Individual Retirement Accounts: IRS Could Better Inform Taxpayers about and Detect Noncompliance Related to Unconventional Assets
Fast Facts
Individual retirement accounts (IRA) help taxpayers save for retirement. Most IRAs invest in assets like stocks and mutual funds, but some IRA owners want to invest in unconventional assets like real estate or virtual currency.
IRS Publications 590-A and B offer guidance to taxpayers with IRAs, but details on unconventional assets are limited. For example, investing in some types of bullion is permitted, but storage requirements are not explained.
We recommended that IRS assess its options—like directing IRA owners to webpages with specialized information and technical regulations—to help taxpayers fully understand the rules on unconventional assets.
A broken piggy bank with cash spilling out of it
Highlights
What GAO Found
The Internal Revenue Service's (IRS) Publications 590-A and 590-B serve as a general handbook for millions of taxpayers with individual retirement accounts (IRA). However, the two-part publication provides limited information for IRA owners with unconventional assets surrounding complex tax rules in four compliance areas: (1) barred investments, (2) prohibited transactions, (3) unrelated business income, and (4) fair market value. GAO found other limited information about these topics on IRS's website. With only about 2 percent of IRAs invested in unconventional assets, adding more pages to Publications 590-A and 590-B may not be practical. By assessing options for informing IRA owners investing in unconventional assets, such as directing them to web pages with specialized information and technical regulations, IRS could better help them comply.
Noncompliance involving unconventional IRA assets is difficult to detect and time consuming for IRS to pursue. Whereas IRS relies on automated enforcement for IRAs invested in conventional assets held by custodians and trustees, enforcement for IRAs invested in unconventional assets or under IRA owner control requires labor-intensive audits of individual taxpayers. Using newly compiled information, IRS identified about 2 million IRAs that held certain types of hard-to-value assets as of 2016; however, about 20 percent of the forms were missing fair market value amounts for these assets (see fig.).
Numbers of IRAs Reporting Certain Types of Unconventional Assets and Reporting Their Value (Tax Year 2016)
|
Data element from IRS Form 5498 |
Number of forms reporting |
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Certain types of unconventional nonmarket assets |
2.0 |
|
Fair market value of specified assets |
1.6 |
Source: GAO analysis of IRS data. | GAO-20-210
IRS officials said this type of reporting alone may be inadequate for audit selection and identifying potentially abusive IRAs. When IRS lacks sufficient data to detect abusive transactions, IRS can require taxpayers to self-report certain transactions that have been used by other taxpayers to avoid taxes. Additional taxpayer or custodian disclosure of potentially abusive IRA transactions coupled with IRS analysis of reported details may help IRS to select IRA owner tax returns to audit.
Fragmented responsibility among IRS divisions creates challenges for examiners who need to share expertise and collaborate on IRA enforcement. The division responsible for tax-exempt entities trains its examiners on how to determine if an employee retirement plan has engaged in business activities subject to taxation. However, examiners in the division that audits complex individual tax returns, including those involving IRAs, do not receive such training. Training for those examiners could help improve collaboration on IRA enforcement.
Why GAO Did This Study
Unconventional IRA investments—such as real estate, certain precious metals, private equity, and virtual currency—can introduce risks to account owners who assume greater responsibility for navigating the complex rules that govern tax-favored retirement savings. IRS enforces tax rules relating to IRAs and can assess additional taxes.
GAO was asked to examine the challenges associated with enforcing rules governing IRAs invested in unconventional assets. This report examines (1) the extent to which IRS offers guidance to help taxpayers understand the rules governing unconventional IRA assets; and (2) the challenges IRS faces in enforcing those rules. GAO identified and analyzed IRS information to help taxpayers understand four compliance areas. GAO reviewed IRS analysis of nonmarket IRA assets reported by IRA custodians, and IRS audit procedures and training materials; and interviewed relevant IRS officials to identify enforcement challenges.
Recommendations
GAO is recommending that IRS (1) assess options for updating its IRA publications to provide more information for taxpayers with unconventional assets, (2) evaluate the feasibility of requiring disclosure for high-risk IRA asset types associated with abusive tax schemes, and (3) develop auditor resources (such as training materials or job aids) that explain how IRAs with unconventional assets can generate unrelated business income tax. IRS generally agreed with GAO's recommendations.
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Internal Revenue Service | The Commissioner of Internal Revenue should assess options for updating Publications 590-A and 590-B to either include more information or direct taxpayers to other resources for IRA owners with investments in unconventional assets. Such information could include: storage requirements for IRA investments in certain precious metals; valuation methods for hard-to-value IRA assets; the Department of Labor's process for granting exemptions to IRA prohibited transactions rules; and IRA investments with the potential to create unrelated business income tax liabilities. (Recommendation 1) |
IRS agreed with GAO's January 2020 recommendation and has taken some steps to provide more resources to address four areas where GAO identified limited information was available for IRA owners with investments in unconventional assets. For the prohibited transaction rule, IRS updated Publications 590-A in March 2021 and 590-B in May 2021 with information and links for Department of Labor procedures for granting exemptions to IRA prohibited transactions. However, IRS said that the Department of Labor has the regulatory authority to take further action to address GAO's recommendation for information to help IRA owners understand the rule. As of January 2024, IRS did not provide a plan to work with Labor on providing more information to help IRA owners avoid prohibited transactions. For precious metals, IRS updated its IRA investment frequently asked questions specifying that home storage is not allowed for precious metals held in an IRA. For valuation methods for hard-to-value IRA assets, the Department of the Treasury and IRS were planning to issue additional proposed regulations on IRAs as of January 2024. IRS officials told GAO that these new regulations would address how to determine the value for certain categories of non-publicly-traded unconventional assets. For IRA investments with the potential to create unrelated business income tax liabilities, as of January 2024, GAO is reviewing what actions, if any, IRS has taken to provide more information for IRA owners. Additional information and resources could help IRA owners better understand how IRA investment decisions and certain types of unconventional assets can increase their risks for noncompliance. Misunderstanding the rules governing IRAs could result in increased tax liability for taxpayers making unintentional errors and jeopardize their retirement savings.
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| Internal Revenue Service | The Commissioner of Internal Revenue, building on forthcoming compliance research using new IRA asset data, should evaluate the feasibility of requiring disclosure for high-risk IRA asset types associated with abusive schemes as transactions of interest. (Recommendation 2) |
IRS agreed with GAO's January 2020 recommendation and took some steps to address it by reviewing two IRA compliance research projects. However, as of January 2024, IRS was planning no further evaluation of additional disclosure requirements to identify potentially abusive schemes. Its October 2019 research project examining a sample of approximately 50 IRA owner cases revealed that audits detecting IRA prohibited transactions can result in substantial tax adjustments. However, its January 2021 compliance research project examining a sample of approximately 50 IRA owners with certain hard-to-value assets did not find any IRA-related noncompliance. Based on the limited sample data, IRS did not recommend requiring disclosure of IRA arrangements based on asset type as a transaction of interest. Without information to identify a transaction or arrangement with enough specificity to capture abusive schemes, IRS determined that requiring additional IRA disclosures would unnecessarily burden taxpayers and generate an unmanageable number of reports to IRS. However, examiners on the second research project suggested focusing on IRAs where the custodian allows direct control by the IRA owner over the assets. According to IRS officials, those arrangements are appealing to individuals who are more likely to intentionally engage in prohibited transactions. As of January 2024, IRS did not plan research to review custodian reporting patterns for arrangements with greater potential for abuse. Continued consideration of additional disclosure of potentially abusive IRAs may help IRS select IRA owner tax returns for detailed review and better allocate limited resources for labor-intensive audits.
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| Internal Revenue Service | The Commissioner of Internal Revenue should develop resources (such as training materials or job aids) for Small Business/Self-Employed examiners conducting IRA owner audits that explain how IRAs with unconventional assets can generate unrelated business income tax liability, and how examiners can refer cases to unrelated business income experts in IRS for assistance. (Recommendation 3) |
The Internal Revenue Service (IRS) agreed with GAO's January 2020 recommendation and took action to educate Small Business/Self-Employed (SB/SE) examiners responsible for auditing IRA owners that unconventional IRA assets may generate unrelated business income tax liability and require the IRA to file an income tax return. Specifically, IRS added information about the unrelated business income tax rule to the SB/SE IRA Frequently Asked Questions (FAQ) job aid. The job aid explains which IRA asset types and information to review, and directs an examiner to contact SB/SE IRA program analysts and Counsel for additional information. It also explains how to refer a potential IRA tax filing case to the Tax Exempt/Government Entity division using the IRS specialist referral system. In January 2021, IRS posted the updated IRA job aid on its IRS-wide Knowledge Management intranet site for use by examiners. As a result, IRS is better positioned to share expertise for detecting unrelated business income unreported by an IRA.
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