Owners/managers of IRA-owned LLCs (also known as IRA LLCs or
Checkbook IRAs) could be hit with taxes and penalties if they provide
“prohibited services” to their IRA and the LLC it owns. In a recent ruling, the
U.S. Tax Court clarified that it will base decisions regarding prohibited transactions
on a broad reading of the tax code.
So what does this mean for IRA owners?
First, let’s look at the decision. The U.S. Tax Court ruled that
two individuals who set up an IRA-owned closely held corporation and provided
it with personal loan guarantees violated Section 4975. The tax court
emphasized that the “broad language”
used by Congress in the prohibited transaction laws is intentional and aimed to
prohibit a wider variety of acts than would be prohibited without it.
In specifically addressing a loan guarantee—which the two mean
illegally provided—the court said:
“The language of section
4975(c)(1)(B), (lending of money or
other extension of credit between a plan and a disqualified person) when given
its obvious and intended meaning,
prohibited the taxpayers from making loans … either directly or indirectly to
their IRAs by the way of the entity owned by the IRAs.”
The ruling has ramifications for all IRA owners. Managers of IRA-owned
structures, usually LLCs, may suffer similar treatment under a similar broad
application of 4975(c)(1)(C). That clause prohibits “furnishing of goods, services, or facilities between a
plan and a disqualified person.”
Most IRA LLC advocates
point to the Swanson v. Commissioner, 106 T.C. 76 (1996) tax court
ruling as the decision that allows an IRA owner to be the President of an IRA-owned
entity. While the case indicates that
being the President is not prohibited, neither the IRS code nor the Swanson case addresses what “services,”
if any, that President/Manager can provide to the entity. This creates an
ambiguity of which IRA/LLC owners should take notice.
There is little doubt
that decision-making is always the responsibility of the IRA account holder, but
far more than just decision-making is required for the operation of a
business.
Thus, this Court ruling
raises serious concerns that day to day running of the LLC business, including
such things as recordkeeping, accounting, and financial reporting, as well as
operational and administrative functions, could be prohibited under a broad definition
provision of “services.” All of these
services are typically provided to a business at a cost.
IRA owners who are
actively managing an IRA/LLC may want to explore having the LLC engaging
outside providers of active “services” to avoid potential tax/penalty
consequences.
