Campaign to rein in mega IRA tax shelters gains steam in Congress
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Two members of Congress who have long been responsible for shaping federal laws on retirement savings are considering major reforms after ProPublica exposed how the ultrawealthy are turning retirement accounts into gargantuan tax shelters.
Rep. Richard Neal, the Massachusetts Democrat who chairs the powerful House Ways and Means Committee, told ProPublica that he has directed the committee to draft a bill that “will stop IRAs from being exploited."
The committee is considering “limiting the total amount of money that can be saved in tax-preferred retirement accounts," Neal said in a written statement.
“Incentives in our tax code that help Americans save for retirement were never intended to enable a tax shelter for the ultra-wealthy," Neal said. “We must shut down these practices."
In addition, Sen. Ben Cardin, a Maryland Democrat who has co-authored a series of changes to retirement savings laws in the past decade, is also in favor of reforms that his spokesperson said would “prevent the type of massive abuses exemplified by the ultra-wealthy."
But provisions lurking deep in unrelated legislation currently wending its way through Congress could undermine those efforts.
In its June 24 story, ProPublica detailed that one technique investors have used to sock hundreds of millions of dollars — even billions — away in their IRAs is to fill the accounts with bargain-basement shares in companies that are not publicly traded, so they have no clear valuation. Then, when the companies go public or are sold, their accounts explode in value — with all of the gains tax-free.
Cardin's spokesperson told ProPublica that the senator now supports banning such transactions, which would be one of the biggest reforms in decades to the rules governing the accounts. The Internal Revenue Service recommended a similar change more than a decade ago. Congressional investigators wrote that an IRS team in 2009 had suggested “limiting the types of investments IRAs can make to publicly traded or otherwise marketable securities with a readily ascertainable fair market value."
Cardin is “considering reforms, such as banning the use of IRAs to purchase nonpublic investments," calling it “a good starting point while protecting IRAs for every day Americans to save for their retirement," his spokesperson wrote in an email.
The growing interest in changing the system gives momentum to the plans of Oregon Sen. Ron Wyden, chair of the Senate Finance Committee, who last month declared that he was eyeing a similar crackdown on giant IRAs.
Wyden's move came after ProPublica detailed how the Roth IRA, a ho-hum retirement account designed to help the middle class save for retirement, had been hijacked by the ultrawealthy, who used it to create gigantic onshore tax shelters. Tax records obtained by ProPublica revealed that Peter Thiel, a co-founder of PayPal and an early investor in Facebook, had a Roth IRA worth $5 billion as of 2019. As long as Thiel waits until he is six months shy of his 60th birthday, he will be able to withdraw his fortune tax-free.
Thiel made an end run around the strict limit on what can be put into a Roth IRA by purchasing so-called founders' shares of PayPal in 1999 when he was chairman and CEO of that company, according to tax records and a financial statement Thiel included in his application for citizenship in New Zealand. Securities and Exchange Commission records show Thiel bought 1.7 million shares for $1,700 — a price of a tenth of a penny per share. PayPal later told the SEC that the shares were among those sold at “below fair value."
When PayPal took off and Thiel's shares ballooned in value, he sold them and used the proceeds — still within his Roth — to invest in other startups, including Facebook, long before they went public, according to court records and Thiel's financial statement filed in New Zealand. He never had to make another contribution to his Roth again. The account's stratospheric growth all stemmed from a private stock deal available only to a handful of people.
This is the type of nonpublic IRA investment that Cardin is considering banning. A spokesperson for Thiel did not respond to requests for comment.
But this new appetite for reining in the accounts may be too late to slow contrary bipartisan legislation already rolling through Congress. Buried deep inside two complex and sweeping bills — each more than 140 pages long — are provisions that could make it harder for the IRS to crack down on the ultrawealthy who dodge tax rules.
Those bills, paradoxically, are co-sponsored by Cardin and Neal, two of the lawmakers who are now calling for reining in giant retirement accounts.
The House and Senate bills were introduced before ProPublica launched its ongoing series last month exposing how the country's richest citizens sidestep the nation's income tax system. ProPublica has obtained IRS tax return data on thousands of the wealthiest people in the U.S., covering more than 15 years, allowing it to conduct an unprecedented examination of how the ultrawealthy employ tricks to avoid taxes in ways that most Americans cannot.
The bills are being pitched as helping ordinary Americans save for retirement, including automatic enrollment of workers in employer-sponsored retirement plans. But they also include perks for retirement and financial industries, such as relaxing certain rules in ways that are seen as a boon for insurers.
Deciphering the handouts is nearly impossible without a background in the intricacies of retirement plan tax laws and the help of experts. The bills hide critical changes in language most laypeople would never understand. For instance, a key piece of the Senate bill reads, “Paragraph (2) of subsection (e) of section 408 is repealed." But the scope of that change only makes sense when layered with this: “Section 4975(c)(3) is amended by striking 'the account ceases to be an individual retirement account by reason of the application of section 408(e)(2)(A) or if'."
ProPublica had to reverse-engineer the meaning of that series of numbers and letters to determine that it would take away one of the most potent weapons in the IRS' arsenal: the ability to strip an entire IRA of its tax-favored status.
Complicated IRS and Department of Labor rules prohibit IRA investments that involve conflicts of interest or self-dealing. That can be a particular concern with nontraditional IRA investments, such as purchases of real estate or of shares of companies that are not publicly traded. Under the current law, if the IRS determines that a retirement account has engaged in a prohibited transaction, the agency can blow up the entire account — an event that Warren Baker, a tax attorney whose practice focuses on IRAs, likens to “Armageddon." The whole account then ceases to be an IRA, and the owner has to pay income taxes on it.
The two bills propose defusing that bomb. In the House bill, the tax benefits would only be stripped from the part of the account involved in the forbidden transaction. The Senate bill would loosen the rules even more, applying a 15% excise tax on the part of the account involved in the prohibited transaction without blowing up the account. A spokesperson for Cardin said, “The penalty jumps to 100% if not corrected in a timely manner."
Still, someone who violates the rules suddenly would have a “massive long-term upside benefit" of tax-free growth, Baker said, while “your downside risk is a penalty that is smaller than the capital gains rates," the federal tax on the income that's generated when stocks or other assets are sold.
Bob Lord, a tax attorney and tax counsel to Americans for Tax Fairness, said he has represented clients who settled Roth IRA cases because the threat of losing the tax benefits of their entire accounts was “leverage the IRS had." He was stunned when he read the bills and saw that power stripped from the IRS.
“These changes will lead to more aggressive transactions that lodge greater wealth in Roth IRAs, with less risk if the IRS audits," Lord said.
The proposed Senate bill, experts say, makes another concession to IRA owners who might be tempted to dodge the rules. Under current law, an IRA account holder who violates rules is never totally in the clear. That's because the current statute of limitations for violations is a bit of a gray area, experts say. The IRS, “could virtually go back indefinitely," said Jeffrey Levine, a CPA and chief planning officer at Buckingham Wealth Partners.
The Senate bill proposes stopping the clock at three years. Yet, it can take more than three years for some nontraditional investments to balloon. If the IRS were to discover something amiss, under the bill's proposed statute of limitations it would be too late to act.
“For the little guy this makes all the sense in the world," Levine said. But for the ultrawealthy with huge accounts and squadrons of lawyers, he said, the changes could incentivize bad behavior. “Someone with all the resources in the world could say, 'I'll do this now that my risk-reward calculation is different and I'm looking at getting through three years and then I'm kind of home free.' That, you know, is a real boon for those who want to take advantage of the system."
The House bill is co-sponsored by Neal and Rep. Kevin Brady, a Texas Republican, and the Senate bill is co-sponsored by Cardin and Sen. Rob Portman, an Ohio Republican.
A spokesperson for Portman defended the legislation, which she said was “borne out of contact from our constituents — including innocent middle class savers who had their retirements wrecked by innocent and minor errors." ProPublica asked aides to Portman and Cardin for examples, but neither provided any. A Cardin spokesperson wrote in an email that “there usually is not litigation when this happens, and non-public examples are confidential taxpayer information."
In a joint statement, the offices of Portman and Cardin defended the Senate bill, saying it would help small businesses offer 401(k) retirement plans, expand access to savings for low-income Americans and “allow people who have saved too little to set more aside for retirement." The new legislation, they added, included measures to prevent Americans from inadvertently losing their IRAs while “implementing safeguards to prevent abuse."
Brady's communications director asked for questions in writing, then did not respond.
A staffer with Neal's Ways and Means Committee said the House bill had broad support and touted many provisions, including the automatic enrollment of employees in retirement plans, a national lost-and-found to locate retirement plans from prior jobs and a requirement that employers let certain long-term, part-time workers enroll in 401(k) plans.
The House bill, she noted, doesn't repeal the prohibited transaction rules; it limits the impact to the inappropriate purchase. She described Neal as “very committed to maintaining these important rules and believes that full sanctions should apply when violated."