Have you taken a loan from your employer 401(k) plan and plan on leaving? Unfortunately, most company plans will require you to repay the loan within 60 days, or they will distribute the amount outstanding on the loan from your 401(k) account. Its one of the ways they try to keep their employees from leaving. “Don’t leave or we’ll distribute your 401(k) loan that you took from your money in your 401(k) account.”
How to Buy Yourself More Time & Avoid the Distribution
The good news is that following the Tax Cuts and Jobs Act (TCJA) you now have the option to re-pay the loan to an IRA to avoid the distribution and you have until your personal tax return deadline of the following year (including extensions) to contribute that re-payment amount to an IRA. By re-paying the amount outstanding on the loan to an IRA, you will avoid taxes and penalties that would otherwise arise from distribution of a participant 401(k) loan.
How It Works In Practice
Let’s say you left employment from your employer in February 2019 and that you had a 401(k) loan that was distributed by your employer’s plan following your termination of employment. You will have until October 15th of 2020 (if you extend your personal return, 6 month extension from April 15th) to make re-payment of the amount that was outstanding on the loan to an IRA. These funds are then treated as a rollover to your IRA from the 401(k) plan and your distribution and 1099-R will be reported on your federal tax return as a rollover and will not be subject to tax and penalty. While it’s not perfect it’s far great time than was previously allowed. Traditionally, you had 30 or 60 days at most to try to make re-payment.
The ability to rollover an outstanding 401(k) loan amount to an IRA is only available when you have left an employer (for any reason). It does not apply in instances where you are still employed and have simply failed to re-pay the loan or to make timely payments.
The Government Accountability Office (“GAO”) issued their most recent report on self-directed IRAs and concluded that the IRS and DOL should do more to collaborate on prohibited transactions in IRAs. The report and the GAO’s work was an excellent analysis of some of the issues facing IRA owners.
There were two significant sections in the report for Self-Directed IRA accounts: Prohibited transaction exemption applications and IRAs with large balances likely being self-directed.
Prohibited Transaction Exemption Applications
An IRA owner may request an exemption for a prohibited transaction by making a formal written request to the DOL. While the IRS enforces the prohibited transaction rules, the DOL has interpretative authority and is the agency who can grant exemptions. An exemption must be obtained in advance of the transaction and takes on average one year to obtain.
A common prohibited transaction exemption request is one where the IRA owner owns real estate in an IRA which they would like to use personally. While the property could be distributed as an in-kind distribution there are tax consequences to such distribution. The DOL has granted this exemption request for IRA owners in the past and generally requires an appraisal to set the value and a broker/agent to effectuate the transaction.
The prohibited transaction exemption process is rarely utilized by IRA owners. The GAO noted that in the past 11 years only 48 prohibited transaction exemptions where granted for IRAs.
The biggest deterrent from my experience with clients is that it takes 6 months to 1 year to get approved and about $5,000 in legal fees to make the application and handle it to decision. Usually such long timelines are not something IRA owners are willing to wait on as circumstances change from one year to the next. The DOL does have some expedited prohibited transaction exemption procedures, known as EXPRO, that can be used when an account owner is seeking to rely on an exemption that has already been granted by the DOL to someone in a similar situation. Use of such procedures with IRA owners, which is already allowed but not readily known, could provide a better outcome as EXPRO applications are granted more quickly.
The GAO recommended that the IRS and DOL collaborate on prohibited transaction exemptions to better regulate and understand IRAs.
IRAs With Large Balances Likely Self-Directed
In their report, the GAO also noted some of their prior work on self-directed IRAs and stated the following:
“…IRA owners who have accumulated unusually large IRA balances likely have invested in unconventional assets like non-publicly traded shares of stock and partnership interests.”
While this is no news to self-directed IRA owners, it should be something of interest to policy makers and financial advisers who may view self-directed accounts with skepticism. If self-directed accounts have proven to get unusually high balances, wouldn’t we want more people to use them to do the same thing and to secure their retirement. The concept of self-directed IRAs is simple: Give more freedom and control, and let people invest in what they know. Let account owners decide and obtain the benefits (or burden) of their decisions with their money. Sure, there are risks but the best person to take risks is the person whose actual hard-earned money is on the line.
When you establish an IRA, 401(k), or other retirement account you are required to designate the beneficiary of that account so that the institution/custodian holding the account knows who will receive the account upon your death. You will die one day (sorry for the bad news), and without a properly completed beneficiary designation, your account will be stuck and won’t be able to be moved until a probate court orders otherwise. The form can be completed easily, so make sure you take care of this important step when establishing your retirement accounts and bank accounts.
What’s a beneficiary designation?
A beneficiary designation is simply a written and signed statement placed on record with your account custodian that specifies who receives your account upon your death. Beneficiary designations are used on IRA accounts, 401(k) accounts, HSA accounts, and life insurance policies. Beneficiary designations are used by IRA custodians, 401(k) account custodian/administrators, banks/credit unions, and life insurance companies to pass the deceased persons account on to the person(s) designated on the form without reference to the deceased person’s will, trust, and without the involvement of the probate courts. As a result, your beneficiary designation form is a powerful instrument.
You can list a primary beneficiary and secondary beneficiaries. A primary beneficiary is the first person whom you list, and this person or persons receive the account upon your passing. A secondary (aka “contingent”) beneficiary is someone you list who receives the account if the primary beneficiary is not living. For example, a common way to list your beneficiary designations is to list your spouse as your primary beneficiary and your children as your secondary beneficiary. If your spouse is not living when you die, then your account passes to your secondary beneficiary.
To have a valid beneficiary designation you must ensure the following:
- Designation: Use your institution’s/custodian’s form and designate the person(s) you desire as your beneficiary by listing their name, city/state, date of birth, and relationship to you. You can list one beneficiary or multiple beneficiaries in percentages. So, for example, if you had two children you wanted to receive the account, you would list them as 50% each on the designation form.
- Sign the designation: This may be eSigned using an eSign method accepted by your institution/custodian.
- Spousal waiver where applicable: If you have a spouse and you HAVE NOT listed your spouse as your primary beneficiary, then your spouse must sign a spousal waiver agreeing to someone else being listed as the primary beneficiary and your spouse’s signature on the waiver must be notarized. This is required as a matter of law. Failure to provide the waiver will result (at best) to your surviving spouse receiving at least half of your account upon your passing with the rest passing to your secondary beneficiaries.
- Coordinate with your estate plan: If you list your trust for estate planning as the beneficiary of your IRA, 401(k), or other retirement account, you must provide a copy of the trust to your institution/custodian. The trust must have readily identifiable beneficiaries who receive your account upon your passing and must be considered a see-through trust (most revocable living trusts are).
The beneficiary designation is the “trump card”
Your beneficiary designation is the “trump card” when it comes to estate planning documents. For example, your beneficiary designation on your retirement account or bank account will control over a will which states someone different is to receive all your assets. As a result, it is critical that you provide a beneficiary designation for every account you have, and that these designations are updated when certain major life events arise.
Action required in three common situations
If you already provided beneficiary designations on your retirement accounts, bank accounts or life insurance, it is critical that you review them and update them upon the following events:
- Divorce: There are plenty of cases when someone who failed to update their beneficiary designation passes away and their ex-spouse ends up receiving the account. This is usually contrary to the account owner’s wishes, but if you fail to update your beneficiary designations, your heirs could be in this predicament. (Talk about not leaving gracefully!) This situation is now going to be ugly for your ex, your new spouse (if you had one), and your children.
- New child: If you have a new child who was not previously identified as a beneficiary, you should update your designations to add this new child.
- New estate plan: If you establish an estate plan (will, or ideally, revocable living trust), you should ensure that your wishes in your beneficiary designations for your retirement accounts and bank accounts match-up with the terms of your trust.
When to list your trust versus your spouse/children directly
Even if you have a revocable living trust, you may want to list your spouse as your primary beneficiary. As a rule of thumb, most estate planning attorneys recommend that, for IRA or 401(k) accounts, you list your spouse as your primary beneficiary and your trust as your secondary beneficiary. The reason is that your spouse can receive your retirement account upon your passing and can do what is called a spousal rollover. This rule only applies to spouses. For example, under a spousal rollover, the retirement account of the deceased person can be transferred/rolled over into an IRA surviving spouse. This is an advantageous way for a spouse to receive a retirement account as the account is treated simply as an account of the surviving spouse, and is not subject to RMD or other quirky rules associated with inherited retirement accounts (aka “inherited IRAs” or “beneficiary IRAs”). Rather, the funds are just treated as a Traditional IRA or Roth IRA of the surviving spouse.
Your Trust can be listed second, and, in the case where your primary beneficiary is not living, certain provisions in your trust designated to protect the funds from creditors or misappropriation from inheriting children or other heirs would apply. Your children, or other heirs under your trust who are listed as secondary beneficiaries on your form would receive the funds from your retirement account in an inherited IRA (aka “beneficiary IRA”) and would have RMD requirements to remove funds from their account over their life expectancy. This is sometimes called a “stretch IRA” and is a great tax strategy as it allows them to extend the tax-free (Roth) or tax-deferred (Traditional) benefits of the account over their own lifetime.
Remember, the beneficiary designation is critical and must be completed properly. Take the extra time to get it done right, and check up on the designations on any of your existing accounts that you may be unsure of. It’s better to get these things squared away and in order now than to presume that you completed them right when you set-up the account long ago.
Solo 401(k)s have become a popular retirement plan option for self-employed persons. Unfortunately, many plans are not properly maintained and are at the risk of significant penalty and/or plan termination. If you have a Solo 401(k), you need to ensure that the 401(k) is being properly maintained. Here’s a quick checklist to make sure your plan is on track:
1. Does your Solo 401(k) need to file a Form 5500-EZ?
There are two primary situations where you are required to file a Form 5500 for your Solo 401(k).
- If your Solo 401(k) has more than $250,000 in assets, and
- If the Solo 401(k) plan is terminated (regardless of total asset amount).
If either of these instances occur, then the Solo 401(k) must file a Form 5500 to the IRS annually. Form 5500 is due by July 31st of each year for the prior year’s plan activity. Solo 401(k)s can file what is known as a 5500-EZ. The 5500-EZ is a shortened version of the standard Form 5500. Unfortunately, the Form 5500-EZ cannot be filed electronically and must be filed by mail. Solo 401(k) owners have the option of filing a Form 5500-SF online through the DOL. The online filing is preferred as it can immediately be filed and tracked by the plan owner. In fact, if you qualify to file a 5500-EZ, the IRS and DOL allow you file the Form 5500-SF online, but you can skip certain questions so that you only end up answering what is on the shorter Form 5500-EZ. We regularly file Form 5500-EZs and 5500-SFs for Solo K clients in the law firm for only $250.
2. Is the plan up-to-date?
The IRS requires all 401(k) plans, including Solo 401(k)s, to be amended at least once every six years. If you’ve had your plan over six years and you’ve never restated the plan or adopted amendments, it is not compliant and upon audit, you will be subject to fines and possible plan termination (IRS Rev Proc 2016-17). If your plan is out of date, your best option is to restate your plan to make sure it is compliant with current law. On average, most plan documents we see update every two to three years as the laws effecting the plan documents change. We’ve had two different plan amendments to our IRS pre-approved plan in the past six years.
3. Are you properly tracking your plan funds?
Your Solo 401(k) plan funds need to be properly tracked and they must identify the different sources for each participant. For example, if two spouses are contributing Roth 401(k) employee contributions and the company is matching employer Traditional 401(k) dollars, then you need to be tracking these four different sources of funds, and you must have a written accounting record documenting these different fund types.
4. Plan funds must be separated by source and participant
You must maintain separate bank accounts for the different participants’ funds (e.g. spouses or partners in a Solo K), and you must also separate traditional funds from Roth funds. In addition, you must properly track and document investments from these different fund sources so that returns to the Solo 401(k) are properly credited to the proper investing account.
5. Are you properly reporting contributions and rollovers?
If you’ve rolled over funds from an IRA or other 401(k) to your Solo 401(k), you should have indicated that the rollover or transfer was to another retirement account. So long as you did this, the company rolling over the funds will issue a 1099-R to you, but will include a code on the 1099-R (code G in box 7) indicating that the funds were transferred to another retirement account, and that the amount on the 1099-R is not subject to tax. If you’re making new contributions to the Solo 401(k), those contributions should be properly tracked on your personal and business tax returns. If you are an S-Corp, your employee contributions should show up on your W-2, and your employer contributions will show up on line 17 of your 1120S S-Corp tax return. If you are a Sole Prop, your contributions will typically show up on your personal 1040 on line 28.
Make sure you are complying with these rules on an annual basis. If your Solo 401(k) retirement plan is out of compliance, get with your attorney or CPA immediately to make sure it is up-to-date. Failure to properly file Form 5500 runs at a rate of $25 a day up to a maximum penalty of $15,000 per return not properly filed. You don’t want to get stung for failing to file a relatively simple form. The good news is there are correction programs offered for some plan failures. But, don’t get sloppy, or you’ll run the risk losing your hard-earned retirement dollars.
The IRS recently announced that the State Department will be denying passports, and may revoke yours if you have a “seriously delinquent tax debt.” A seriously delinquent tax debt is where you owe more than $52,000 (including interest and penalties). While this law has been on the books for some time, the IRS recently started sending certifications of seriously delinquent taxpayers to the State Department last year.
If you owe the IRS money and have plans to travel abroad, there are a couple of options you can use to maintain or obtain a passport even through you may be a “seriously delinquent taxpayer.” Here are the most common options:
1. Installment Agreement
Enter into an installment agreement with the IRS to repay the debt (i.e. A payment plan). So long as you are current on your installment agreement, you can obtain or maintain your passport. An installment agreement is essentially and agreement whereby you agree to the debt owed and set-up a payment plan to have it paid back over time. The IRS usually requires financial disclosures in order to determine the payment amount and schedule. You can learn more here.
2. Offer in Compromise
Have a pending offer in compromise with the IRS, or be paying timely on an agreed upon offer in compromise. An offer in compromise is a method of negotiating a compromise on the amount owed to the IRS. The IRS only accepts an offer in compromise if there is a debt as to the liability (i.e. There is a legitimate tax question over your position and that of the IRS), or there is a doubt as to collect-ability (i.e. “Can you really pay it back?”). You can learn more about an offer in compromise here. Keep in mind, so long as the offer in compromise request is pending, you can still obtain or maintain your passport. So, start here if you still have issues to work out with the IRS before you agree to the amount owed in an installment agreement. Though, if you don’t have a legitimate reason for an offer in compromise, you should consider the installment agreement.
If you’ve got plans to travel abroad AND you’ve got a serious tax debt, be proactive about paying it back with an installment agreement or start the process of making an offer in compromise. You don’t want to be surprised by a letter in the mail from the state department that your passport has been revoked. Or even worse, have non-refundable travel plans that have to be cancelled because your passport is revoked. And, last but not least, be abroad and have your passport revoked and your travel status in jeopardy. You may just end up spending your foreign trip at the local U.S. Embassy.
An IRA must report its fair market value to the IRS annually. Fair market value is reported to the IRS by your IRA custodian via IRS Form 5498. For standard IRAs holding stocks or mutual funds, those account values are automatically determined as they simply take the stock or fund price as of the close of the market on December 31st each year. They then use these amounts to set the year-end account fair market value. For self-directed accounts, such fair market values are not readily available, and it becomes the IRA account owner’s responsibility to obtain their self-directed investment values so that their custodian can properly report the account’s fair market value. The value of an account is important for a few reasons. First, the IRS requires it to be updated annually. Second, it is used to set required minimum distributions (RMDs) for those account holders over the age of 70 ½ with Traditional IRAs. Last, the account value is used when converting an entire account, or a particular investment or portion of the account, from a Traditional IRA to a Roth IRA.
What is “Fair Market Value?”
Fair market value of an investment has been broadly defined by the Court as:
“The price at which property would change hands between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.” U.S. v. Cartwright, 411 US 546 (1973).
Now here’s the hard part: Even though the IRS requires IRAs to update their fair market value on an annual basis, the Government Accountability Office noted in their recent report that:
“Current IRS guidance includes NO [emphasis added] guidance or advice to custodians or IRA owners regarding how to determine the FMV [fair market value]”. United States Government Accountability Office, GAO-17-02, Retirement Security Improved Guidance Could Help Account Owners Understand the Risks of Investing in Unconventional Assets. (Dec. 2016).
The absence of guidance, however, has not relieved IRA owners or their custodians from obtaining and reporting this information. While there is no specific fair market valuation guidance for IRAs, there are commonly accepted methods of reporting value used by professionals and companies within the self-directed IRA industry. Most of these methods have been adopted from law and regulations governing employer retirement plans or estates.
Methods to be used by Asset Type
The table below outlines preferred valuation methods that are commonly used in the industry for the most common self-directed IRA assets. As you will note, when the valuation is needed for a taxable event, such as a distribution or Roth conversion, greater detail and supporting information will be required as the valuation will result in tax being due.*
||Non-Taxable (Annual FMV)
||Taxable (RMD, distribution or conversion)
||Comparative Market Analysis (CMA) from a real estate professional is preferred. Some IRA custodians accept property tax assessor values or Zillow reports in non-taxable situations.
||Real estate appraisal is preferred. Some IRA custodians accept a broker’s price opinion.
||Value of a note can be reported by calculating the principal due plus any accrued and unpaid interest. This is the valuation method used for calculating the value of a note for estate tax purposes.
||Same as non-taxable, principal amount due plus accrued and un-paid interest. For notes in default, a third-party opinion as to value is typically required in order for the note to be written-down below face value.
||For bullion, use the spot value of the metal in question times the ounces owned. Spot value is widely reported on a daily basis on financial sites.
For acceptable coins, use market data for the coin in question via the Grey Sheets available at www.bullionvalues.com.
|Same as non-taxable.
|LLC, LP, or Private Company Interest
||Obtain a third party-opinion of value of the LLC interest. The opinion should rely on IRS Revenue Ruling 59-60. For asset holding companies, the valuation should focus on the value of the assets. For operating companies, the valuation should focus on earnings.
||Similar requirement, but the detail of the opinion should be more significant. For example, for an asset holding company where the IRA’s interest is determined by the assets of the LLC. A CMA would be acceptable for calculating that assets value in the company in an annual valuation. However, an appraisal of the real estate to calculate in that asset would be required in a taxable situation.
Since the valuation reporting policies of custodians vary, IRA owners should make sure that they understand their IRA custodian’s policies for valuations of the assets in question.
Our firm routinely assists clients with obtaining third-party opinions of value, and can assist IRA owners who need to produce a report or third party opinion as to an LLC or other investment interest held by an IRA. Call us at (888) 801-0010.
*Please note that there are clearly differences of opinions on these matters, and since there is no specific legal guidance for IRA valuations, please keep in mind that the table above is based on my own industry experience and opinions. Seek a licensed professional in all instances for your specific situation.