Editor’s Note: The House Ways and Means Committee recently approved funding provisions for the Build Back Better Act of 2021, including several retirement plan provisions (starting on page 665, and summarized here.)
That part of the bill is aimed at limiting the ability of high-income individuals to defer or avoid excessive amounts of taxes through the use of retirement plans, although some of the provisions apply to a broader group of taxpayers. It generally limits high-income taxpayers from making IRA contributions, requires high-income taxpayers to disgorge excess amounts, and prohibits IRAs from utilizing certain investments that have the potential of generating astonishing rates of return, but that are not available to most investors.
In this second part of a three-part series, the ARA’s Robert Richter provides a deep dive into the three provisions affecting IRA contributions, reporting and investments. Part 1, on the provision affecting RMDs, is here.
Limitations on Contributions to IRAs
Effective after 2021, high-income taxpayers would be prohibited from making “annual additions” to an individual retirement plan (i.e., a traditional or Roth IRA) for a taxable year. The limitation only applies to an applicable taxpayer rule who, as of the close of the preceding calendar year, has aggregate vested accounts in all defined contribution plans (i.e., qualified plans, 403(a) and (b) arrangements, governmental 457(b) plans and IRAs) that exceed $10 million (as adjusted for COLAs).
Rollovers and accounts acquired by death, divorce or separation are not “annual additions” for this purpose, although, as stated above, these amounts are taken into account in determining whether the $10 million threshold has been met. In addition, contributions to a SEP or SIMPLE IRA are still permitted. The provision, therefore, prohibits an individual from contributing to her or her IRA, but it does not prohibit contributions to be made on his or her behalf to an employer-sponsored retirement plan, such as a 401(k) plan or a non-qualified deferred compensation plan.
Example 1
Andy, an “applicable taxpayer,” has a vested 401(k) account balance of $9,999,000 as of Dec. 31, 2021. In 2022, Andy would be limited to a $1,000 contribution to his IRA (other than contributions made pursuant to a SEP or SIMPLE IRA).
Example 2
Alisa, an “applicable taxpayer,” has a vested 401(k) account balance of $11M as of Dec. 31, 2021. In 2022, Alisa would not be able to make a contribution to her IRA (other than contributions made pursuant to a SEP or SIMPLE IRA).
Example 3
Marcia, an “applicable taxpayer,” has a vested account balance of $1 million in her IRA as of Dec. 31, 2021. Marcia’s maximum IRA contribution for 2022 would not be impacted by the bill. In 2022, Marcia inherits $10 million in defined contribution accounts from several deceased relatives. As of Dec. 31, 2022, she exceeded the $10 million threshold and therefore cannot make any IRA contributions in 2023 (other than contributions made pursuant to a SEP or SIMPLE IRA).
In each of these examples, the individuals would still be able to make and receive contributions (e.g., elective and nonelective contributions) to a 401(k) plan.
A 6% excise tax (under IRC §4973) applies to any “excess contributions.” “Excess contributions” are the sum of:
1. The excess IRA contributions under the above rules, plus
2. The lesser of: (a) any excess contribution for the prior year (the excess amount determined under this section for the prior year (reduced by any “additional” RMDs), or (b) the value of the account that exceeds $10M (as adjusted for COLAs).
New Reporting Requirement
For years beginning after Dec. 31, 2021, defined contribution plans (including IRAs) would be required to report to the IRS any participants who have balances of at least $2,500,000 (subject to COLAs). The reason for this new reporting requirement is because the IRS does not have data on the value of most retirement savings accounts. For this purpose, balances attributable to inheritance, divorce or separation are excluded. This reporting can be included on IRS Form 8955-SSA for those participants who must also be reported because they have deferred vested benefits.
New Restrictions on IRA Investments
The bill would make numerous changes to the investments that may be made in an IRA. While the purpose of these changes is aimed at restricting the ability of certain IRA owners to invest in investments that aren’t generally available to the public, these changes are overly broad and impact a considerably larger group of IRA owners. The prohibitions are effective in 2022, or 2024 if an IRA has such investments as of the date of enactment. The delay to 2024 for existing investments is very short, especially where the investments are illiquid. And the consequences of violating the restrictions is severe—the IRA loses its tax-exempt status.
The first restriction prohibits IRAs from investing in any security where the issuer of the security requires the investor to:
1. have a specified minimum of income or assets;
2. have completed a specified level of education; or
3. hold a specific license or credential.
One of the concerns with this provisions is that it could be interpreted as prohibiting an IRA from investing in a lower-fee class of investments which are available based on the amount being invested. It is doubtful Congress intended for this to be interpreted that broadly.
The second change to permissible IRA investments is that the bill would prohibit an IRA to be invested in any investment where the IRA owner owns 10% or more of the entity (currently this is 50% or more) or where the IRA owner is an officer or director.
Both of these provisions would impact many IRAs—well beyond just those of high-income taxpayers. Practitioners and providers are concerned about the negative impact these changes will have on the funding of small businesses, private placements and LLCs that are an efficient way of investing in real estate. It is hoped that Congress will make modifications to the bill to pare down these prohibitions.
The bill also clarifies that the owner of an IRA is a disqualified person for purposes of the prohibited transaction rules of IRC §4975. Under existing rules, the owner of a self-directed IRA is a fiduciary and therefore a disqualified person. Thus, this modification will not have any effect on existing practices for self-directed IRAs.
Lastly, the current 3-year statute of limitations for any substantial errors (willful or otherwise) relating to the reporting of the valuation of IRAs would be extended to 6 years. Similarly, the statute of limitations would be extended to 6 years for any taxes due to an IRA losing its tax-exempt status. This is effective for taxes with respect to which the 3-year statute of limitations ends after Dec. 31, 2021.
Next up: “Mothra.”
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