Tax-advantaged accounts like IRAs and Health Savings Accounts allow you to save for the future by deferring taxes on your investment earnings. However, IRS reporting is required to track fair market values and movements of account-held cash and assets. New Direction Trust Company performs this service as your account custodian, but, as the account owner and tax filer, it’s important that you understand the various tax filings and documents that may be associated with your self-directed plan.
Let’s take a look at a few common tax forms you may encounter:
New Direction Trust Company will submit Form 5498 directly to the IRS and provide you with a participant copy (typically following the tax filing deadline; click here for important information about Tax Day 2020). You will receive one Form 5498 for each account you hold.
Form 5498 reports two key pieces of information – the fair market value of your account and any contribution activities from the applicable tax year.
The IRS needs to know the value of your account holdings on an annual basis. Although we submit Form 5498 to the IRS on behalf of your account, we need your assistance in identifying the fair market value it reports.
Assets like real estate, private equity, and other such alternatives must be independently valued. If, for instance, your IRA owns a home and rents it out, you could solicit the services of a real estate agent; submit a copy of the county assessment; or utilize a similar third-party source to value the property.
To submit a fair market valuation to New Direction Trust Company:
Some assets may not require you to submit independent fair market value information. These assets include:
Please bear in mind that these fair market valuation practices also apply in the unfortunate case of a zero-valued asset. Click here to review our Zero Value Packet. Completing the zero-value process can help alleviate tax burdens associated with the asset.
The IRS also records annual contributions. Depending on your account type, contributions can provide considerable tax advantages (e.g. income tax deductions) even before making an investment. All accounts also carry limits on how much holders can contribute each year. To fund your account and qualify for tax benefits, the IRS must ensure that you’re following contribution rules.
As with Form 5498, New Direction Trust Company will send Form 1099-R to the IRS and provide a copy for your records in January for the prior tax year.
However, a Form 1099-R will only be issued if you took a distribution. Whether your distributions are taxed as income (as with a Traditional IRA or another such pre-tax plan) or tax-free (as with a Roth IRA, if qualified), the IRS keeps an eye on withdrawals from your account.
If you executed a rollover in the prior tax year, you will receive a Form 1099-R from your issuing custodian that reports the rollover distribution. You will also receive a corresponding Form 5498 from your receiving custodian to report the subsequent rollover contribution.
A rollover distribution that isn’t returned to a qualified account within 60 days will count as a regular distribution, for which any applicable taxes and penalties may apply. Matching amounts on Forms 1099-R and 5498 communicate to the IRS that a proper rollover has taken place.
A Schedule K-1 reports income from certain assets under specific circumstances. If you receive a Schedule K-1 your account may have earned passthrough income from an operating business or rental income.
There’s a fair amount to unpack here: “Passthrough income” refers to investment returns that were not taxed at the corporate level. An “operating business” actively produces and offers goods or services.
So, if your self-directed IRA invests in an operating business that doesn’t pay taxes at the corporate level, that un-taxed income will be reported on a Schedule K-1.
A Schedule K-1 may also report rental income, either from real estate or another type of property (e.g. your account could own equipment and lease it to businesses).
These nuanced situations may carry additional ramifications for your plan. Click here to learn more if you received a Schedule K-1 for your account.
Tax time can be daunting, but New Direction Trust Company is here to help answer any questions you have about your self-directed account. Feel free to give us a call at 877-742-1270 or send us an e-mail at firstname.lastname@example.org.