BE AWARE OF UNKNOWN AGREEMENTS WITH YOUR IRA

IRA assets are protected from creditors and income taxes while the assets remain in the IRA. However, you need to be aware that transactions relating to your IRA may unintentionally create a taxable event. In the Department of Labor (“DOL”) Advisory Opinion Letter 2009-03A (October 27, 2009) the DOL stated that if a taxpayer grants a broker a security interest in a non-IRA account to cover IRA debts such transaction was similar to personally guaranteeing a loan, creating a “prohibited transaction.” If a client incurs a prohibited transaction, then an IRA could be disqualified creating huge adverse income taxes.

In a recent DOL Advisory Opinion Letter 2011-09A (October 20, 2011) the DOL stated that an IRA owner’s personal guaranty to cover losses incurred in an IRA account agreement due to trading futures was a prohibited transaction because the personal guaranty was not an exception allowed for either operating expenses or expenses incidental to the ordinary operation of the plan. Any owner of an IRA with these types of prohibited transactions would be deemed to have their IRA immediately distributed and taxed.

In an unusual twist of events in response to these two DOL Advisory Opinions, the Internal Revenue Service (the “IRS”) provides relief and good news! Announcement 2011-81 clarifies the treatment of IRAs with personal guaranty agreements. Even though a prohibited transaction would occur at the time the IRA agreement was signed, the IRS will only treat the transaction as a prohibited transaction if non-IRA monies were actually used to satisfy outstanding debts of the IRA or IRA monies were used to satisfy debts of non-IRA assets.

Advice: Although the IRS can adjust how it will treat prohibited transactions, only the DOL can grant exemptions to being classified as a prohibited transaction. Thus, if you have entered into a personal guaranty IRA agreement, make sure you do not allow IRA monies to be used to pay the debts of non-IRA assets or vice-versa to avoid a prohibited transaction.