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IRA LLC Structures Laws & Cases
IRC § 4975. There are numerous sources of law that affect the IRA/LLC structure and govern how an IRA/LLC may be established and operated. The first and most significant body of law is the prohibited transaction rules
IRC § 4975 (c)(1)(E). The second claim by the IRS in the Swanson case was that a self dealing prohibited transaction occurred when the IRA-owned corporation returned profits and dividends to the IRA in violation if this statute. The Tax Court ruled that there was no evidence of self dealing and ruled that:
…the only direct or indirect benefit that the petitioner [Swanson] realized from the payments of dividends [profits] by Worldwide [the corporation] related solely to his status as the participant of IRA#1. In this regard, petitioner benefitted only insofar as IRA#1 accumulated assets for future distribution…[which is not a prohibited transaction]. Id. at 89-90.
IRC § 4975 (c)(1)(E) and (F). In the CCA, the IRS stated that this exemption to the prohibited transaction rules would avoid a per se prohibited transaction but reasoned that it would not exempt a self dealing prohibited transaction. the IRA owner is in a conflict of interest situation when paying himself or herself as manager of the IRA/LLC.
IRC § 4975 (d)(10). The plain language of the reasonable compensation exemption to the prohibited transaction rules is that the exemptions apply to all prohibited transactions including self dealing and per se prohibited transactions. It provides an exemption to the prohibited transaction rules for payments of reasonable compensation from an IRA to a disqualified person (e.g., IRA owner) for services rendered to manage the IRA. Also, provides an exemption to the prohibited transaction rules for “receipt by a disqualified person of any reasonable compensation for services rendered.”
IRC § 7430. Id. at 91. 26 USC § 7430. Awarding of cost and certain fees. In addition to ruling in favor of Mr. Swanson, the IRA owner, the Tax Court also ruled that the challenges brought by the IRS against Mr. Swanson were not “substantially justified” in law and ordered the IRS to pay Mr. Swanson’s attorney’s fees in defending the case.
Cases and Opinions
|Citation: Swanson v. Commissioner, 106 T.C. 76 (1996).|
Case Facts: The IRA purchased 100% of the shares of the corporation in exchange for a cash investment. The corporation was taxed as a foreign sales corporation. The IRS challenged the IRA-owned corporation structure on two fronts: First, the IRS claimed that a per se prohibited transaction occurred when the IRA purchased shares of the corporation. IRC § 4975 (c)(1)(A). The rationale from the IRS was that the new corporation was a disqualified person to Mr. Swanson’s IRA, and therefore, the purchase of shares by the IRA was a transaction with a disqualified person. The U.S. Tax Court disagreed with this analysis and ruled that:
…a corporation without shareholders does not fit within the definition of a disqualified person…accordingly, the issuance of stock to the IRA#1 did not, within the plain meaning of section 4975 (c)(1)(A), qualify as a “sale or exchange, or leasing, of any property between a plan and a disqualified person.” Id. at 89.
In other words, the corporation is not a disqualified person upon formation: and therefore, the IRA’s purchase of 100% of the initial ownership was not a prohibited transaction as there was no transaction with a disqualified person. As a result, in the IRA/LLC context, it is important that an IRA become the owner of the company upon formation of the IRA/LLC to avoid ownership transferring from the IRA owner to the IRA.
|Citation: Hellweg v. Commissioner, T.C.M. 2011-58 (2011).|
|Case Facts: Hellweg involved the creation of four 100% owned C corporations which were owned by Roth IRAs of family members and the Roth IRA owners each served as the president of their respective Roth IRA-owned company. The IRS challenged the structures and alleged prohibited transactions. The Tax Court dismissed the IRS’s challenges and stated in its opinion:|
Congress has enumerated the types of transactions which IRAs are prohibited from making in section 408(e)(2) through (5) and (m). No part of the Transaction here is prohibited under any of those provisions….Section 4975 (c)(1) prohibits a list of self dealing prohibited transactions between a plan and disqualified persons. We have previously held that a similar transaction was not a prohibited transaction under section 4975 (c)(1(A) or (E). See Swanson v. Commissioner, 106 T.C 76 (U.S. Tax Ct. 1996). Id. at pg. 24-25.Citation: Ellis v. Commissioner, T.C. Memo 2013–245 (2013), citing, S. Rept. No. 93–383 (1974).
Case Facts: In Ellis, the Tax Court held that an IRA can acquire substantially all of the initial membership interest of an LLC (e.g., 98%) in exchange for a cash investment. The Court also ruled that it is a prohibited transaction for the IRA owner to be paid compensation for managing the IRA/LLC.
In deciding the case, the Court looked to the operating agreement of the LLC which authorized payment to Mr. Ellis for serving as the general manager. The Court also looked to the actual records of the LLC, which showed the company expensing payments to Mr. Ellis. When using an IRA/LLC, one of the many important clauses in the operating agreement is one which restricts compensation to the IRA owner or any other disqualified person (e.g. IRA owner’s spouse or kids).
Case Facts: Mr. Repetto’s Roth IRA owned 98% of a company, and a third-party partner owned 2%. Mr. Repetto was also the president of his Roth IRA-owned company. Additionally, Mrs. Repetto’s Roth IRA owned 98% of a separate company and a third-party partner owned 2%. Mrs. Repetto was the president of her Roth IRA-owned company.
The transactions in question were payments from the Repettos’ personally owned construction company to their Roth IRA-owned companies. The actual Roth IRA-owned company structure was not in question in the case and the Tax Court wrote that,
The [IRS] agrees that generally an entity in which substantially all of the interest is owned or acquired by a Roth IRA may be recognized as a legitimate business entity for Federal tax purposes. However…the resulting payments [from the Roth IRA owners personal construction company to the Roth IRA owned companies] were nothing more than a mechanism for transferring value to the Roth IRAs [since there was no legitimate business purpose for the payments to the Roth IRA owned companies].
The Roth IRA-owned company structure was not put into question by the IRS in Repetto. However, the activities that the companies engaged in clearly violated the prohibited transaction rules as well as IRS Notice 2004-8 as the structure was an unfair transfer of value from a disqualified person to a Roth IRA-owned corporation.
Citation: DOL Advisory Opinion 97-23A.
|Case Facts: Subsequent investments from a retirement plan to a company owned 100% by the plan would not result in a prohibited transaction as the funding of money between a retirement plan and a company the plan owns 100% is an “intra plan” transfer of money and not a “transaction” for purposes of the prohibited transaction rules. As a result, additional investment from an IRA to the IRA/LLC is acceptable.|
IRS Publication 3402 (2012) and Treasury Regulations § 301.7701-3. When there is one IRA that owns 100% of the IRA/LLC, the IRA/LLC is considered a single-member LLC and is disregarded for tax purposes.
IRS Form 5305. Is completed, with some variations, when an IRA custodian establishes an IRA on behalf of an IRA owner.
IRS Chief Counsel Advice Number (CCA) 200952049 (12/24/2009). the IRS in 2009 determined that compensation from the IRA/LLC to the IRA owner is a self dealing prohibited transaction. The IRS Chief Counsel’s Office wrote in response to questions from internal revenue agents that:
Yes you are correct the payment of salary to the IRA owner, even indirectly by an IRA owned LLC, is a prohibited transaction.
Ice, Noel C., When Can an IRA or Qualified Plan Invest in a Closely Held Business?, Fort Worth, Texas (March 2012). Experienced IRA attorney Noel C. Ice, explained regarding the IRS CCA:
IRA/LCC DO’S & DON’Ts
Maintain the registration of your Company in whichever State it is registered.
Provide Annual Valuations to the Custodian of your self directed retirement account.
Make distributions from your Company pro-rata according to the ownership percentages established at the initial formation of your Company.
Perform rigorous due diligence on the investments in which your Company intends to participate.
Allow your Company to lend cash to a disqualified person.
Pay yourself or other disqualified person for performing management to your Company.
Allow yourself or other disqualified persons to Contribute sweat equity (labor) to your Company (for example make repairs to property owned by your Company).
Enter into a contract in your personal name or a disqualified person’s name when the contract should be with your Company.
Set up a bank account for the Company and maintain separate bookkeeping.
Unless your Company is a “Single-Member-LLC,” file your annual partnership tax return for the Company (Form 1065).
Report any UBTI or UDFI that arises from the operations of your Company (reported on Form 990 for IRAs and form 5500 for 401(k)s.
Update your Beneficiary Designation forms with the Custodian of your self directed retirement account(s).
Consult with your CPA or Attorney for your specific situation in order to avoid prohibited transactions or unintended tax consequences related to your Company’s investments.
|DON’TsSign a personal guarantee or give personal credit on behalf of your Company.|
Take a “retirement distribution” directly from your Company. This must be done through your IRA Custodian.
Rent, live in, or otherwise use or benefit from any property or assets owned by the Company.
Transfer ownership in the Company to or from a disqualified person.
Co-mingle personal or other non-retirement assets or expenses within Company.
Use Company funds to pay for personal expenses, even if those expenses are somewhat related to the company.