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Personal Guaranty Creates Prohibited Transaction?


Guest tschotland
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Guest 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

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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.

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Guest 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

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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.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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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.

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Guest tschotland

> No, it's not still open.

I meant open in my mind, as in I still don't fully understand the reasoning.

> You've either not read or not fully understood the code section that Jim Norman cited above.

When it comes to me, bet on "not fully understood". I did read it.

> Both you and the company constitute a party in interest / disqualified person

Here is where I am still stuck. Further down from the code section Jim Norman cited there is a section (4975(e)(2)) that defines what a disqualified person is. If that person is a corporation the section states it is only disqualified if it is 50%+ owned by disqualified persons. Since I am only a 1/3 owner I do not understand why the corporation is disqualified. Jim Norman cited that code section before I floated the 1/3-owned corporation idea. He was explaining why I personally am disqualified to extend credit, not why the 1/3-owned corporation is disqualified.

Moreover GBurns asked me a host of questions about the corporation after I floated the idea. He didn't reply, "no way can the corporation sign." I figured if a pro asked me specific questions rather than just shooting me down, maybe my idea had some merit.

At the end of 4975(e)(2) I find this:

"The Secretary, after consultation and coordination with the Secretary of Labor or his delegate, may by regulation prescribe a percentage lower than 50 percent for subparagraphs (E) and (G) and lower than 10 percent for subparagraphs (H) and (I). "

Paragraph (G) is the one about corporations. Are you guys saying that there is a regulation lowering the percentage from 50% in my case?

Thanks,

Tom

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Guest tschotland

> 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.

I may have mentioned this elsewhere but over the years I have found so much disagreement between experts that at this point I feel my only option is to listen to a lot of different opinions, weigh them all and decide for myself. My attorney has told me many times in the past that it takes 50%+ ownership for a corporation to be disqualified. I am still interested in hearing what others have to say.

As for using his opinion as some kind of insurance policy: first of all, I never thought of that. I knew I could rely on an attorney's opinion as "substantial authority" for avoiding some penalties and/or interest; I never considered suing the guy himself if he was wrong. Second, counting on being able to win a lawsuit as my sole protection is just not my way of doing things. I just don't like the idea personally. It is also way more risk than I care to take on, since prevailing in a suit is by no means certain, especially when your opponent is a top-ranked law firm!

Thanks,

Tom

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OK, lets summarize this thread.

The consensus opinion of the panel of responders is that you are looking at high risk and dangerous options that puts your entire (not just the part invested) retirement assets at risk.

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Tom

The reason for my questions was just to make sure that all bases were covered in case there was some loophole that no one saw because of some detail.

Controlled group, ASG, attributon issues etc not being considered, both you and the corporation are disqualified nor a number of reasons.

Rather than go into details, which is what the advisors you have paid, should have and could have easily done, I make a simple suggestion, use Google searches on the terms 4975(e)(2) and "disqualified person IRA" (without the "").

In the mean time read this, especially the last few paragraphs which explain why the corporation is disqualified even with less than 50% ownership:

http://www.checkbookira.net/Father_Kids.pdf

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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The standards that apply to what your attorney says to you and a tax opinion are quite different. Under Circular 230, the penalties for the attorney's making a mistake are considerable, in addition to the potential liability to you in case you detrimentally rely upon his opinion and ultimately his position is upheld. Many tax attorneys will not issue written opinions any more. Those who continue to do so have implemented safeguards to avoid making mistakes. If your ERISA/tax attorney will give you a favorable opinion, you can go ahead with the transaction. Otherwise you should not.

Your excuse ("I have found so much disagreement between experts") doesn't wash. Here on this thread you have consistent opinions from several knowledgeable people and you don't want to accept those, only to argue with them.

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Guest Sieve

Here's a recent string, Tom, which discusses this issue about midway through & reaches the same conclusion as we have here--& I'm sure there are other similar strings, but I didn't look . . .

http://benefitslink.com/boards/index.php?s...ic=39174&hl=

. . . & read the DOL advisory opinion GBurns provided.

You don't have to agree with us, but don't expect us to be convinced by your protestations to the contrary.

[shades of 410b . . . http://benefitslink.com/boards/index.php?showtopic=39081 ]

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Guest tschotland

> In the mean time read this, especially the last few paragraphs which explain why the corporation is disqualified even

> with less than 50% ownership:

http://www.checkbookira.net/Father_Kids.pdf

Thanks for this link. Let me see if I can summarize: A self-directed IRA owner wants to lend money to a corporation that he works for, directs, and owns less than 50% of. The DOL says the corporation is not a disqualified person by reason of either the IRA owner's employment or ownership. However the transaction is still prohibted because as fiduciary the IRA owner can't do anything that would benefit himself (in this case, lend IRA assets to his own company).

My situation is sort of the opposite. I am a self-directed IRA owner and I want a corporation that I work for, direct and own less than 50% of to extend credit to my IRA. Per the DOL letter the corporation is not disqualified by these facts. Are you saying the transaction is still prohibited because of my fiduciary responsibility to the IRA? I don't see how the guaranty violates that. I do not get personal benefit from the guaranty, only the IRA does. From the standpoint of my ownership of the corporation the guaranty could be said not to benefit me.

If I've missed the point here please spell it out for me in block letters.

Thanks.

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Guest tschotland

> Here on this thread you have consistent opinions from several knowledgeable people and you don't

> want to accept those, only to argue with them.

I have accepted the board's opinion that I cannot personally guarantee the plan. Now I am just trying to understand the argument that says my 1/3-owned corporation cannot do so.

Thanks.

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In block letters:

YOU STAND TO GAIN/BENEFIT.

It cannot be simpler.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Guest tschotland

Hi Larry,

> Here's a recent string, Tom, which discusses this issue about midway through & reaches the same

> conclusion as we have here--& I'm sure there are other similar strings, but I didn't look . . .

> [...]

> . . . & read the DOL advisory opinion GBurns provided.

I read both the string you referenced and the DOL opinion from GBurns. They are very similar, in both cases the issue is that the plan/IRA fiduciary does something that benefits him personally. I think I've got it going the other way. I can understand someone arguing that I have blown my fiduciary responsibility to my corporation by having it sign the guaranty. But I just don't see why it violates my fiduciary responsibility to the IRA. Only the IRA benefits, not myself nor the corporation. I must be missing some big obvious point here that the rest of you see, and I'd be grateful if someone could explain it to me.

>shades of 410b . . .

Ouch. I read that string too. I really don't mean to get on anyone's nerves. You guys have convinced me about one point already (no personal guaranty). I am now just getting stuck on understanding your current point about the corporation being disqualified too. From where I sit when I read your logic it sounds like we are comparing apples and oranges, but as I said, I am willing to believe there is something you all understand that so far I am just not getting.

Thanks.

ADDENDUM: While I was writing this GBurns posted his opinion in block letters per my request. Is that the consensus opinon: that as fiduciary of my IRA I somehow personally benefit when my company signs the guaranty?

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It is BOTH your IRA AND your CORPORATION (to a sufficient extent). You have a fiduciary duty to BOTH. Any way you cut it, you are self-dealing and causing actions with the sole purpose of getting a benefit. This is the point of the last few paragraphs of the DOL letter.

The action by the corporation is an action by you and/or for you exclusively.

Benefits do not enure to the IRA they enure to the owner of the IRA.

You cannot separate yourself from either the IRA or the corporation. That is the point that you are missing.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Guest tschotland

Hi George,

The light is beginning to break. I don't want to wear out whatever might be left of my welcome here, so please say no if you're sick of this, but otherwise would you mind going a little further with me on it?

I reread the DOL letter. This seems to be the key sentence:

"Accordingly, a prohibited use of plan assets for the benefit of a disqualified person under

section 4975©(1)(D) or an act of self-dealing under section 4975©(1)(E) is likely to result

if Mr. Darragh directs the IRA to loan funds to the Corporation."

Here's what 4975©(1)(D) and (E) say:

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

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

Here is my remaining point of confusion: These subparagraphs both refer to things a disqualified person cannot do with the income or assets of the IRA. I understand that I am disqualified both personally and as a fiduciary, which is the reason I think you are saying these subparagraphs apply. I also understand your point that benefits accrue to me as the IRA owner and not to the IRA itself, therefore the guaranty benefits me directly. However the guaranty does not do so by doing anything with the income or assets of the IRA; rather it draws upon the assets of the corporation. In fact the only time it would come into play would be when the IRA has no income or assets. So I am having trouble understanding how (D) and (E) apply here.

If you're still with me and haven't given up in disgust, thanks... ;-)

Tom

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Guest tschotland

Lost in the shuffle here is the fact that many people before me who have signed these personal guarantys are at risk. Does anyone have any thoughts on the best way to get the word out?

I have now spoken with two alternative asset IRA custodians and two introducing brokers, all of whom agree that it is clearly a prohibited transaction. Apparently I created quite a stir at one of the custodians; they told me they had a big meeting where everybody wanted to know if the guaranty was a new thing, and if not, how had they missed it? They said they have thousands of customers trading futures and I was the first person to raise the issue.

I spoke to two other custodians who told me they knew it was a prohibited transaction but their clients do sign the guaranty and it would be up to me to decide to take the risk. Can't they get in trouble for knowingly permitting that to happen?

One of them told me that it wasn't a problem because whenever an IRA enters into a prohibited transaction they resign as custodian. Another said the guaranty would only come into effect when the IRA was broke, so what did it matter if it was a prohibited transaction, there was no money left anyway. I swear, this is what they said.

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As you have now discovered:

1. That many people do something does not make it right. They might never get caught but you might. Is it worth the risk?

2. That some seller of a product says that his product is good, does not make it so. You bear the burden and penalties, if it goes bad. Is it worth the risk?

3. When errors in judgement are discovered and changes are made by purveyors of products, those changes are made at your expense. Is it worth the risk?

4. The quality of the advice you have been getting for a long time. Are you at risk with anything else ? At the least you should have learned that topics are broad and not narrow, which means you have to do your homework and ask good questions when seeking advice. Even more important to check the competency of advisors before you engage and pay.

I think that you still do not quite get it. You are apparently still hung up on you the person and will not move to the issue of the corporation. All you have to do is to read the last few paragraphs of the DoL letter. It is plain and simple. You cannot use the corporation in this self dealing manner. The corporation exists for transacting business not to act as your personal checkbook. Doing so places your corporate status at risk and makes piercing of the corporate veil in litigation or disqualification by regulators or the IRS easy.

Just pay attention to the last few paragraphs which talk about the corporation.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Guest tschotland

> The corporation exists for transacting business not to act as your personal checkbook.

> Doing so places your corporate status at risk and makes piercing of the corporate veil

> in litigation or disqualification by regulators or the IRS easy.

That loud sound you hear is me smacking my forehead. Okay, I think I get it. In my defense I don't see that the DOL letter makes this point, because in it Mr. Darragh is straightforwardly self-dealing with his IRA assets through his company. While what I asked about would not touch plan assets, I think your point is if my corporation is set aside then I am personally extending credit to the IRA. So the issue is not 4975©(1)(D) or (E) as in the letter, but (B). Did I get it right?

Would you agree that a totally unrelated party could sign the guaranty, e.g. a kindly rich uncle? This is just intellectual curiousity at this point. I have no such rich uncle (nor rich anything for that matter), and wouldn't ask him to sign even if I did.

> The quality of the advice you have been getting for a long time. Are you at risk with anything else ?

I've only been dealing with these IRA custodians for the past few weeks, and I don't really count what they say as advice becuase of course they want to sell me their services. I don't think I've received bad advice from my ERISA attorney or accountant in the past, but then again I was never so tuned in to the controversial nature of these things before, so in the past I did not solicit and compare multiple opinions.

Thanks for all your help. Can I buy you a virtual beer?

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Guest tschotland

They blinked.

I have an email from the VP and Senior Compliance Counsel of the futures brokerage to my introducing broker saying I do not have to sign the guaranty. I will sign a document saying I will stop trading if my account drops by 50% (something the CTAs have to do anyway in a retirement account).

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No. Not getting it yet.

It is not the setting aside that would cause anything as much as your actions causing the set aside, but that is another issue.

Although the letter deals with the IRA lending funds to the corporation, the reverse would be the same result. Mr. Darragh has an interest in the corporation which might affect his best judgement as a fiduciary. Hence the sentence in bold print in the letter... "Accordingly, a prohibited use ... or an act of self-dealing under 4975©(1)(E) is likely to result......."

Loan from IRA to corporation or loan from corporation (in which you have a substantial interest) to your IRA is substantially the same. Substance prevails over form.

But you now have the authoritative answer that you were seeking. Now that the CTA etc have been called out, they have essentially admitted that it was wrong in the first place.

As for using a third party, I do not know. Maybe one of the experts in this area ha an opinion and is willing to share.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Guest tschotland

Okay, I know it doesn't matter to me anymore, but I find this kind of fascinating...

4975©(1)(E) talks about a fiduciary's duty with regard to plan income and assets - he can't use them in his own interest. I see that a loan in either direction would violate that. But a guaranty? I see that my ownership of 1/3 of the company "affects [my] best judgment" because it induces me to want to create the guaranty. I see that as IRA owner/fiduciary I get the benefit of it. But a guaranty is not a loan. So the IRA pays nothing to the guarantor. No interest, no principal. Nada. Zilch. This means nothing is done with plan income or assets in anyone's interest.

I know, I know, this horse is ready for the glue factory...

> Now that the CTA etc have been called out, they have essentially admitted that it was wrong in the first place.

I don't want to give the CTAs a bad name - to be clear, this guaranty is entirely a brokerage deal.

Thanks again George.

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Guest tschotland

> This means nothing is done with plan income or assets in anyone's interest.

Unless a negative balance counts as plan assets, in which case that asset does get transferred to the corporation!

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