Most self directed IRA owners know that their self directed IRA cannot conduct transactions with themselves or certain family members (e.g. spouse, kids, parents, etc.). Most self directed IRA owners also know that their self directed IRA cannot do business with a company they own or that their disqualified family members own 50% or more of. However, one of the most confusing areas of the prohibited transaction rules are the prohibited transaction rules which apply to business partners or officers, directors, and/or highly compensated employees of companies the IRA owner or family members are personally involved in. For example, what if I own a business with a partner? Can my IRA enter into a transaction with that business partner if we aren’t family? Well, it depends.
To analyze the rules you first need to determine whether the company in which the business partner (or officer, or director) is involved in is a company that is owned 50% or more by the IRA owner or their disqualified family members. IRC 4975 (e)(2)(E),(H), (I). So, for example, if my wife and I owned 60% of the business and our partner owned 40% of the business, then this company would be owned 50% or more by disqualified persons.
Once we know that the company is owned 50% or more by disqualified persons, we need to identify all of the officers, directors, highly compensated employees, and 10 % or more owners of that company. In sum, all of these persons are disqualified to the IRAs of the 50% or more owners. In the example above, since my business partner owned 40% of the company, he is a 10% or more owner and as a result he is a disqualified person to my IRA (since my wife and I own 50% or more of the company).
Let’s look at another example. Say that I am a 35% owner of a business with a few other partners who are not disqualified family members to me. Since I do not own 50% or more of this company, it doesn’t matter who the other partners, officers, or directors, are, as they are not disqualified to my IRA as part of this rule since my ownership (and that of my disqualified family members) is below 50%.
As a final example, let’s say that I own 70% of a company and that I have a partner who owns 5%. Under the rule, my partner or fellow shareholder does not have 10% or greater ownership and as a result they are not disqualified to my IRA. However, if that 5% owner was the President of my company then they would be a disqualified person.
These rules can be tough to understand when you read the code, but if you take the two step analysis you can easily determine what partners, officer, directors, or highly compensated employees are disqualified to your IRA.
Here’s also a quick summary of the rule from my book where I took the text of the tax code and put it into plain language.
KEY PERSONS IN COMPANY OWNED 50% OR MORE BY DISQUALFIED PERSONS. An officer, director, or 10% or more shareholder, or highly compensated employee (earns 10% or more of the company’s wages) of a company owned by the IRA owner or other disqualified persons. IRC § 4975 (e)(2)(H).
Before investing with someone who is an officer, director, highly compensated employee, or a shareholder/owner in a company you are involved in, please consult these rules and where you are un-clear, seek the advice of competent counsel.
By: Mat Sorensen, Attorney & Author of The Self Directed IRA Handbook