IRS Auditor playing hardball re: non-qualifying assets for EZ filer

[Brenda Wren]

We have a 5500-EZ filer under IRS audit. She is indicating that the failure of the Trustee to obtain independent appraisals for the real estate parcels in the plan is a failure to follow the terms of the document and sanctions will be imposed. There are no real issues involved here. The only other participant was the owner's spouse who was paid out of the plan based on assumingly higher than market values. None of the participants are old enough for RMD's. Additionally, the plan document does not use the term "independent third party appraisal". It simply says the Trustee shall appraise all securities, property, etc. each year at the then fair market value for each asset. The 5500-EZ does not contain any questions about the valuation of non-liquid assets (and rightfully so since this is really a DOL issue anyway!).

Has anyone else had experience with this in dealing with the IRS?

It appears to me that she is working outside her jurisdiction. This is a DOL issue. No one was harmed other than the owner who is stuck with the real estate parcels purchased at the height of the market. The 5500-EZ was filed correctly; no changes are necessary. And, the plan document does not contain language specifying "independent third party appraisal". Real estate is worth whatever a buyer and seller agree upon. Seems to me that an argument could be made that since he was not willing to sell them at the bottom of the market, he has a valid reason for continuing to value them at cost....at least until a REAL issue arose within the plan such as RMD requirements.

Does anyone disagree with me and agree with the IRS' position?

[ETA Consulting LLC]

I understand your position, but also understand the IRS's position. As a rule, qualified plans MUST be valued at least annually. This goes a little beyond an arbitrary determination of value (which is what the IRS is implying the taxpayer did). Not agreeing with any position, but there wouldn't be a challenge had the sponsor had an appraisal performed by someone licensed to do such appraisals.

Good Luck!

[QDROphile]

Distributions based on incorrect values of plan assets touch on some very serious issues and the self-dealing aspect only makes it worse.

[jpod]

If this is an EZ then there is no DOL jurisdiction or Title I issue. So, the effect of an inaccurate valuation is that the spouse was overpaid or underpaid. I realize that there is a technical problem with qualification rules if gains/losses are not allocated accurately, but what is the IRS' end-game here? To disqualify the plan because too much was allocated to spouse and away from owner, or vice versa? If the facts are as simple as this, there is nothing here that constitutes some sort of abuse or even mis-use of the benefits of tax-qualification. I would call the IRS' bluff.

[jpod]

On the other hand, I've been around the block a couple of times so the minute someone says "real estate" I expect to find other funny things going on (such as a use of the real estate that is a Section 4975 PT, paying RE taxes with non-plan assets, co-ownership of parcels by a non-plan party and the plan, etc.).

[shERPA]

Is the IRS' issue that the values used were not fair market value? Or is it that there was no 3rd party appraisal?

FMV can be a range, not necessarily a single number. Did the trustee use any sort of comps or other basis for assigning the values used, or did they just carry them at some clearly outdated value?

AFAIK there is no requirement that the trustee obtain a 3rd party appraisal.

[masteff]

http://www.irs.gov/irm/part4/irm_04-072-008.html

"4.72.8.1.2 (09-01-2006)
Formality of Valuation
1.Whether a formal valuation is required will depend on the transactions that occur with the plan and the form of the plan.
•For example, the valuation in a single participant plan, a self-directed account, or frozen plan can be less formal in a year in which the plan or self-directed account receives no contribution and makes no distribution or change in investment.
2.The reasonableness of the method for valuing plan assets is based on the surrounding facts and circumstances. Except for certain employer securities held by an ESOP, there is no absolute requirement the annual valuation be based on an independent appraisal. On the other hand, it may be reasonable for an agent to request an appraisal for hard-to-value assets under certain circumstances, such as when distributions are made to plan participants."

[shERPA]

That's a useful cite, thanks masteff.

[Brenda Wren]

Thanks very much to all responders, especially Masteff. If this audit is ever closed (it's been almost a year already), I'll post the outcome.

[Peter Gulia]

Brenda Wren, has your client asked you to evaluate whether the remaining participant and business owner's tax situation could be improved by deliberately treating the plan as tax-disqualified?

[Brenda Wren]

The IRS has taken its final position. In lieu of retroactive disqualification back to 1991 (inception of the plan), they will accept a $15,000 sanction. They are claiming a violation of Section 1.401-1(a)(2) and Revenue Ruling 80-155 for failure to annually value the real estate parcels in the plan.

To reiterate, this is a husband/wife plan only. And, contrary to my previous post, the spouse was NOT paid out.