Help! Can I use my IRA to invest in my employer's IPO?

[Guest Richard Bellamy]

I am an employee of a company with some managerial duties. My employer is having an IPO that I wish to invest in. It would be a sizeable investment, but wouldn't approach 50% ownership (more like 3 or 4%).

I am generally familiar with the prohibited transaction rules, and it doesn't seem to violate any, but my IRA custodian wants me to sign a form removing all of their liability if it turns out to be a prohibited transaction. This is because it is a disqualified person is "an employer, an of whose employees are covered by the Plan." But the IPO should meet the definition of qualified employer securities in the exceptions.

Can anyone see any (other) problems with this investment?

[QDROphile]

There is no exception to prohibited transaction rules against use of IRA asssets for your personal benefit, tangible or intangible. Any time you have an ownership interest in you employer, it raises the prospect that the ownership gets you some goody beyond the investment return to your IRA.

The rule is not the employee of the plan sponsor rule, it is the fiduciary of the account rule. You are a fiduciary of your IRA if you are directing the investments.

[John G]

Will this be a publicly traded company? Are you a Director, Officer or just a standard employee? How many shareholders will exist after the IPO?

There are lots of examples of where a person invests in the IPO of their firm using a Roth or IRA, IF (1) it is a publicly traded company and (2) they are not part of mgmt, a Director, or a highly compensated individual. I can't address the technical legalities, but I know it is done frequently. Just conjecture on my part, but there seems to be a difference between large % ownership in a closely held company and a small piece of a publicly traded company. Not all custodians will handle this kind of transaction. It is very common for custodians to ask for you to sign waivers on any unussual transaction.... that they are relying upon your information and are not providing investment or tax advice, for example.

I would be interested in the opinions of our other tax experts on this one.

[Kirk Maldonado]

There are IRS rulings approving such arrangements.

[Guest Richard Bellamy]

Thanks for the replies. I'm not sure how being "management" or being "highly compensated" affects the calculation, but I think I would qualify under both categories if that effects your conclusions.

Kirk, are the IRS rulings you mentioned precedential?

[Kirk Maldonado]

They only protect the person that applied for and got the ruling.

[mbozek]

The PLRs that have been issued are merely confirmations of the obvious- a common law employee of a corporation (e.g., IBM, Microsoft) does not engage in a PT under the IRC solely because his IRA purchases stock of the corporation.

The one question I have is how is the IRA going to get access to purchase stock since only cash can be contributed to the IRA. Will the terms of the IPO allow you to have your allocated shares purchased by a trustee or custodian under your control?

[John G]

There are probably multiple answers to your question mbozek, but I will suggest two paths with which I am familiar. First, if your IRA custodian is an underwriter of an IPO, you can often request for shares to be purchased directly from the IRA. An example of this would be and IPO or secondary via Schwab, which is also where the account is located. I have done this for a Nazdaq IPO and also for something you might call a private placement. The second example involves an IPO or other offering where there is a subscription process and you have some access or rights (such as by being an employee). A check is cut and sent to the entity making the offering and shares and cash (interest or partial return of dollars because you do not get all the shares you requested) is returned to the custodian. I am not sure if they have set this up as a custodian to custodian or via some other arrangement, but there have been hundreds of this type of transaction dating back at least 20 years. I have done many of these.

Not all custodians will be interested in supporting these kinds of transactions. Some don't understand them. Some have cut their services to the bone and see these as high cost transactions. For example, Schwab used to do these transactions with out any fees. After the dot.com bubble burst and commissions dropped very low, they initiated something like a $175 fee. (I don't remember the exact amount)

These are complicated transactions and I would not recommend a beginner investor to consider them.

[Mary Kay Foss]

This wasn't part of your question, but I felt that I had to comment. If I had an opportunity to invest in a company that I expect to be highly profitable, I would not use my IRA. If the IPO hits a home run, instead of long term capital gains all of the appreciation would eventually come out of the IRA as ordinary income.

If the company doesn't make it, the IRA has no deduction for the loss. The individual would have one.

If you expect a quick run up in value, you could withdraw funds from the IRA, invest them and put them back after 60 days... if you could sleep nights during the interim. If we were in the IPO glory days, you might have enough of a profit so sell just enough to do a rollover within 60 days and retain the rest for long term gains and further appreciation.

The old *eggs in one basket* is another consideration. Having your investments and your livelihood tied up at the same place could be risky.

[John G]

"If the IPO hits a home run, instead of long term capital gains all of the appreciation would eventually come out of the IRA as ordinary income."

No tax issues if it is a Roth. Second problem is that big gains need to be held for a year for LTCG, so selling on a shorter timeframe is more attractive with any IRA.

Life is too unpredictable to fool with the 60 day rollover rule. The best plans can come unravelled very quickly and the taxpayer could be stuck trying to replace the funds.