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What Acts Result in Penalties or Additional Taxes? The tax advantages of using traditional IRAs for retirement savings can be offset by additional taxes and penalties if you don’t follow the rules. There are additions to the regu- lar tax for using your IRA funds in prohibited transactions. There are also additional taxes for the following activities. • Investing in collectibles. • Making excess contributions. • Taking early distributions. See Pub. 590-B. • Allowing excess amounts to accumulate (failing to take required distributions). See Pub. 590-B. • Having unrelated business income. There are penalties for overstating the amount of non- deductible contributions and for failure to file Form 8606, if required. This chapter discusses those acts that you should avoid and the additional taxes and other costs, including loss of IRA status, that apply if you don’t avoid those acts. Prohibited Transactions Generally, a prohibited transaction is any improper use of your traditional IRA account or annuity by you, your bene- ficiary, or any disqualified person. Disqualified persons include your fiduciary and mem- bers of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant). The following are some examples of prohibited trans- actions with a traditional IRA. • Borrowing money from it. • Selling property to it. • Using it as security for a loan. • Buying property for personal use (present or future) with IRA funds. If your IRA is invested in nonpublicly traded as- sets or assets that you directly control, the risk of engaging in a prohibited transaction in connection with your account may be increased. Fiduciary. For these purposes, a fiduciary includes any- one who does any of the following. • Exercises any discretionary authority or discretionary control in managing your IRA or exercises any author- ity or control in managing or disposing of its assets. • Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so. • Has any discretionary authority or discretionary re- sponsibility in administering your IRA. CAUTION ! Effect on an IRA account. Generally, if you or your ben- eficiary engages in a prohibited transaction in connection with your traditional IRA account at any time during the year, the account stops being an IRA as of the first day of that year. Effect on you or your beneficiary. If your account stops being an IRA because you or your beneficiary en- gaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market val- ues on the first day of the year. If the total of those values is more than your basis in the IRA, you will have a taxable gain that is includible in your income. For information on figuring your gain and reporting it in income, see Are Dis- tributions Taxable in Pub. 590-B. The distribution may be subject to additional taxes or penalties. Borrowing on an annuity contract. If you borrow money against your traditional IRA annuity contract, you must include in your gross income the fair market value of the annuity contract as of the first day of your tax year. You may have to pay the 10% additional tax on early dis- tributions discussed in Pub. 590-B. Pledging an account as security. If you use a part of your traditional IRA account as security for a loan, that part is treated as a distribution and is included in your gross income. You may have to pay the 10% additional tax on early distributions discussed in Pub. 590-B. Trust account set up by an employer or an employee association. Your account or annuity doesn’t lose its IRA treatment if your employer or the employee association with whom you have your traditional IRA engages in a pro- hibited transaction. Owner participation. If you participate in the prohibi- ted transaction with your employer or the association, your account is no longer treated as an IRA. Taxes on prohibited transactions. If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction isn’t corrected. Loss of IRA status. If the traditional IRA ceases to be an IRA because of a prohibited transaction by you or your beneficiary, you or your beneficiary aren’t liable for these excise taxes. However, you or your beneficiary may have to pay other taxes as discussed under Effect on you or your beneficiary, earlier. Exempt Transactions The following two types of transactions aren’t prohibited transactions if they meet the requirements that follow. • Payments of cash, property, or other consideration by the sponsor of your traditional IRA to you (or members of your family). Chapter 1 Traditional IRAs Page 33