Individual Retirement Accounts:

IRS Could Bolster Enforcement on Multimillion Dollar Accounts, but More Direction from Congress Is Needed

GAO-15-16: Published: Oct 20, 2014. Publicly Released: Nov 19, 2014.

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James R. McTigue, Jr
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mctiguej@gao.gov

 

Charles A. Jeszeck
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jeszeckc@gao.gov

 

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What GAO Found

For tax year 2011 (the most recent year available), an estimated 43 million taxpayers had individual retirement accounts (IRA) with a total reported fair market value (FMV) of $5.2 trillion. As shown in the table below, few taxpayers had aggregated balances exceeding $5 million as of 2011. Generally, taxpayers with IRA balances greater than $5 million tend to have adjusted gross incomes greater than $200,000, be joint filers, and are age 65 or older. Large individual and employer contributions sustained over decades and rolled over from an employer plan would be necessary to accumulate an IRA balance of more than $5 million. There is no total statutory limit on IRA accumulations or rollovers from employer defined contribution plans.

Estimated Taxpayers with Individual Retirement Accounts (IRA) by Size of IRA Balance, Tax Year 2011

Estimated Taxpayers with Individual Retirement Accounts (IRA) by Size of IRA Balance, Tax Year 2011

Notes: The taxpayer reflects a taxpaying unit including individuals as well as couples filing jointly, which may have more than one IRA owner. The IRA balance aggregates the value of all IRAs owned, including inherited IRAs.

A small number of taxpayers has accumulated larger IRA balances, likely by investing in assets unavailable to most investors—initially valued very low and offering disproportionately high potential investment returns if successful. Individuals who invest in these assets using certain types of IRAs can escape taxation on investment gains. For example, founders of companies who use IRAs to invest in nonpublicly traded shares of their newly formed companies can realize many millions of dollars in tax-favored gains on their investment if the company is successful. With no total limit on IRA accumulations, the government forgoes millions in tax revenue. The accumulation of these large IRA balances by a small number of investors stands in contrast to Congress's aim to prevent the tax-favored accumulation of balances exceeding what is needed for retirement.

The Internal Revenue Service (IRS) has enforcement programs covering specific aspects of IRA noncompliance, such as excess contributions and undervalued assets. As recommended by an internal task team, IRS plans to collect data identifying nonpublicly traded assets comprising IRA investments. IRS expects the data will help it identify potential IRA noncompliance. However, research on those taxpayers and IRA assets at risk will hinge on getting resources to effectively compile and analyze the additional data. IRS officials said IRA valuation cases are audit-intensive and difficult to litigate because of the subjective nature of valuation. Additionally, the 3-year statute of limitations for assessing taxes owed can pose an obstacle for IRS pursuing noncompliant activity that spans years of IRA investment.

Why GAO Did This Study

In 2014, the federal government will forgo an estimated $17.45 billion in tax revenue from IRAs, which Congress created to ensure equitable tax treatment for those not covered by employer-sponsored retirement plans. Congress limited annual contributions to IRAs to prevent the tax-favored accumulation of unduly large balances. But concerns have been raised about whether the tax incentives encourage new or additional saving. Congress is reexamining retirement tax incentives as part of tax reform.GAO was asked to measure IRA balances and assess IRS enforcement of IRA laws.

This report (1) describes IRA balances in terms of reported FMV aggregated by taxpayers; (2) examines how IRA balances can become large; and (3) assesses how IRS ensures that taxpayers comply with IRA tax laws. To address these objectives, GAO analyzed 2011 IRS statistical data, reviewed IRS documentation and relevant literature, and interviewed government officials, financial industry stakeholders, and academics. GAO compared IRS enforcement plans and procedures with law and criteria for evaluating an enforcement program.

What GAO Recommends

Congress should consider revisiting its legislative vision for the use of IRAs. GAO makes five recommendations to IRS, including approving plans to fully compile and digitize new data on nonpublicly traded IRA assets and seeking to extend the statute of limitations for IRA noncompliance. IRS generally agreed with GAO's recommendations.

For more information, contact James R. McTigue, Jr., at (202) 512-9110 or mctiguej@gao.gov or Charles A. Jeszeck at (202) 512-7215 or jeszeckc@gao.gov.

Matter for Congressional Consideration

  1. Status: Open

    Comments: In its October 2014 report, GAO found that individuals with limited, occupationally related opportunities could engage in sophisticated investment strategies and accumulate considerable tax-preferred wealth in IRAs and subsequently suggested to Congress legislative options. As of October 2016, legislation had not been introduced on any aspect of this suggestion, although the Senate Finance Committee held a hearing on IRA policy in September 2014 for which GAO provided a statement for the record.

    Matter: To promote retirement savings without creating permanent tax-favored accounts for a small segment of the population, Congress should consider revisiting the use of IRAs to accumulate large balances and consider ways to improve the equity of the existing tax expenditure on IRAs. Options could include limits on (1) the types of assets permitted in IRAs, (2) the minimum valuation for an asset purchased by an IRA, or (3) the amount of assets that can be accumulated in IRAs and employersponsored plans that get preferential tax treatment.

Recommendations for Executive Action

  1. Status: Open

    Comments: As of September 2016, IRS plans to transcribe paper-filed Form 5498 submissions and compile information from electronically filed Form 5498 submissions beginning with tax year 2016 data filed in calendar year 2017. For tax year 2015, the first year the new IRA asset reporting was required, IRS did not fund electronic compilation. GAO will consider the recommendation implemented once IRS has its fiscal year 2017 budget in place and begins implementation of its planned transcription of the paper returns and compilation with the electronically filed Form 5498 data.

    Recommendation: To improve IRS's ability to detect and pursue noncompliance associated with undervalued assets sheltered in IRAs and prohibited transactions, the Commissioner of Internal Revenue should approve plans to fully compile and digitize the new data from electronic and paper-filed Form 5498s to ensure the efficient use of the information on nonpublicly traded IRA assets.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Open

    Comments: As of September 2016, IRS had taken some action to develop a research plan using the new information on types of nonpublic IRA assets reported on Form 5498. Prior to the new asset reporting requirements, IRS tried searching Form 5498 filings for certain key words or phrases and other patterns to identify IRAs holding assets with the greatest risk of noncompliance. Once IRS moves forward with its plans to transcribe the new data from paper Form 5498 submissions and make electronically filed Form 5498 information available for use, IRS researchers plan to use the asset type data to streamline the process of identifying those IRAs. As of September 2016, IRS plans to electronically compile data for tax year 2016 that will be filed in 2017, but IRS has not provided a date on when the new IRA asset type data will be available for further analysis.

    Recommendation: To improve IRS's ability to detect and pursue noncompliance associated with undervalued assets sheltered in IRAs and prohibited transactions, the Commissioner of Internal Revenue should conduct research using the new Form 5498 data to identify IRAs holding nonpublic asset types, such as profits interests in private equity firms and hedge funds, and use that information for an IRSwide strategy to target enforcement efforts.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Open

    Comments: IRS agreed with GAO's October 2014 recommendation on IRAs with large balances and said it had discussed the recommendation with Treasury's Office of Tax Policy and Benefits Tax Counsel. Consequently, IRS said Treasury is aware of IRS's willingness to support legislative efforts in this area. However, Treasury and IRS have not drafted a legislative proposal as of August 2016.

    Recommendation: To improve IRS's ability to detect and pursue noncompliance associated with undervalued assets sheltered in IRAs and prohibited transactions, the Commissioner of Internal Revenue should work in consultation with the Department of the Treasury on a legislative proposal to expand the statute of limitations on IRA noncompliance to help IRS pursue valuation-related misreporting and prohibited transactions that may have originated outside the current statute's 3-year window.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Open

    Comments: IRS had taken some action to provide general outreach but has not yet compiled data to target taxpayers at greater risk of noncompliance, as GAO recommended in October 2014. In June 2016, IRS published information on IRS.gov outlining the new information to be reported for nonmarketable IRA assets and included a general caution that IRAs with nonmarketable investments or assets under direct taxpayer control may be subject to a heightened risk of committing prohibited transactions. This caution is similar to those that IRS added to its publications about IRA contributions and distributions. IRS said it could refine its outreach to those taxpayers with nonpublic IRA assets using the new asset type data reported beginning in 2015, but for tax year 2015, the first year the new IRA asset reporting was required, IRS did not fund electronic compilation. As of September 2016, IRS plans to digitize the IRA assets data for tax year 2016 that will be filed in 2017, but IRS has not provided a date on when the new IRA asset type data will be available for further analysis.

    Recommendation: To help taxpayers better understand compliance risks associated with certain IRA choices and improve compliance, the Commissioner of Revenue should, building on research data on IRAs holding nonpublic assets, identify options to provide outreach targeting taxpayers with nonpublic IRA assets and their custodians, such as reminder notices that engaging in prohibited transactions can result in loss of the IRA's tax-favored status.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Closed - Implemented

    Comments: In response to GAO's recommendation, IRS in January 2015 added an explicit caution to taxpayers of the potential risk of committing a prohibited transaction when investing in non-publicly traded assets or in directly controlling IRA assets within both the new Publication 590-A, which focuses on IRA contributions, and the 590-B, which focuses on IRA distributions.

    Recommendation: To help taxpayers better understand compliance risks associated with certain IRA choices and improve compliance, the Commissioner of Revenue should add an explicit caution in Publication 590 Individual Retirement Arrangements (IRAs) for taxpayers about the potential risk of committing a prohibited transaction when investing in nonpublicly traded assets or directly controlling IRA assets.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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