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.

Question of the Day – March 13

Ask the Experts!

Here’s the question of the day.

Question: My client wants to roll his pension money into a self-directed IRA, so he can invest that money in real estate.  Is that allowed?

Answer: Maybe, if the client is not using the real estate personally.  The client needs to make sure he’s not violating any prohibited transaction rules or rules against self-dealing.

The prohibited transaction rules and rules against self-dealing mean the 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.

In ERISA Opinion Letter 2011-04, the taxpayer sought a ruling that his IRA could purchase the note and mortgage on an eight-unit apartment building owned by the taxpayer’s living trust.  The apartment building had been financed originally through a personal loan taken from a bank by the taxpayer and his wife, and secured by a deed of trust on the property.  

The taxpayer argued that an IRA could purchase a note and mortgage already in existence from the bank and this would not constitute a new loan from the IRA or other extension of credit to a disqualified person.  The Department of Labor did not agree.  It held that although the IRA would acquire the note and deed of trust from the bank, an otherwise unrelated party, the IRA would hold the note and receive payments on the note from the taxpayer and his wife, who are disqualified persons.  Buying the note and mortgage from the bank would constitute an indirect loan to the IRA owner, and was thus prohibited.

The consequences of engaging in a prohibited transaction are catastrophic.  Code Section 4975(a) imposes an excise tax equal to 15% of the amount involved with respect to the prohibited transaction for each year (or part thereof) in the taxable period.  In addition, Section 4975(b) imposes a 100% excise tax if the prohibited transaction is not corrected within the taxable period.

In addition to the excise taxes, under Code Section 408(e)(2), an IRA is disqualified if it engages in a prohibited transaction.  If an IRA is disqualified, income taxes and a 10% penalty if the owner is under age 59-1/2 will be due on the entire balance of the IRA.

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.