Hard-To-Value Retirement Plan Assets

As employer and broker-sponsored retirement plans continue to fail in their sole purpose of providing a reliable retirement income, the distinctly American traits of independent thinking and self-determination have materialized in the form of an exponential increase in self-directed retirement plans. Managed by the beneficiary, self-directed IRA and 401k plans frequently hold hard-to-value assets, such as early stage companies, partnership interests, undivided real estate, restricted stock, promissory notes, options, contracts, and even intellectual property.

It has long been a requirement to report the Fair Market Value (FMV) of IRA and 401k holdings at the end of each year. This IRS requirement is the responsibility of the custodian/trustee, and under most custodial agreements the investment sponsor or owner of the retirement account is required to arrange for the year-end FMV to be determined.

Since 2015, the IRS no longer accepts appraisals or estimates of plan asset values performed by the IRA/401k beneficiary or any disqualified parties, and the original cost or book value cannot be used.[1]  The fair market value of plan assets must now be determined by an independent, qualified and experienced third party business valuation advisor in accordance with Internal Revenue Code 2512 and Treasury Department Regulations 25.2512.1-6.

If the fair market value of an interest in an LLC, partnership or corporation must be determined for purposes of a Roth conversion, distribution to beneficiaries, as part of a required minimum distribution or other taxable distribution, the valuation must also be signed and attested to by a licensed, qualified and experienced valuation advisor (CPA/ABV, ASA) who is knowledgeable about valuing the business interest held by the IRA or 401k (in accordance with Internal Revenue Code 2512 and Treasury Department Regulations 25.2512.1-6.)  Any costs associated with the determination of fair market value must be paid through the plan trustee or custodian, not personally.

The fair market value is the price at which an asset would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, assets and holdings of the LLC, private equity interest, or debt instrument.

If the retirement account is a partial owner of an LLC, the Fair Market Value must include only the FMV of the portion of the LLC owned by the referenced retirement account. If another account also owns a portion of the LLC, the value per share or member/partnership interest may differ from the pro-rata enterprise value as a result of different applicable marketability and control discounts or premiums.

Increased IRS Scrutiny

IRS Form 5498 is the required form for IRA reporting and Form 5500 is required for 401(k) reporting. Both include new requirements for self-directed retirement account assets that are not readily valued by reference to some nationally recognized public market as are publicly traded stocks, bonds, and mutual funds.

With the new information it will be gathering, the IRS presumably will focus on those Forms 5498 and 5500 which reveal that (1) an elective in-kind distribution was made or minimum distribution was required and (2) the account holds hard-to-value assets. The participant may have taken his required distribution, and taken it in cash, but if the account holds hard-to-value assets, the IRS may want to investigate the valuation of the hard-to-value assets. If the hard-to-value assets were undervalued when the RMD was computed, the participant probably did not take a large enough distribution and may owe the 50 percent penalty for failure to take a RMD.

It has always been the case that Form 5498 required the IRA custodian or 401k trustee to report the “fair market value” of the IRA as of the preceding year-end. However, until 2015, there did not appear to be any general effort by the IRS to police IRA valuations, which may have encouraged IRA owners and providers to be less than diligent in updating the account valuations of non-publicly traded assets.

For a living account owner who is under age 70½ and who does not take a non-cash distribution or convert his account to a Roth, the annual valuation exercise has no immediate tax implications, but it still must be done in order to properly complete Form 5498.  Whatever may have been the case in the past, there are four reasons why IRA owners and providers should take the annual valuation requirement very seriously.

1. Whenever there is a noncash distribution, the distributed assets must be correctly valued so the tax liability can be calculated. The same is true for any “deemed” distribution such as occurs with a Roth conversion or prohibited transaction.
2. If the account holder is subject to taking required minimum distributions (RMDs), as in the case of an inherited IRA, or if the traditional IRA owner is over 70½, the total account value must be determined correctly in order to compute the required distribution.
3. If the owner of the account dies, the account must be correctly valued for estate tax purposes.
4. Form 5329 is the form taxpayers must use to report any IRA-related penalties they may owe, such as the 10% penalty for premature distributions (under age 59½), excess contributions (6%), and the 50 percent penalty for failure to take an RMD. Every IRA owner and beneficiary should file Form 5329 every year as part of their personal tax return even if they don’t owe any penalty. A fair market valuation must be performed to demonstrate that this is the case.  There is no statute of limitations protection against IRS assertion of these penalties if no return was filed, and Form 5329 is the applicable return. See Paschall, Robert, et ux., 137 TC 8 (2011). If the IRA contains assets without a “readily available FMV” that is one more reason to want statute of limitations protection to shield against later IRS claims that the assets were undervalued for RMD purposes.

Other Considerations

IRA providers are required to file Form 5498 to report the account’s value as of the preceding year-end, and Form 1099-R to report any distributions made during the preceding year.

In the 2014 version of these forms (to be filed in 2015), the IRS added several new boxes and codes, pertaining to assets without a readily available FMV. The reporting of such assets was optional for the 2014 tax year filed in 2015, but is mandatory for the 2015 reports filed in 2016. These reports are ostensibly used to help the IRS select which IRAs to audit.

The licensed professionals at New Value, LLC are experienced in the valuation of hard-to-value assets including early stage companies, partnership interests, undivided real estate, restricted stock, debt instruments, options, contracts, patents, trademarks and other intangible assets. For a free consultation with a CPA business valuation expert contact us at info@NewValueLLC.com or call 215-850-1403.