501(a) tax exempt trust

[Guest dubya]

This is pretty much over my head, but in general, does the following sound OK?

An individual leaves a company and has $200,000 in his retirement account there. Now he wants to use this money to buy a separate business, but does not want to be taxed on taking the $200,000. So, he establishes a retirement plan for the new business (C-Corp), rolls the money into this new plan, and purchases shares of the new business with this rollover money. Somewhere along the line, I'm told a 501(a) tax exempt trust was established, that makes this whole scenario work (i.e. uses the rollover money to buy the new business with no tax consequence).

This is not something I am trying to design mind you. I was asked about this from someone who has come across it.

[rcline46]

I have heard of it but......

Is it a prudent investment for the trustee to invest in a start-up? IE would an independent trustee do it?

[Lori Friedman]

Is the individual merely investing in the new business, or is he also involved in its operations? If he has any substantial role in the business, wouldn't there be disqualified person and party-in-interest problems?

[Guest Pensions in Paradise]

This scheme had been discussed before. Do a search on the boards for ERSOP. (sorry, couldn't figure out how to include a link to another thread)

[Guest dubya]

Thanks for the responses. The owner of the rollover money will also be the owner of the company and will be involved in the operation of the business. Thanks for the ERSOP thread. I found it and it answered some questions. Still a pretty confusing topic. The ERSOP thread is almost a year old, I wonder if there has been any more updates on these arrangements?

[QDROphile]

Until you can come up with a plausible explanation why it is not a prohibited transaction, why look further? Among other things you have to explain away Flaherty's Arden Bowl, Inc. v Commissioner.

"The owner of the rollover money will also be the owner of the business ... ." The trust will be the owner of the rollover money. I assume that you mean that the beneficiary of the trust account that holds the equity interest in the business will manage the business (e.g. be a director, officer, employee).

[mbozek]

The only sucessful application of this concept is where an IRA owner directs the custodian to purchase an initial offering of stock from a business that the owner is incorporating which results in the IRA owning 100% of the income from the dividends generated by the business. Under the Swanson decision the issue of an initial offering of stock to the IRA is not a sale which would violate the PT rules of IRC 4975. The client needs to retain a tax advisor who understands the PT rules.

As for the tax aspects isnt the individual taxed on the receipt of the 200K since he is selling his interest the C corp stock to the IRA in exchange for 200k in cash?

[GBurns]

In the explanations that they have attempted to give me, the individual is not selling his interest or his stock, the ERSOP (or whatever) is an additional investor who gets their stock from the company's "Treasury". The individual still has X number of shares and the ERSOP has the additional amount that is issued to match the $200K. The individual also does not receive the cash, the Corporation does.

FLPSOP is another variation on the theme.

By the way, there was more than 1 thread discussing this issue, in fact almost the exact same scenario and phrasing was used by an initial poster to describe the plan. It makes me wonder if we are the victims of Viral Marketing.

http://benefitslink.com/boards/index.php?s...t=0entry77472

[Guest dubya]

GBurns: The thread you referenced is the one I was able to locate. I agree, the wording and structure seems real similar, but thats just a coincidence; no connection.

qdrophile: Your assumption as to what I meant vs. what I wrote is correct.

Has anyone actually seen an IRS determination letter on these "plans"? The crux of the responses seems to be, at best, proceed with extreme caution. Yet, I have a hard time reconciling that an outfit, like ersop.com, or whoever, could market these arrangements without some sort of assurances, whether from the IRS or from other legal minds. Would the IRS issue a determination letter specifically for something like this?

[mbozek]

If the funds used to buy the investment come from rollover money which have been transferred to a Qual plan then there are three different tax consequences depending on how the investment is structured.

1. If the indivdual uses the rollover money to become a minority investor in a private corporation where no other plan participants can invest there is a question of whether this investment violates the BRF rules for non discriminaton in a qualified plan.

2. If the individual uses the funds to invest in another co in which he is the majority owner then you have a PT under the Flahrety's Arden Bowl Inc. decision which is subject to the 15/100% excise tax as well as a BRF issue.

3. If the individual uses the funds in the plan to purchase his interest in the Plan sponsor as some form of ESOP then he could have income tax on the gain on the purchase price paid by the plan.

Receiving a favorable determination letter for qualified plan does not mean that any investment transaction is approved by the IRS because the Service only approves the form of the plan, not its operaton under the tax law. So getting a determination letter does not mean that the individual or the plan will not have adverse tax consequences for making an investment.