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Personal Guaranty Creates Prohibited Transaction?


Guest tschotland
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That a guaranty is not a loan is irrelevant.

The guaranty serves to cause you to benefit. Simple.

And No, things can be done in the interest of many, just not those disqualified, otherwise ineligible, or those with conflict of interest issues.

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'm gonna change this up on you...

Let's get rid of the guaranty. Let's say that I get some company that I own part of to provide a service to my plan at no charge. So I benefit from the service. Company gets no benefit. Plan income/assets are never touched. Still prohibited?

Just my curiousity talking at this point - if you're sick of this I'll go quietly...

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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.

I can believe they said it. I've heard similar things from financial institutions over the years.

If you want to ruin someone's day, you might point out to them that the guaranty itself is the PT, not whether or not payment is actually made. Further point out to them IRC Sec 408(e)(2)(B) which clearly provides that the entire IRA is treated as distributed and fully taxable. Then ask them how many clients they have, representing how many dollars in IRA accounts, where their clients have unknowingly entered into a guaranty on their advice, thereby making the entire IRA taxable.

Nah, on second thought they probably still won't get it.

Glad to see they caved. Good job.

I'm addicted to placebos. I could quit, but it wouldn't matter.

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After I posted the excerpt, I wondered if I should not have given the whole quote. Now I see that I should have. But I won't bother.

The operative phrases are "for the benefit of a disqualified person" and "an act of self-dealing".

As for your new scenario, not much changes.

Who is the company going to charge for the service rendered ? If no one, then you have misappropriation by a misuse of corporate assets. Your additional worry would be what would happen in an audit of the plan or the company. Service rendered to you or for you is reportable income to you. You might even have under or misreporting charges. No different from private use of a company car or jet. You benefit, you pay.

Again, regardless of how many shares you have, a corporate entity is not your private fiefdom, as many like Kozlowski of Tyco found out.

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 Jim,

I did point that out - it didn't seem to make much of an impression though.

Your point about all the clients who have unknowingly put their retirement funds at risk is not lost on me. I am glad I managed to navigate these waters safely, but I would like to find a way to warn others. I would be willing to write a short article on it, but I've no clue where to submit it.

By the way, your "it's like a credit line at a bank" argument was really useful to me in making my case to the futures brokerage. Thanks for that.

One of the IRA custodians seems to have something on the ball. The rep I talked to many days ago told me they know that signing the guaranty is a prohibited transaction and it was up to me to decide to take the risk. However yesterday they emailed me an agreement they make the brokerage sign. Among other things it provides as follows:

1) The agreement supercedes anything the brokerage has signed in the past with either the custodian or the client.

2) Any margin calls or debit balance may only be met from available funds, allowable annual contributions, or rollovers/transfers from another retirement account.

So the custodian's agreement undoes the personal guaranty.

I find this kind of fascinating. If you execute both agreements on the same day, is there still a prohibited transaction?

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If you sign the guaranty that should immediately be the point of the creation of a PT. Why in heavens name do you think that the custodian could give you anything that would undo the PT ? Are you considering that somehow the custodian has the power to override regulations and decide for the DoL and IRS what their enforcement should be ? That is even more questionable than the custodian being able to override an agreement that they are not a party to. The guaranty you said was between the brokerage and the guarantor.

In any case if the custodian agreement undoes the guaranty, Why would the guaranty be needed? Something is 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 operative phrases are "for the benefit of a disqualified person" and "an act of self-dealing".

This point was not lost on me. Don't forget, you won the war - I agree with you that the company can't sign the guaranty. We just can't seem to reach agreement on what the decisive battle was. I am hung up on the fact that the IRC sections cited in the DOL letter (4975©(1)(D) and (E)) refer to plan income and assets, which the guaranty never touches. On the other hand, if the corporation is set aside because I have abused it, then 4975©(1)(B) applies. So I think it would go like this with the IRS:

IRS: Mr. Schotland, why didn't you pay attention to that nice Mr. Burns? He warned you that you couldn't use your corporation as a personal bank account! Your corporation, which would not in and of itself be a party in interest, is now no different than yourself. That means you have personally extended credit to your plan. IRC 4975©(1)(B) says that's a no-no. We are hereby vaporizing your IRA.

Me: Mumble...

On the other hand, if the IRS tried using 4975©(1)(D)/(E) I think it would go like this:

IRS: Mr. Schotland, didn't Mr. Burns warn you that as fiduciary you can't do anything that benefits yourself? Where do you get off having your own corporation sign that guaranty? It's a clear act of self-dealing. IRC 4975©(1)(D)/(E) say that's a no-no...

Me: Wait a minute, those sections say I can't do anything to benefit myself with plan income or assets! Well I never touched 'em!

IRS: Mumble...

My example of the corporation providing a free service to the IRA was poorly chosen because as you point out, getting the service for free amounts to a kind of income. I can't think of anything analogous to the guaranty at the moment that might make my point clearer in another context.

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Guest tschotland

> In any case if the custodian agreement undoes the guaranty, Why would the guaranty be needed? Something is missing.

The whole thing is very strange. It's like the custodian is trying to outfox the brokerage - the brokerage is hoping the client doesn't notice, and the custodian is hoping the brokerage doesn't notice.

I have no idea if the IRS would actually forgive the PT. But it appears to be a goal of the custodian's agreement to make any guaranty null and void. It seems this custodian is at least aware of the problem with them.

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Many things in the tax world have broad meanings. You are being too narrow with "plan income and assets". The guaranty relates to, affects and is affected by the plan assets. If that was not so, there would be nothiing to use the guaranty for.

Consider what the term "tax return" means. To some it means 1040 and 1120 etc only. To me, and the IRS it also means 941, W2C etc etc etc.

Every nit-picking attempt that I have ever seen has failed when challenged or was not worth the effort to defend. Then there are the ever present issues of substance over form and economic substance.

Weigh the pros and cons, make your decision, then pray. Good Luck.

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

Thanks George, I see your point.

I no longer have to sign the guaranty, plus you convinced me not to sign it anyway. This was just my curiousity talking. I hope I am never in a position where I have to nitpick the IRS.

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Guest tschotland

> Nice to see that you weren't self-destructing after all. Good luck!

Thanks vebaguru. Say, would you mind clearing one thing up for me? Early in this thread you wrote:

> Would you be doing any leveraging? While leveraging such trades is common,

> it creates a separate set of problems. Similar to PTs, the penalty for debt-financed

> unrelated business taxable income is plan disqualification.

While I have no plans to do anything with borrowed money, I was surprised by this because I thought that debt-financed transactions were permissible in retirement plans, though one might have UBTI. For example, I think many people do real-estate deals in their IRAs using non-recourse loans secured only by the property. Are you saying this is prohibited? Or are you talking about something else?

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You have me puzzled.

What is the similarity that you see between leveraged trading of any sort and the financing of a real estate purchase ?

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

> What is the similarity that you see between leveraged trading of any sort and the financing of a real estate purchase ?

If you have $50K in your IRA and want to buy a $100K house you need a loan (a note+mortgage). If you have $50K in your IRA and want to buy $100K of stock you need a loan (a margin loan). In both cases you are using borrowed money to purchase an asset that is worth more than you have.

The leverage you get with futures trading is different in that it doesn't involve borrowing (although, just as with options, financing costs do figure implicitly in the cost of carry).

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> What is the similarity that you see between leveraged trading of any sort and the financing of a real estate purchase ?

If you have $50K in your IRA and want to buy a $100K house you need a loan (a note+mortgage). If you have $50K in your IRA and want to buy $100K of stock you need a loan (a margin loan). In both cases you are using borrowed money to purchase an asset that is worth more than you have.

The leverage you get with futures trading is different in that it doesn't involve borrowing (although, just as with options, financing costs do figure implicitly in the cost of carry).

George's point was that in your previous post you equivocated the two... now you're stating they're different which proves George's point. Perhaps it would be best if you stop asking follow-up theoretical questions as you seem to only be confusing your issues even further.

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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Guest tschotland

> in your previous post you equivocated the two

Which previous post do you mean? Way back near the start of this thread I was careful to distinguish between the leverage one gets from margin borrowing and from futures trading. I'm making the same distinction now.

If the consensus here is that additional questions are not welcome I will stop posting.

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Which previous post do you mean?

In this case that would mean your post #62, which is your posting that was "previous" or "immediately prior" to George's post #63.

You took Vebaguru's posting explicitly referring to leveraging of trades and you posted a follow-up question that referred to real-estate. It was this that George questioned in post #63 as you were putting the two items on equal footing (in your post #62). In post #64, you stated leveraged trading and real-estate were different. So in post #65, I attempted to point out what point George was making in post #63, which you seemed to have not understood in your post #64.

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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Guest tschotland
Which previous post do you mean?

In this case that would mean your post #62, which is your posting that was "previous" or "immediately prior" to George's post #63.

You took Vebaguru's posting explicitly referring to leveraging of trades and you posted a follow-up question that referred to real-estate. It was this that George questioned in post #63 as you were putting the two items on equal footing (in your post #62). In post #64, you stated leveraged trading and real-estate were different. So in post #65, I attempted to point out what point George was making in post #63, which you seemed to have not understood in your post #64.

Okay, got it.

There are two types of leveraged trading being referred to: leveraged equity trading, which requires a margin loan, and leveraged futures trading, which does not. George asked about what similarity I saw between any sort of leveraged trading and debt-finanaced real-estate. I wasn't equivocating, I was distinguishing between these two types of leverage and describing the similarity of one of them to debt-financed real estate.

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No, you don't "got it", but let us leave it at that.

Good luck.

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 vebaguru,

Looks like my question was posed in an unclear way, so I'll restate it.

Early in the thread you wrote, "The penalty for debt-financed unrelated business taxable income is plan disqualification." Would you consider taking out a margin loan to buy stock to be an example of that? How about taking out a mortage to acquire a piece of property? Can you give me a citation for the part of the IRC that deals with this?

Thanks.

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In most cases I have seen, purchasing assets in excess of what the plan can afford to pay cash for will require a personal guarantee, which will result in a prohibited transaction. This is true whether the borrowed funds are used to purchase a piece of real estate, securities or otherwise.

Debt financing using a non-recourse note secured only by the plan's assets will not result in a PT, but may result in UBIT.

cf, http://www.sterlingtrustcompany.com/Default.aspx?tabid=468 and Pensco

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Guest tschotland

Oh okay, it was the guaranty you were worried about, not the borrowing. Sorry, I didn't get that in your original post.

I was asking about this mostly out of curiousity, but a couple years back I almost did a non-recourse loan to buy a property in my plan and that old post had me thinking I had dodged a bullet!

Thanks again for all your help (and to everyone else here as well).

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