Investing in your own company in a Roth IRA

[dh003i]

This is a theoretical question. The way a Roth IRA works is that initial contributions are taxed, but any growth of those contributions, no matter how great, is completely tax-free. So, could someone set up a Roth IRA, and invest in his own company, of which he has complete shareholder ownership, and then place the profits generated in the Roth IRA, by passing off cash as dividents on the stock? (of course, this assumes that one could run a profitable company, which most people can't do).

[BPickerCPA]

Check out the prohibited transactions rules.

[dh003i]

Any specifics? The prohibited transaction rules for Roth IRA's specifically, or just general prohibited transactions? SOmething that would be mentioned in All you ever wanted to know about Roth IRAs but were afraid to ask?

[mbozek]

The only way it can be done is for the owner of an unincorporated business to incorporate it and give instructions to the IRA custodian to subscribe to the initial issue of all the stock of the company for $3000. The IRA as the owner can collect 100% of the dividends. You would need to retain experienced tax counsel.

[BPickerCPA]

Mbozek,

Wouldn't there also be a prohibition against the IRA owner running the corporation?

[Appleby]

I’m with Barry .

The type transaction mentioned above does not appear on any list of PTEs.

IRC 4975(b)(1)(A) Defines a "prohibited transaction" as any direct or indirect

sale or exchange, or leasing, of any property between a plan and a disqualified person;.

Included in the definition of a plan is “an individual retirement account”

Included in the definition of a disqualified person is :

1) an owner, direct or indirect, of 50 percent or more of

------- a) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation

------- b) the beneficial interest of a trust or unincorporated enterprise,

For the purposes of the prohibited transaction rules it does not matter whether the business is incorporated

[mbozek]

The IRA is the owner of the stock. See Swanson v. Commissioner, 106 TC 76 (1996) for authority.

[KJohnson]

The following article has a in-depth discussion of Swanson and the related PT rules:

http://www.trustsandestates.net/IRAsFLPs/I.../IceSwanson.htm

The one thing about Swanson that has always made me a bit wary, is that the IRS did not assert an"I know it when I see it" self-dealing prohibited transaction under Sections 4975©(1) E or F. Here is Mr. Ice's take on that issue:

On the whole, Swanson is a very supportive case. One cause for concern, however, is the statement by the court that the IRS “never suggested that petitioner, acting as a “fiduciary” or otherwise, ever dealt with the corpus of IRA #1 for his own benefit.”[76] This may have been an oversight by the IRS. Even if the taxpayer escapes the net cast by the specific litany of prohibited transactions, there is always the IRC §4975©(1)(E) and (F) catch-all provisions prohibiting a fiduciary from dealing “with the income or assets of a plan in his own interest or for his own account; or . . . [receiving] any consideration for his own personal account . . . in connection with a transaction involving the income or assets of the plan.” This attack was apparently not raised by the IRS in Swanson.

[Appleby]

In Swanson v. Commissioner, the IRA formed the corporation and remained the owner of the corporation. In the example given by dh003i, wouldn't the IRA would be conducting a sale with an already existing disqualified person?.

Note: Summary opinions may not be treated as precedent for any other case-- IRC 7463(b),

[Appleby]

Another source of reference is DOL Adv Op 2000-10A though this contradicts my POV

It is interesting to note that the DOL refused to give an opinion on whether the transaction would violate sections 4975©(1)(D) and (E) (see highlighted section).

Notwithstanding … it is the IRS that has the final authority to determine if an IRA is disqualified as a result of a prohibited transaction, not the DOL

[mbozek]

IRAs are only subject to PT rules enforced by IRS since they are not plans subject to DOL regulaton under ERISA. The exemption requires that the business be incorporated and that the IRA become the owner of the shares though a subscription of a new issue. Also in Swanson the the business owner was the incorporator of the business and fiduciary of the IRA who directed the custodian to puchase all of the shares of the corp. By the way, the IRS has accepted Swanson, see FSA 1999-524.

[KJohnson]

The one area where DOL does have jurisdiciton is that if you have a transaction that would be a PT and you want an exemption. DOL has the power to issue exemptions that are binding under both 408 of ERISA and 4975 of the Code.

[Appleby]

BenefitsLink Retirement Plans Newsletter 12/31/03

related IRS Notice http://benefitslink.com/IRS/notice2004-8.pdf