Advanced Underwriting Consultants

Question of the Day – May 22

Ask the Experts!

Here’s the question of the day.

Question: Can my client use her IRA in some tax-free way to fund her start-up business?

Answer: Maybe, but probably not directly, due to the rules prohibiting self-dealing.

The most obvious way to try to use IRA money to fund a start-up is by using a self-directed IRA.  The IRA would hypothetically buy ownership interests in the taxpayer’s business.

However, the prohibited transaction rules and rules against self-dealing mean that property cannot be purchased from the IRA owner or family member, and once purchased, cannot be used to benefit the IRA owner or family member.  The investment must be a strictly arms-length transaction not involving the IRA owner or family member.  Having the IRA buy shares in a company where the taxpayer is another owner—or even a key employee—would likely violate those rules.

The consequences of engaging in a prohibited transaction are catastrophic—involving prohibitive excise taxes and causing disqualification of the IRA.

Some experts have advocated setting up a qualified plan, such as a profit sharing plan, in the start-up business.  The owner of the business can roll over the IRA money into the qualified plan, and the plan can buy stock in the employer company.  The transaction would effectively provide capital for the new company to use, arguably without an income tax result to the taxpayer.

The IRS has never completely approved the rollover and purchase company stock strategy, although it has affirmed that some of the steps work.  We strongly urge any would-be entrepreneur to seek independent advice before starting such a strategy.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.