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Did you know that in addition to the Internal Revenue Service (IRS), the Department of Labor (DOL) also has responsibilities for overseeing prohibited transactions relating to IRAs? The DOL handles interpretive guidance and has exclusive authority to grant exemptions from the rules regarding prohibited transactions in IRAs and retirement plans. The IRS enforces tax laws and assesses additional taxes related to prohibited transactions.

This spring, the U.S. Government Accountability Office (GAO) published a comprehensive report advising that the DOL and IRS collaborate more closely regarding the exemptions from prohibited transaction rules. This advisory report was the result of the GAO’s examination of the grant exemption process and its examination into the extent to which the Department of Labor and Internal Revenue Service currently collaborate on oversight of these matters.

What constitutes a prohibited transaction?

As we’ve often educated our clients on the subject, certain types of transactions are prohibited, as outlined here. Any self-dealing (gaining personal benefit) or conducting a transaction with a disqualified individual puts the self-directed retirement plan at risk for loss of its tax-advantaged status, and the account holder may incur increased income tax liability, along with other penalties.

According to Internal Revenue Code Sections 408 & 4975, a disqualified person is generally defined as the IRA holder, any of his/her ascendants or descendants, and any entity controlled by such persons. If you have questions, or if you’re concerned about whether or not a transaction could be considered prohibited, our team of transaction specialists are ready to help.

The significance of the study

The authors of the GAO report felt that prohibited transactions are more likely to arise due to investor noncompliance with IRS guidelines and the complex rules governing tax-favored retirement accounts.

It is for this reason that we always remind our clients that they must conduct their own due diligence regarding any investments they wish to include in their self-directed IRAs. Fully understanding any risks can help protect the tax-advantaged status of their accounts.

What the GAO study comprised

According to the report, “GAO reviewed relevant federal laws and regulations; examined agency guidance, exemption process documentation, and application case files; assessed interagency coordination using internal control standards and prior work on interagency collaboration; and interviewed DOL and IRS officials.”

The GAO audit was performed from December 2016 to June 2019, during which the GAO team:

  • Interviewed DOL officials from the Employee Benefits Security Administration (EBSA) about their prohibited transaction exemption process and procedures
  • Reviewed the 124 applications for documentation of DOL coordination with IRS about the application review or decision.
  • Interviewed DOL officials responsible for the exemption process about their interactions with IRS regarding prohibited IRA transactions, and interviewed IRS officials responsible for enforcement of prohibited transactions rules on IRAs about their use of DOL exemption information.
  • Assessed coordination using the relevant identified key practices and considerations for implementing collaborative mechanisms.

GAO found that most processed applications were seeking exemptions that involved the sale of IRA assets. Further, the agency found that DOL has not sufficiently documented internal policies and procedures to help ensure effective internal control of its process.

The DOL exemption process

DOL regulations outline the process for filing and processing applications for prohibited transaction exemptions: who may apply and the information required; when a conference with DOL can be requested as well as requests for reconsideration of a DOL decision; and how DOL and the applicant will notify interested parties if a tentative approval is warranted.

The application evaluation uses statutory criteria and follows codified administrative procedures. Generally, DOL may grant an exemption only if it finds the exemption to be administratively feasible; in the interest of the plan, its participants and beneficiaries; and protective of the rights of plan participants and beneficiaries.

Before granting an exemption, DOL generally must publish a notice of proposed exemption in the Federal Register inviting interested parties to comment on the proposed exemption.

GAO recommendations

The agency found that interactions between DOL and IRS are infrequent and limited in scope. GAO therefore recommends that they increase their interaction/interagency collaboration regarding these applications as follows:

  • The Secretary of Labor should document internal policies and procedures for managing the IRA prohibited transaction exemption process
  • The Secretary of Labor, in consultation with the Commissioner of Internal Revenue, should establish a formal means, such as a memorandum of understanding or other mechanism, to support and guide DOL’s and IRS’s collaborative efforts to oversee IRA prohibited transaction exemptions
  • The Commissioner of Internal Revenue, in consultation with the Secretary of Labor, should establish a formal means, such as a memorandum of understanding or other mechanism, to support and guide DOL’s and IRS’s collaborative efforts to oversee IRA prohibited transaction exemptions

These steps will increase transparency about how applications are handled, reduce the risk of inconsistency among DOL employees in carrying out their duties, and record and retain organizational knowledge. Both entities generally agreed with the recommendations.

As a custodian and administrator of self-directed IRAs, and in accordance with our mission to provide top-notch education and customer service, this report caught our attention. We felt it necessary to share these insights so that we can continue providing the white-glove quality service that the Next Generation name upholds. If you have any questions regarding the content within this post, please do not hesitate to contact our office. We can be reached via email at NewAccounts@NextGenerationTrust.com or via phone at (888) 857-8058.

Alternatively, if you’re interested in learning more about the benefits of self-directed IRAs, or to learn more about the do’s and don’ts, you can register for a complimentary educational session with one of our representatives.