IRA as C-corp investor?

[lexi]

A client wants to start a business but has no liquid assets. He does, however, have an IRA. He would like to direct his IRA to purchase stock of the company he wants to start. I am looking at IRC 4975 and am thinking that this would be a prohibited transaction but IRC Section 4975©(3) has a special rule for IRAs that might (??) allow it?

How do you read 4975's application to this idea? thanks in advance.

[J Simmons]

The penalty for an IRA that engages in a prohibited transaction is not the excise tax, but immediate loss of the IRA's tax advantage on all of the IRA's assets. That can often be more drastic to the taxpayer than the excise tax would have been. 4975©(3) just coordinates that with 408. But true, you don't face the excise tax of 4975 from an IRA's prohibited transaction if the IRA loses its tax advantage under 408.

[Guest mjb]

You need to review the case of Swanson v. IRS where the tax court held that the direction by an IRA owner to have the custodian of his IRA subscribe to an initial offering of stock of a company in which the owner was an incorporator was not a PT because it was not a sale of stock between the IRA and the owner.

[J Simmons]

After the Swanson purchase of the initial issue of stock of the corp, then what? Can the IRA owner have any involvement with operating or working for the C corp without that constituting a prohibited transaction? Does the IRA owner who then directs the IRA to vote the corporate stock to elect himself as the director, or to elect directors who will appoint the IRA owner as an officer, or hire the IRA owner as an employee or consultant, commit a prohibited transaction? Is that an indirect use or benefit? Would free gratis services from the IRA owner to the corporation constitute a 'contribution' to the IRA since he's enhancing the value of the corporate stock and thereby the IRA assets?

[John G]

A client with no liquid assets wants to start a business....

There seems to be many things wrong with that statement. I don't think we are talking about a public IPO where the IRA holdings might be inconsequential.

Where to begin?

1. The planet is currently drowning in private equity funds and venture capital money. What about family money? If this business is a great idea, there will be money to fund it.

2. I would rather own stock and eventually pay long term capital gains then have all that effort get taxed as ordinary income.

3. If this is a risky enterprise, then why would you ever want to bet the farm. A few years back, the fellow who lived next to me "bet the farm" and lost his car, house, wife (she divorced him) and became unemployed in one year. He made a foolish bet on a marginal business and lost two decades of financial achievement.

You did not post enough details to answer the question of was there some format under which this might be allowed. From the little you said, this sounds more like a dream than a realistic idea.

PS: I have started three businesses and been involved in the creation of three others. Money was never a big issue in the start up on any of these. The "idea" was the key driver, followed by the significant mgmt figures.

[lexi]

It is like this:

Man owns IRA.

IRA own corporation outright.

Does the man own the corporation through his ownership of the IRA?