is a fiduciary under the proposed fiduciary rule or not, the IRA advisor should be transparent with the IRA holder regarding any direct and indirect compensation with respect to the product transaction. This would be consistent with the DOL disclosure requirement under the proposed “Best Interest Contract Exemption” if we assume that the insurance product transaction is not within the purview of the DOL rule. The DOL’s proposed fiduciary rule is detailed and complex, but it points in the direction of consumer protection and transparency.
Seymour Goldberg, CPA, MBA, JD, is a senior partner in the law firm of Goldberg & Goldberg, P.C., in Long Island, N.Y., and 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, New Jersey Institute for Continuing Legal Education, local bar associations and law schools. He 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 has authored guides for the American Bar Association and the American Institute of CPAs on the IRA compliance rules. His most recent guide in 2014 is entitled “Can You Trust Your Trust? What You Need to Know About the Advantages and Disadvantages of Trusts and Trust Compliance Issues,” published by the American Bar Association. The guide will also be available through Amazon.com and Barnes & Noble on June 10, 2015.
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