Temporary relief for IRA owners who entered broker indemnification agreements

Quincy Says: As I predicted long ago, the IRS will not invalidate millions of IRAs because of the indemnification and cross-collateralization clauses in a typical brokerage style of IRA.  In at least some brokerage accounts, the account agreement calls for the assets of the IRA to indemnify any other losses from individual accounts at that brokerage and vice versa.  This of course has never been a problem with self-directed IRAs because we have no cross-indemnification clause.  However, there were people who then used this to scare people into paying them thousands of dollars to apply for an individual prohibited transaction exemption.  I maintained that if there was a problem with brokerage IRAs because of these clauses the solution would be a global solution in the form of a class prohibited transaction exemption, not an individual exemption for each IRA. 

See below.  Now the IRS has granted temporary relief from the scary scenario of a disqualified IRA simply for signing the typical brokerage account agreement in anticipation of a class exemption request expected to be submitted to the Department of Labor. 

Make no mistake, this is big news in the IRA world.  It is worthy of an article in any newsletter that is sent out, etc.  While not a permanent solution yet, the light can be seen at the end of the tunnel and the immediate threat has been removed.

If you do not understand the background of this announcement and need any clarification, please feel free to contact me at Quincy@questira.com. Have a great day!

Temporary relief for IRA owners who entered broker indemnification agreements

Ann. 2011-81, 2011-52 IRB

IRS has provided temporary relief for IRAs where the owner has signed an indemnification agreement with a broker or other financial institution, or granted certain security interests in other accounts held by the institution, that may result in a prohibited loan transaction under Code Sec. 4975.

Background. If an IRA engages in a prohibited transaction under Code Sec. 4975, it ceases to be considered an IRA and loses its tax-exempt status. (Code Sec. 408(e)(2)) The direct or indirect lending of money, or other extension of credit, between a plan and a disqualified person is a prohibited transaction. (Code Sec. 4975(c)(1)(B))

For these purposes, a “plan” includes an IRA. (Code Sec. 4975(e)(1)(B)) The term “fiduciary” includes any person who exercises any discretionary authority or discretionary control over management of a plan, or who exercises any authority or control over management or disposition of plan assets. (Code Sec. 4975(e)(3)) A “disqualified person,” includes a fiduciary, and members of the family of a fiduciary. (Code Sec. 4975(e)(2))

Department of Labor (DOL) Prohibited Transaction Exemption 80-26– is a class exemption that permits interest-free loans and extensions of credit to a plan from a party in interest in instances in which the plan faces a temporary cash shortage. If certain requirements are met, these loans won’t result in a prohibited transaction.

Previous guidance. In ERISA Op Letter No 2011-09A, 2011, the Department of Labor’s (DOL’s) Employee Benefits Security Administration (EBSA) determined that where a broker required an indemnification agreement in order for an IRA owner to open a futures trading account in his IRA, Prohibited Transaction Exemption 80-26– was not available to save the agreement from being a prohibited loan under Code Sec. 4975(c)(1)(B).

Notably, EBSA found that granting the broker a security interest in the assets of the IRA owner’s personal accounts to cover the IRA’s debts to the broker would be akin to the IRA owner guaranteeing those debts. Thus, DOL concluded that the grant of the security interest in non-IRA assets would amount to a prohibited extension of credit under Code Sec. 4975(c)(1)(B) (see article in Federal Taxes Weekly Alert 11/19/2009).

Similarly, in ERISA Op Letter No 2009-03A, 2009, EBSA issued an earlier advisory opinion to this same requester holding that an individual’s grant to a brokerage firm of a security interest in the assets of the individual’s non-IRA accounts as a requirement for the individual’s establishment of an IRA with the broker would be a prohibited loan.

Now, EBSA has advised IRS that it is considering further action regarding these agreements (collectively known as cross-collateralization agreements), including consideration of a class exemption request expected to be submitted to EBSA.

Temporary relief. In response to these developments and pending further action by EBSA, IRS says it will determine the tax consequences relating to an IRA without taking into account the consequences that might otherwise result from a Code Sec. 4975 prohibited transaction from entering into any indemnification agreement, or any cross-collateralization agreement, similar to the agreements described in ERISA Op Letter No 2011-09A, 2011 and ERISA Op Letter No 2009-03A, 2009.

This relief is available only if there has been no execution or other enforcement under the agreement against the assets of an IRA account of the individual granting the security interest or entering into the cross-collateralization agreement. IRS advises that no inference with respect to the application of any Code section other than Code Sec. 4975 should be drawn from this announcement.

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