IRS Publication 590 is entitled “Individual Retirement Arrangements.” The following text is from page 43 of Publication 590:
What Acts Result in Penalties or Additional Taxes?
The tax advantages of using traditional lRAs for retirement savings can be offset by additional taxes and penalties if you do not follow the rules. There are additions to the regular 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.
- Allowing excess amounts to accumulate (failing to take required distributions).
There are penalties for overstating the amount of nondeductible 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 do not avoid those acts.
Generally, a prohibited transaction is any improper use of your traditional IRA account or annuity by you, your beneficiary, or any disqualified person.
Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
The following are examples of prohibited transactions with a traditional IRA.
- Borrowing money from it.
- Selling property to it.
- Receiving unreasonable compensation for managing it.
- Using it as security for a loan.
- Buying property for personal use (present or future) with IRA funds.
Fiduciary. For these purposes, a fiduciary includes anyone who does any of the following.
- Exercises any discretionary authority or discretionary control in managing your IRA or exercises any authority 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 responsibility in administering your IRA.
Effect on an IRA account.
Generally, if you or your beneficiary 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 engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values 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 Distributions Taxable, earlier. The distribution may be subject to additional taxes or penalties.