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Mar 2012
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March 22, 2012

Update on IRA Cross-Collateralization Agreements


At the end of last year, the IRS issued Announcement 2011-81, which provides temporary tax relief to individual retirement accounts (IRAs) where the IRA owners have signed certain indemnification agreements or granted certain security interests in accounts that may have an effect on their IRAs (referred to collectively as “cross-collateralization agreements”).  These cross-collateralization agreements generally provide that if (1) the IRA experiences investment-related losses or incurs fees that exceed the amount in the IRA, the assets of the IRA owner’s non-IRA accounts may be used to cover the indebtedness, or (2) if a non-IRA account experiences losses/fees in excess of the account balance, the assets in the IRA may be used to cover the shortage.

The Department of Labor, which has the authority for interpreting the prohibited transaction rules, ruled in Advisory Opinions (AOs) 2011-09A (issued on October 20, 2011) and 2009‑03A (issued on October 27, 2009) that these cross‑collateralization agreements are prohibited transactions and that Prohibited Transaction Exemption (PTE) 80-26 does not provide relief.

If an IRA engages in a prohibited transaction, it loses it tax-exempt status.  When that happens, all of its assets are deemed distributed and immediately subject to tax.  The IRS tax relief was granted in response to these AOs.

Temporary Tax Relief

The IRS Announcement says that the DOL is considering further action regarding to cross-collateralization agreements, including consideration of a class exemption request expected to be submitted to the DOL. So, pending further action by the DOL and until issuance of further guidance from the IRS, the IRS will not treat a cross‑collateralization agreement similar to those described in the AOs as a taxable event, provided there has been no execution or other enforcement pursuant to the agreement against the assets of an IRA of the individual entering into the cross-collateralization agreement.

Recommendations

Because the tax relief is not available if the cross-collateralization agreement is actually executed or enforced, IRA sponsors might want to consider not executing or enforcing such agreements pending further DOL and IRS guidance in order to avoid causing negative tax consequences for their IRA clients.

If you have any questions, please feel free to contact me at lzimmer@wnj.com.

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