Personal Guaranty Creates Prohibited Transaction? Options

[tschotland]

Hi Larry,

I appreciate the opinions offered by you and mjb, it's just that I am not clear on why it is a PT (though I am worried that it is). I would not be loaning money to the plan/IRA, nor making a deposit to it. I would be agreeing to pay off the broker if the plan/IRA went into debt. I would not get any tax deferred benefits from doing that - it's not like I would be putting extra money into the plan and seeing it grow. I couldn't claim it as a tax loss outside the plan either. And guaranty or not I would always be free to make contributions to a new plan/IRA in future years, so it's not as though the guaranty enables me to avoid having to make up the losses with only tax-deffered money. From the standpoint of the IRS getting their cut it seems like the guaranty is a non-event. Am I missing something?

Vebaguru said there have been cases where a personal guarantee was treated as a PT. I'd like to see those and understand why. If you guys have citations please let me see them.

Thanks,

Tom

Didn't mjb already give you the answer? In mjb's view--and in mine--a personal guaranty of IRA obligations is a prohibited transaction.

If you think you've been burning money without getting answers, then here you will not burn money but you still will not be able to get full agreement on a difficult issue (but of course, here you will not get legal advice, either).

[tschotland]

> The "screening questions" should have established knowledge and ability.
> So I do not understand how you could be "burning money".

I have been with my ERISA attorney for years, so I didn't screen him. I just called him up and discovered that it was going to be a fishing expedition. The tax accountant and his in-house tax attorney have written numerous books and articles on all aspects of taxation for traders and use of retirement vehicles for trading. They came highly recommended by numerous traders. I had no problem starting to pay for their time just on that basis. It was after we burned an hour that I realized that on these particular issues, which are highly specific to be sure, they were also going to have to go on a fishing expedition...

If you could suggest some really hard-ball questions to ask to avoid paying to learn there is going to be a fishing expedition, I would love to hear them.

Thanks,

Tom

[Jim Norman]

Tom,

See Internal Revenue Code Section 4975©(1)(B) under the list of prohibited transactions. You will find "lending of money or other extension of credit between the plan and a disqualified person".

You are a disqualified person with respect to your IRA. Can it seriously be argued that a personal guaranty is NOT an "extension of credit" to the IRA? What is an "other extension of credit"?

How much are you willing to risk to make this argument? The penalty for an IRA engaging in a prohibited transaction is full and immediate taxation of the entire IRA account. If the IRS audits and finds this it will be 2-3 years down the road from 2008, so you would have a 3 year old 2008 tax deficiency with accumulated interest and penalties due to the IRS. Sure, you can fight it later if and when the issue arises, but at what cost?

[jpod]

There is no question that a guarantee is a pt. That is the reason (or at least one of the reasons) why there is a statutory exemption for ESOP loans: the exemption is necessary in order for the employer to guarantee the loan.

I don't think I'm sticking out my neck to say that this is "ERISA 101." This is the type of question to which we can provide a direct answer on this message board, but if you don't accept it as an answer we're not going to argue with you.

[Belgarath]

See if you can find the text of Janpol v. Commissioner, 101 T.C. 518 (1993) which may illuminate the subject a bit. I don't have a link to the actual case.

[tschotland]

I'm sorry if this is all ERISA 101 stuff. Here is my confusion: I understand that if I actually fund my IRA/plan with extra money that is a prohibted transaction. This is very clear. What is not clear to me is, does the mere promise to pay a debt accrued by the IRA/plan should the need arise create a prohibited transaction? Please note, this hypothetical payment of debt would NOT occur by funding the plan with additional money, it would be a direct payment from myself to the broker. Moreover this payment will never actually occur, since if the account declines in value by even 50% the CTA must stop trading, and I would have him stop long before that point anyway.

I cannot find the text of Janpol v. Commissioner. However I did find a document that references it in connection with a case that was ruled on similarly. In that case, a private foundation deposited its assets in a futures margin account to secure the performance of futures trading by the director of the foundation and his family. So money actually was deposited somewhere, not just a mere promise to do so maybe someday.

Thanks,

Tom

[Jim Norman]

does the mere promise to pay a debt accrued by the IRA/plan should the need arise create a prohibited transaction?

If the mere promise to pay is an "extension of credit", then YES, it does create a PT. Is such a promise an extension of credit? IMO yes, it is.

Much like a company may have a credit line with a bank. The bank is extending credit to the company even if the company does not actually draw against the line. Having the line allows the company to tie up its cash in ways that it would not otherwise be possible if it could not rely on the credit line as a backup. Your personal guarantee on behalf of the IRA allows the IRA to make investments it would not be able to make if the guarantee was not there.

The question is, how much risk do you want to take, and how much do you want to spend in legal fees to fight the IRS over the definition of an extension of credit, knowing that it is more likely than not that you would lose the case anyway?

[Sieve]

When you decide if you want to take a chance on this transaction in spite of the strong feeling of this group that your loan guarantee is a PT, remember that the consequences of an IRA entering into a PT generally are much more severe than for a qualified plan. For an IRA, the IRA ceases to be an IRA as of the first day of the taxable year in which the PT occurs, and all amounts are treated as distributed as of that date (and the 15% PT excise tax does not apply). For a qualified plan, the excise tax applies for each year that a PT continues to exist, and the transaction must be undone (which may be difficult for this transaction).

This post has been edited by Sieve: Jul 23 2008, 06:55 PM

[tschotland]

Okay, you guys have put the fear in me...

Here's another approach: I am 1/3 owner of one of my businesses. If that business signs as guarantor it would not be a prohibited transaction because I do not own a controlling interest in it. Is that correct?

Thanks,

Tom

[GBurns]

For clarification :

What type of business entity is it?
Are you an employee?
Are you an officer ?
Are you a Director/Board member ?
Is this business part of a controlled group or otherwise related to the other businesses ?

[tschotland]

Hi GBurns,


> What type of business entity is it?

2 member LLC taxed as an S corp


> Are you an employee?

No, but only because we have no payroll yet. We are in the process of launching our first product. Once we are making money we will start paying ourselves salaries.


> Are you an officer ?

Yes (VP).


> Are you a Director/Board member ?

The LLC is co-managed by its members. I am 1 of 2 members, own 1/3 of the LLC and have 1/3 of the voting power. In practice we don't do anything unless we both agree but that's what the operating agreement says.


> Is this business part of a controlled group or otherwise related to the other businesses ?

Not part of a controlled group, no connection to my other businesses (which are single-member LLCs).


Thanks,

Tom

[vebaguru]

You certainly seem to want to live dangerously. You want to do highly leveraged commodity trading with retirement funds. And if the investment risk isn't enough risk for you, you now desire to take legal risks as well. If you are a moth, why bother to come on the board to assuage your conscience? You're going to self-destruct no matter what we say because you are hell bent on taking risks.
Imagine being at the roulette table in Las Vegas (or otherwise). You bet black and win, doubling up. You bet black again and win, doubling up again. How many times can you leave all your chips on black before you have nothing left? 2, 3, 7, 10? The point is that if you keep taking risks, sooner or later you will be left with nothing. There are investments, even investments in commodities and currency futures that are not highly leveraged, do not require a personal guarantee and can provide an adequate return.
Stop letting greed get the best of your judgment before it is too late.
Ask your ERISA attorney to put his opinion in writing. If he is a decent ERISA attorney (as a member of the Employee Benefits Committee of the ABA, I know many of the top ones) he will not give you the response you reported. My guess is that you heard what you wanted to hear from him and need to speak with him again.

[tschotland]

Hi vebaguru,

I can hear you snickering now, but actually I am trying my hardest to avoid living dangerously here. I have no intention of trading futures myself. I am hiring CTAs to do it for me with only part of my retirement funds. There are something like 3600 registered CTAs out there but only a handful are of any possible interest to me. This handful trades in a highly disciplined matter where only 1-2% of the account is risked on any one trade, and only 10%-15% of the account is risked in total at any one time, and that across uncorrelated markets. They have multi-year track records that put any mutual fund to shame. Personally I feel safer with those parameters than dealing with the full exposure to market risk that e.g. an index fund has.

As for the legal risks, my goal is not to take them, but rather to determine what they are so I can avoid them. You guys have convinced me that I cannot sign the personal guaranty, although the question of whether my 1/3 owned company can do so is still open. I am also pressing the compliance department at the futures brokerage on this issue, and so are my introducing brokers. It is my hope that they may waive the personal guaranty.

I would be interested in knowing what commodity/currency futures investments you are speaking of. I am guessing either ETFs or public commodity funds? I agree, some of these are attractive choices that are also of interest to me. Thing is, I am also trying to diversify across strategies and the CTAs I want to have trade for me are running strategies not available in any of the ETFs or funds I know about.

Best regards,

Tom

[masteff]

You guys have convinced me that I cannot sign the personal guaranty, although the question of whether my 1/3 owned company can do so is still open.

No, it's not still open. You've either not read or not fully understood the code section that Jim Norman cited above. Both you and the company constitute a party in interest / disqualified person (don't get hung up on the word "person") and therefore cannot extend credit to/for the plan.

[Guest_named_mjb_*]

Hi vebaguru,

As for the legal risks, my goal is not to take them, but rather to determine what they are so I can avoid them. You guys have convinced me that I cannot sign the personal guaranty, although the question of whether my 1/3 owned company can do so is still open. I am also pressing the compliance department at the futures brokerage on this issue, and so are my introducing brokers. It is my hope that they may waive the personal guaranty.

I would be interested in knowing what commodity/currency futures investments you are speaking of. I am guessing either ETFs or public commodity funds? I agree, some of these are attractive choices that are also of interest to me. Thing is, I am also trying to diversify across strategies and the CTAs I want to have trade for me are running strategies not available in any of the ETFs or funds I know about.

Best regards,

Tom

So why not ask you expert ERISA counsel for an opinion on whether your 1/3d owned company can guarranty the loan which you can rely upon and will allow you to sue him if he is wrong.