An IRA with an LLC: Flexible Investment or Trap for the

Unwary?

2015 Lincoln Inne

• Mr. Swanson directed his IRA to purchase 100% of all newly issued stock of a C corporation

• Mr. Swanson was sole director and held all officer positions

• Over four years, corporation issued $600,000 of dividends to the IRA.

2015 Lincoln Inne

• IRS claimed two prohibited transactions occurred: • Issuance of stock by corp to IRA • Issuance of dividends

2015 Lincoln Inne

• Tax Court said no. • Issuance of stock by corp to IRA

not a PT because corp was not a disqualified person

• Issuance of dividends not a PT because Swanson did not personally gain outside of IRA

2015 Lincoln Inne

• Tax Court also said that IRS was not reasonably justified in its position and ordered IRS to pay attorney fees of Mr. Swanson

2015 Lincoln Inne

2015 Lincoln Inne

Could Swanson pay himself a salary?

Could Swanson use a corporate vehicle or take expensive business trips?

Could the corporation loan Swanson money?

Could Swanson direct the corp to acquire certain collectibles not permitted to be owned by an IRA?

Would this work with a Roth IRA?

2015 MIEFP

In general, when a disqualified person and an IRA are on opposite sides of a transaction, a prohibited transaction may result:

(A) sale/exchange, or leasing, of any property between a plan and DP;

(B) lending of money or extension of credit between a plan and a DP;

(C) furnishing of goods, services, or facilities between a plan and a DP;

(D) transfer to, or use by or for the benefit of, a DP of income/assets of a plan;

(E) act by a DP who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

(F) receipt of any consideration for his own personal account by any DP who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan

2015 Lincoln Inne

Section 4975(e)(2). A “DQP” includes…

(A) a plan fiduciary;

(B) a person providing services to the plan;

(C) an employer any of whose employees are covered by the plan;

(D) an employee organization any of whose members are covered by the plan;

(E) an owner, direct or indirect, of 50 percentor more of—

◦ (i) the combined voting power of all classes of stock entitled to vote or the total value of shares of a corporation,

◦ (ii) the capital interest or the profits interest of a partnership, or

◦ (iii) the beneficial interest of a trust or unincorporated enterprise,

which is an employer or an employee organization described in subparagraph (C) or (D);

(F) certain family members of individuals described above;

(G) a corporation, partnership, or trust or estate of which 50 percent or more of—

◦ [the vote or value of interests]

◦ is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);

(H) an officer, director, a 10 percent or more shareholder, or a highly compensated employee of a person described in (C), (D), (E), or (G); or

◦ (I) a 10 percent or more (in capital or profits) partner or joint venturer of a person described in (C), (D), (E), or (G).

What about the IRA Owner?

◦ Section 408(e)(2)

◦ TAM 8849001

◦ IRS FSA 200128011 (2001)

◦ Ellis v. Commissioner (2013)

A “DQP” includes…

(A) a plan fiduciary;

(F) certain family members of individuals described above;

(G) an entity owned 50% or more by the above.

Section 4975(e)(2)

Swanson v. Commissioner, 106 T.C. 76 (1996)—

◦ Using IRA assets to buy stock in IRA Owner’s corporation

IRS FSA 200128011 (2001)

◦ Using IRA assets to buy stock in IRA Owner’s Corporation

DoL Advisory Opinion 2006-01A

◦ LLC owned by IRA leased property to corporation owned by IRA Owner

Peek v. Commissioner, 140 T.C. No. 12 (2013)

◦ Where IRA Owner guaranteed a loan received by the IRA’s wholly owned corporation

IRS CCA 200952049 (2009)

◦ If IRA Owner is paid compensation for his services to the IRA.

◦ If IRA Owner is paid compensation for his services to an LLC owned by the IRA

Ellis v. Commissioner, T.C. Memo 2013-245 (2013)

◦ If IRA Owner directs his IRA to invest in newly established LLC

◦ If IRA Owner is paid compensation for his services as manager of the LLC owned by the IRA.

2015 Lincoln Inne

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OK NOT OK

2015 Lincoln Inne

The Bank Custodian!

2015 Lincoln Inne

If You Discover a Prohibited Transaction—

You must report a PT on Form 1099-R [§ 6047]

Penalties for Failure to Disclose

$25 penalty for each day the failure continues

Not to exceed $15,000 [§ 6652(e)]

Annual Valuations for Form 5498

• $50 per return with no maximum [§ 6693]

2015 Lincoln Inne

Under Section 408(e)

◦ The IRA will no longer be considered an tax exempt.

◦ The IRA is treated as if it distributed all m of its assets on the first day of the year.

Under Section 4975

◦ Excise taxes on DQP

initially 15% of the amount involved

100% of the amount involved if not corrected within the taxable period

2015 Lincoln Inne

The IRS will consider certain Roth IRA transactions to be “listed transactions.” (Notice 2004-8)

◦ IRS says Notice also applies to “substantially similar transactions.”

What are the consequences of failing to disclose a listed transaction?

◦ Penalty = 75% of the decrease in tax shown on the return as a result of the transaction.

◦ Minimum Penalty = $10,000 (or $5,000 in the case of a natural person).

◦ Penalty imposed for each year the transaction is not reported.

2015 Lincoln Inne

Chip wants to know . . .

if his IRA invests in the LLC, but he is careful to avoid any prohibited transactions…

…is there anything else he should worry about?

An IRA is generally exempt from tax [§ 408(e)].

An IRA is taxed on any income from an unrelated business regularly carried on by it [§ 511(a)(1)].

Several types of income are exempted from UBIT, such as dividends, interest, rents from property, and capital gains [§ 512(b)].

So most passive income, such as dividends from a corporation, would not be subject to UBIT.

But if an IRA owns an interest in an LLC taxed as a partnership that carries on an active trade or business, such as The Nut Hut LLC, any income received by The Nut Hut would be treated as earned by the IRA directly [§ 512(c)(1)].

The IRS ruled that income an IRA receives from a limited partnership is subject to the UBIT [PLR 9703026 (Jan. 17, 1997)].

The UBIT is computed using the same rate schedule as for trusts and estates.

The IRA custodian or trustee is responsible for:

◦ Filing the tax return (Form 990-T)

◦ Making quarterly estimated tax payments.

2015 MIEFP

Case law is continually developing in this area, and there is still quite a bit of uncertainty.

An IRA and a DQP such as Chip can, in fact, jointly own a business, but a prohibited transaction can result unless the planner exercises extreme caution

2015 Lincoln Inne

Because of Reporting Requirements, the IRA Custodian Must Determine whether a PT Occurred.

A prohibited transaction may result if—

The LLC or IRA pays compensation to Chip.

There is a loan or guarantee between the LLC and Chip or another DQP.

Chip receives any benefits from the LLC that would be considered a “transfer to, or use by or for the benefit of, the income or assets” of the plan.

Chip receives any benefits from the LLC that the IRS would characterize as dealing with plan income or assets in his own interests or for his own account.

Roth IRAs may have listed transaction reporting

◦ Chip may have reporting obligations under Section 6011 if a transaction is substantially similar to that described in Notice 2004-8.

The IRA may owe UBIT

◦ The custodian would be responsible for filing the return and making estimated tax payments.

Potential Pitfalls

2015 MIEFP

Could Swanson pay himself a salary? No. Ellis

Could Swanson use a corporate vehicle or take expensive business trips? Unresolved.

Could the corporation loan Swanson money? No. Peek

Could Swanson direct the corp to acquire certain collectibles not permitted to be owned by an IRA? Unresolved, but risky

Would this work with a Roth IRA? Yes, but must list the transaction