Checkbook Control IRA-Owned LLCs Just Got Riskier

Estimated reading time: 10 minutes

By: H. Quincy Long
Attorney at Law and 
CEO of Quest Trust Company

A very popular idea in the self-directed IRA industry is to have what some have termed a “checkbook control” IRA.  Basically, this involves the following steps:  1) an IRA is formed with a self-directed IRA custodian; 2) a brand-new LLC or other entity is formed with the IRA owner as the manager or a director and officer; and 3) the IRA custodian is directed to invest the IRA funds in the newly formed entity.  Voila! The IRA owner has checkbook control over his or her IRA funds and can enter transactions quickly without anyone looking over their shoulder to see that the rules are being followed or doing any paperwork required by the IRA custodian.  Admittedly, this sounds like a wonderful idea from the IRA owner’s perspective, but it is fraught with danger and traps for the unwary, as some taxpayers are now discovering.

Most published Tax Court rulings on this topic have resulted in negative tax consequences for the taxpayers who set up a checkbook IRA. The purveyors of checkbook IRAs will point to a few cases that came down in favor of the taxpayers to ‘prove’ the legitimacy of this technique, and they are correct – to a point.  Unfortunately, there is a lot more to the story. The danger is typically not with the initial set-up of the LLC, but what happens after the LLC is funded and the IRA owners begin directing the investments in their position as managers of the LLC. The rules governing IRA investments are somewhat complex, and most IRA owners do not have the knowledge to comply with those rules. An IRA owner considering this type of set-up must have a working knowledge of the prohibited transaction rules, who is a disqualified person to their IRA, the plan asset regulations, the rules regarding Unrelated Business Income and Unrelated Debt-Financed income, and more. If you or your advisor is not familiar with these rules, a checkbook IRA may not be the best idea for you.

Most of the cases in Tax Court rulings deal with prohibited transactions. The effect of doing a prohibited transaction in the IRA for the owner is to disqualify the IRA as of January 1 of the year in which the transaction took place. If that happens, the IRA owner may be subject to premature distribution penalties, income taxes on the distributions that the taxpayer had because of the disqualification of the IRA, and accuracy-related penalties for unreported income that the taxpayer didn’t know he had because he thought his IRA was making the money tax free. Additionally, there are other taxes and penalties due by any other disqualified person who participates or benefits from the prohibited transaction.

Now a new Tax Court ruling has come down with a new, but predictable, attack on the idea of a checkbook IRA. The case of McNulty v. Commissioner involves the purchase and holding of American Eagle coins through a checkbook IRA, which were stored in a safe in the house of the McNultys. Mr. McNulty’s IRA was disqualified and deemed distributed because of certain undisclosed prohibited transactions, but he was appealing the understatement penalties. Mrs. McNulty was not found to have done any prohibited transaction, but she was in receipt of the American Eagle coins, which the Tax Court held was a violation of the Internal Revenue Code section creating IRAs (Section 408).

Generally, IRAs are prohibited from holding certain ‘collectibles’, including coins. To the extent the IRA invests in collectibles, as defined in the statute, they are treated as a taxable distribution equal to the cost of the collectible. Exceptions from the definition of a collectible are made for gold, silver, platinum, and palladium bullion, and for certain gold, silver, or platinum coins issued by the United States or coins issued under the laws of any state. American Eagle coins fit within an exception and were therefore acceptable investments for an IRA. However, the exception for bullion and coins requires them to be “in the physical possession of a trustee” of an IRA. The debate of what “physical possession” means in this context has been debated for some time now. McNulty v. Commissioner has now confirmed that an IRA owner cannot take possession of bullion or permissible coins without triggering a deemed distribution from their IRA.

  Before establishing their self-directed IRAs, the McNultys claimed that they researched the idea of owning American Eagle coins through an LLC owned by their IRAs. They contacted a purveyor of checkbook IRAs through an LLC structure, and established Green Hill Holdings, LLC for that purpose. Green Hill is a single-member LLC that is disregarded for federal tax purposes, and its sole initial member was Mrs. McNulty’s IRA. The McNultys were appointed as managers of Green Hill. 

The checkbook IRA vendor represented on its website that an LLC owned by an IRA could invest in American Eagle coins and IRA owners could hold the coins at their homes without tax consequences or penalties so long as the coins were ‘titled’ to an LLC. The Tax Court noted that there were no certificates of ownership for the American Eagle coins or any other documentation that establishes legal title. Mrs. McNulty argued that the coins were purchased with funds from Green Hills’ bank account, and the invoices from the coin vendor listed Green Hill as the purchaser. However, the recipient on the shipping labels were either Mrs. McNulty individually or Mrs. McNulty along with Green Hill. 

The coins were shipped to the McNultys’ personal residence and stored in a safe, along with coins purchased with Mr. McNulty’s IRA and coins purchased by the McNultys individually. Mrs. McNulty asserted that the coins were labeled separately before being placed in the safe. The Tax Court questioned whether labeling is sufficient to satisfy the Internal Revenue Code’s prohibition against commingling IRA assets “except in a common trust fund or common investment fund.” However, the Court decided that it did not need to resolve the question since Mrs. McNulty’s physical possession of the American Eagle coins was enough to result in taxable distributions.

The IRS argued that Mrs. McNulty should be treated as having possession of the American Eagle coins irrespective of Green Hill’s existence, Mrs. McNulty’s status as Green Hill’s manager, and its purported ownership of the coins. The McNultys countered that the American Eagles coins were assets of Green Hill and Mrs. McNulty’s physical receipt of them did not constitute taxable distributions from her IRA. Despite numerous disagreements between the parties, the Court ultimately decided that it only needed to answer the question of who can have physical possession of the American Eagle coins purchased with IRA funds. Unfortunately for Mrs. McNulty, the Court ruled that she had taxable distributions from her IRA when she received physical possession of the American Eagle coins irrespective of her status as a manager of Green Hill. This is true even though the IRS conceded that Mrs. McNulty did not engage in a prohibited transaction with respect to her IRA, its investment in Green Hill, or the purchase of the American Eagle coins.

The Tax Court cited legal precedents which indicated that the owner of a self-directed IRA is entitled to direct how the investments are invested without forfeiting the tax benefits of an IRA, and that a self-directed IRA is entitled to invest in a single-member LLC. However, the Tax Court ruled that IRA owners cannot have unfettered command over the IRA assets without tax consequences. Mrs. McNulty’s control over the American Eagle coins was the basis for determining that she had taxable IRA distributions. 

The Tax Court stated that a qualified custodian or trustee is “fundamentally important to the statutory scheme of IRAs, which is intended to encourage retirement savings and to protect those savings for retirement…Personal control over the IRA assets by the IRA owner is against the very nature of an IRA.” The Court further stated:

“Mrs. McNulty had complete, unfettered control over the AE coins and was free to use them in any way she chose. This is true irrespective of Green Hill’s purported ownership of the AE coins and her status as Green Hill’s manager. Once she received the AE coins there were no limitations or restrictions on her use of the coins even though she asserts on brief that she did not use them. While an IRA owner may act as a conduit or agent of the custodian, she may only do so as long as she is not in constructive or actual receipt of the IRA assets.”

“An owner of a self-directed IRA may not take actual and unfettered possession of the IRA assets. It is a basic axiom of tax law that taxpayers have income when they exercise complete dominion over it. Constructive receipt occurs where funds are subject to the taxpayer’s unfettered command, and she is free to enjoy them as she sees fit. Accordingly, the value of the coins is includible in her gross income. Petitioners’ arguments to the contrary would make permissible a situation that is ripe for abuse and that would undermine the fiduciary requirements of Section 408.”

Many checkbook IRA providers will argue that this case is not a big deal, since it only applies to US minted coins and gold, silver, platinum, or palladium bullion, which are required by statute to be “in the physical possession of the trustee.” Of course, if you possess those types of assets in your safe at home this case will be of no comfort to you. Only time and new cases will determine whether this case will be of limited applicability or will be used to expand the ways in which you can lose your IRA.

The problem is that the language used by the Tax Court in this case is very broad. A checkbook control IRA-owned LLC all about getting actual and unfettered access to the IRA’s assets. The perceived benefit is that you escape the oversight of the custodian, who the Tax Court said was “fundamentally important to the statutory scheme of IRAs.” If you are the manager of an LLC owned by your IRA, and your IRA contributes money to that LLC, it’s hard to argue that you don’t have unfettered control over the IRA’s assets. The result in this case did not rely on a violation of the requirement in Section 408(m) that precious metals and coins must be in the physical custody of the trustee or custodian of the IRA. Instead, the issue came down to Mrs. McNulty’s unfettered control over the American Eagle coins. Having such control, according to the Tax Court, is against the very nature of an IRA. You cannot just ignore the statutory scheme of IRAs merely by interposing a disregarded entity between you and the custodian. Mrs. McNulty did not enter a prohibited transaction with her IRA. Her only ‘sin’ was taking possession and control of the IRA’s assets. 

It may turn out that this case is limited in its applicability to possession by the IRA owner of permissible coins and bullion in an IRA. For the sake of the thousands of people who have a checkbook IRA I hope so. Regardless of what happens in the future, one thing is certain – checkbook IRAs just got a whole lot riskier, at least until case law limits the applicability of this case.

One other interesting issue in this case bears mentioning. Section 6662(a) and (b)(2) of the Internal Revenue Code imposes an accuracy-related penalty for any portion of an underpayment that is attributable to a substantial understatement of income tax. The Section 6662(a) penalty will not apply where the taxpayers establish that they acted with reasonable cause and in good faith with respect to any understatement. Reasonable reliance on professional advice may constitute reasonable cause. The McNultys argued that they researched the LLC structure and reasonably concluded that they could take custody of the American Eagle coins through an LLC with IRA funds without tax consequences. The parties did not stipulate what research was done by the McNultys but did stipulate three versions of the checkbook IRA provider’s website, as well as screen prints from the website of the IRA custodian. Additionally, Mr. McNulty argued that he did not know that he had engaged in a prohibited transaction when he filed their tax returns.

The Court was unsympathetic. The IRS asserted that the McNulty’s engagement of the checkbook IRA provider to assist in setting up Green Hill did not present a reasonable cause defense. Instead, the McNultys argued in vague terms that they performed research about an IRA investment in American Eagle coins through an LLC structure, without identifying the source or specific results of the research, other than stipulating parts of the checkbook provider’s and the custodian’s websites as exhibits. The Tax Court questioned whether the checkbook provider’s website and/or services could constitute professional advice upon which a reasonable person could rely. The checkbook IRA’s website is an advertisement of its products and services, and a reasonable person would recognize it as such and would understand the difference between professional advice and marketing materials for the sale of products or services. The McNultys were both employed professionals during the years at issue. The McNultys also did not seek or receive any advice from their CPA who prepared their tax returns for the years in question. The point is that you cannot rely on an advisor who participates in structuring the transaction (i.e., a “promoter”) to avoid penalties. This issue comes up regularly in cases where the IRS is asserting accuracy-related penalties. 

It should be noted that this article is not intended to be tax or legal advice. If tax or legal advice is needed, please contact a knowledgeable professional. I have purposely left out the legal references to make it easier to read. No claim is made to materials subject to copyright. This is not intended to be a legal brief, but rather just a summary of an interesting and important case. The McNulty case is titled Andrew McNulty and Donna McNulty vs. Commissioner of Internal Revenue, as was filed in the United States Tax Court on November 18, 2021.

Pros and Cons of Checkbook Control IRAs: Guest Interview with Attorney Jeff Watson

Estimated reading time: 12 minutes

As Self-Directed IRAs gain popularity in the investing world thanks to their many benefits, one type of account in the industry has taken the spotlight: the “checkbook control” IRA. Many people have heard of the benefits of this account, but have only scratched the surface. For this article, attorney Jeff Watson of joins me to share some of the lesser known details about checkbook control and some considerations people may not be thinking about when choosing to have this type of account.

Sarah: Thank you for joining me today, Jeff. I’m excited to talk a little bit about checkbook control IRAs. For those that aren’t familiar, what is “checkbook control”?

Jeff: I believe there are actually two definitions of checkbook control. They are similar but different.  Checkbook control in the world of Self-Directed IRAs (SDIRAs), and we will just say all Self-Directed retirement accounts, refers to forming an entity such as an LLC or certain trusts. Your SDIRA then invests into that entity. That entity has opened up a business bank account, probably a checking account at a local financial institution, local to the account holder or whoever the manager of the LLC is going to be. That manager then receives physical possession of a checkbook, representing the authority to write checks with the money that, ultimately, is from a SDIRA (or HSA or CESA or SEP, etc.) That is the basic definition of checkbook control. Some people interpret checkbook control to go so far as to say that the account holder – the IRA account holder – is the manager of the LLC or the trustee of the IRA owned trust or the president or other officer of the IRA owned c-corporation. Then, as the account holder, they can direct their own retirement funds with the ability to sign a check or send a wire. That is the more zealous definition of checkbook control and that’s also the definition that gives me great pause. 

Sarah: Why do you think some people may see checkbook control as a controversial issue?

Jeff: There is a huge controversy in this space that is unfortunately not really talked about as much as it should be by those that zealously promote the “quickie” account holder checkbook control. When you are going to look at this, the first thing you have to do is ask, “If the IRA is investing in an LLC, is the operating agreement of the LLC written for the specific purpose of the LLC being owned by an IRA?” The vast majority of the checkbook control mills that you’ll see on the internet do not do a good job of that. I’ve read a lot of their documents, and I just walk away shaking my head. The same issue occurs with IRA owned trusts. Now, that leads us to this other next big concern. LLCs are operated by a manager. That is the legal title that we have use throughout the United States for the person who directs the operations of a Limited Liability Company, an LLC, just like we use the title trustee as the person who has authority to direct the functions of a trust. That person is a human being. If you are the account holder and you are serving as the manager of your IRA owned LLC or you’re the trustee and serving as the trustee of your IRA owned trust, how are you personally NOT providing both a service and a direct benefit to your retirement account? Go take a look at three different code sections. 26 USC 4975 (e)(2)(F) and 4975 (c)(1)(C). Those three section of the code have to do with both direct and indirect benefit, as well as, providing a service, facilities, goods, resources, etc. Those are things that are prohibited by the tax code for an account holder to do for their own IRA, HSA, etc. I’ve not heard anyone give me a good answer as to how you are not personally both providing a service to your SDIRA by being the manager of the SDIRA LLC and providing a direct benefit, but I’m just the guy they come to after they make a mess asking, “How am I going to fix this?” 

Sarah: So, if there are all these potential issues, what would make some want a checkbook control IRA?

Jeff: Speed. Speed of implementation. They believe that the only way they can obtain some of the investment advantages that they are looking for and ease of the investment transaction speed is to have this type of checkbook control. There are some types of investments that I would agree that, yes that is right.  Yes, it is easier with checkbook control for you to tell the manager of your IRA owned LLC that yes, it is okay to go ahead and pay that contractor for the work done on the rental house owned by that LLC or trust that’s owned by your IRA. That’s a little faster and a little bit easier rather than going through a custodian. When you are in a competitive bidding situation such as an auction or when you are in a situation where you must have same day funds, then it is definitely something to do. There’s something interesting there. Today, in our banking world, to say that you are able to have “same day funds” you can’t use a check. You have to be wiring or using ACH, just saying. The way the banking system is going with the movement of money, with more and more movement of electronic money, checks are becoming more and more disadvantaged.

Sarah: I like that you mentioned that. It’s definitely something to consider.

Jeff: Now, I will tell you that I do this. I have an IRA owned trust. My self-directed Roth IRA owns a trust. I am not the trustee. But I do that, because it is the easiest way for me to deal with a rental property owned there and do some of the lending investments that I do. I can have loan pay off on Monday, and I can reinvest that money by Wednesday. I am faster than any custodian out there. I got it. But, if I’m also the guy that people across the USA go to when they need to fix their mess with their IRA but I don’t have personal control, makes you wonder why. It’s like asking, why doesn’t that doctor do the surgery on himself? Maybe because they recognize the real risks. 

Sarah: Going right along with understanding those “risks”… What are some ways that people who may want a checkbook control IRA can ensure that they are being safe and abiding by these rules? I know we talked a little bit about those.

Jeff: Let me tell you some things that I think you must do. 1), you must become familiar with prohibited investments. What are the prohibited transactions? You must become familiar with who is a disqualified person or party or entity. If you don’t understand those three things, you will make an absolute screaming mess. It will be painful and expensive. 2), you need to become aware of what the rules are that are published by the IRS in 26 USC 408, 408a, and 26 USC 4975 that apply to a Self-Directed retirement account. Then, because it is also a checkbook control entity – a trust or an entity that is owned by more than 50% by IRAs – you also need to make sure you are familiar with the Department of Labor Plan Asset Rules. I’m just going to assume that the Department of Labor Plan Asset Rules apply to any IRA owned entity that I touch. That way, I am never left questioning if those rules apply. I’m just going to assume it does and then I act with a greater degree of care; I’m more careful. 

Sarah: What are some other concerns people may have? 

Jeff: There are two things that I would caution you about: Ego and haste. You have a tremendous temptation once you have checkbook control, because now you have the results of decades of contributions to a company 401k. You have money that you can deploy. Well, it took you decades to build that money up. Don’t be in a hurry to go invest it. You need to have a set of checks and balances. What are your checks and balances for determining if it is a good investment, or if all of the necessary and proper due diligence has been done? Quest Trust Company can’t do your due diligence for you, but if you’re investing directly through Quest, you have an element of time. It can give you time to slow down and think about it. Most of the time when I see someone make a bad investment with their SDIRA, particularly those with checkbook control, their always in a hurry. They say, “It’s a great deal and I have to do it now”. The con artist is using urgency as a tool. 

Sarah: You are absolutely right. We talk about due diligence, and how con artists will use tricks like urgency to pull people in and it can be a problem. 

Jeff: Well, they appeal to greed and fear, the two strongest human emotions when it comes to money. Don’t be in a hurry to get rich! Slow and steady consistency wins the race. You’ve taken a couple decades of monthly contributions to your company 401(k). That’s not in a hurry. You did that the right way. 

Sarah: Do you have any other advice for those considering checkbook control?

Jeff: Okay great. So, you understand the rules. You’ve decided you are going to do investments that are suited to checkbook control, specifically to do auction type bidding or you are extremely competent in private lending and so there for you know that funding quickly will be fine. Great. Now, make absolutely certain that the operating agreement for your LLC is properly set up. Make absolutely certain that if you’re going to go in the form of an IRA owned trust that the trust agreement is clearly and carefully written for not only the fact that the trust is owned by IRAs, but for the type of investing it’s going to be doing, also. You just can’t go on the internet and find some free template, fill it out, and think you’re good. 

Sarah: So, where would someone go to find a good resource to ensure they aren’t just pulling things from the Internet, like you say? Because Quest can’t give tax, legal, or investment advice, where would someone go for this help?

Jeff: There are resources… You can read some articles or watch some videos that I’ve put up about it (such as, and if you’re still interested, you can set up a paid consultation. There are other resources like Pay attention to the free videos that Quest and other resources make available. Read, absorb, and listen to all the amazing free content that is out there. The rules haven’t changed. The rules about prohibited transaction rules you learn about in the videos are still applicable. 

Sarah: You’re right. Things this important don’t just fly by the wayside. 

Jeff: Exactly. And what I’m about to tell you next is completely antidotal. Some have said that in some work in dealing with the IRS on Self-Directed IRAs, that the IRS is not interested in checkbook control IRAs where the account holder is NOT the manager. If the account holder IS the manager, they are much more interested, because they feel like there is a greater potential of something being done wrong and a better chance of them successfully auditing and levying. Even if it is half right, it’s sound. The thinking behind it is, if the account holder is smart enough to know that they shouldn’t be the manager of the LLC owned by their IRA, then they are probably smart enough to know the rest of the rules and probably didn’t make a mistake. 

Sarah: Yes, I could see how that would make sense.

Jeff: Has this been published? No.  Is it accurate authoritative information? I don’t know. But does it makes sense?

Sarah: Understood. Definitely something to think about. Those are just some thinking points that people should be considering and be aware of as potential issues. Do you have any other bits of advice for those considering checkbook control?

Jeff: I’m going to give you one other disadvantage. If you take all of the available capital in your IRA and you move it to that LLC, you’re creating a potential problem. 1) You’re going to have this mental roadblock to making consistent monthly contributions still to the IRA. There is a mental roadblock there. There shouldn’t be, but there is. And 2), you have to be absolutely 100% certain you put enough capital into that checkbook control entity so that the rules on recapitalizing don’t come back to bite you. If it’s a single LLC owned by an IRA, you probably can put more capital. If it’s a multiple member LLC, it’s a one and done! You can fund it one time and only one time. 

Sarah: And how could this be a problem?

Jeff: I’ve seen people come together and form and LLC 50/50, 2 IRAs, go buy a rental property and then need more money. If they would have bought that rental property in the accounts that funded the LLC, then as they make more contributions to the accounts, they’ve got more money available to deal with the rental property.

Sarah: That’s a huge disadvantage, for sure.

Jeff: It’s a huge disadvantage if people aren’t thinking ahead. This goes back to: if you are going to do checkbook control, you have to have a really solid business plan. You really are creating a business. You’re forming an LLC, and that LLC has to have a business strategy. It needs to understand what its projected capital needs are, what its projected time horizon is, and what its anticipated rate of return is. If you’re saying that you just want to have it to invest in whatever good deal just comes along, I’m sorry. 

Sarah: I agree, it’s so important to make sure you do what you need to on the upfront so that you are covered on the back end.

Jeff: Exactly. So I don’t have to come fix their situation! Last thing I will leave you with. Remember: bad news travels quick! 

Sarah: You said it best, especially in the IRA world. Well, I hope that with this information more people will take the time to really stop and evaluate if a checkbook control IRA is right for them! Thank you for taking the time to share a bit more about what a checkbook control IRA is and some of the times when it may or may not make sense. When it comes to checkbook control IRAs, knowing what responsibilities will come with checkbook control power is necessary. Knowing that you have other options is also important. If you ever have questions about the safest ways to invest your self-directed IRA, call a Quest IRA Specialist at 855-382-4727 or check out our Youtube channel for educational videos! We are always happy to provide more education.  To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE.

What Are Private Entities?

Estimated reading time: 3 minutes

Are private entities the same as private companies? How do private entities gain funding? 

If you’re curious about what exactly a private entity is and what makes them different from public companies, then this article is for you.

You may already know that private entities are privately owned businesses, but there’s a lot more to them than that. Continue reading to learn how private entities work and what makes them different from private companies.

What is a Private Entity?

There are a few groups that can be considered a private entity in the business world. A partnership, corporation, individual, nonprofit organization, company, or any organized group that is not government-affiliated can be considered a private entity.

Because private entities are not publicly traded companies, they do not have public stock offerings on Nasdaq, American Stock Exchange, or the New York Stock Exchange. They do offer private shares to investors who can trade among themselves.

This means that they do not need to meet the Securities and Exchange Commission’s (SEC) strict filing requirements that public companies do. That means their shares are less liquid, and their valuations are harder to determine.

How Do They Work?

A private entity relies on a small group of chosen investors in order to grow and fund their business. This could be employees, colleagues, friends, family, or even large institutional investors. Interested parties are able to support the private entity in order to help the company grow.

Once it reaches a certain size, a private company may eventually decide to go public. This means they are able to have an IPO or initial public offering of stock shares on a public exchange. However, many private companies prefer to remain private to maintain family ownership or avoid the high costs of an IPO.

It is also possible for a public company to go private if a large investor buys out the majority of the stock shares and removes them from public exchanges.

Private Companies vs. Private Entities

The difference between a private entity and a private company is that a private entity is not determined based on the Companies Act of 2013. Instead, they are determined by ownership and holding. Sole proprietorships and partnerships are examples of private entities.

A sole proprietorship is a small business that is owned by an individual. They are the easiest way to organize a company in the U.S. They are set up to create a financial structure that makes the owner and company itself the same person for legal purposes.

All private companies are private entities, but not all private entities are private companies that are registered under the Companies Act of 2013.

How Do Private Entities Trade Stocks?

Shareholders of private companies receive dividends and profits from their stocks, just like public companies. However, there are some major differences that exist. Buyers and sellers of private shares must set their own prices and negotiate sales themselves. 

It can be difficult to figure out the worth of private shares since they aren’t traded often. Plus, no set price exists for the shares. They do not need to report trades to the SEC. This means privately-owned companies tend to be subject to fewer government regulations than publicly traded companies.

However, there is also a greater risk when becoming a shareholder of a private entity. 

Make the Most of Your Small Business

Now that you know the facts about private entities, you may be wondering how to start one of your own. There is a lot to consider when becoming a sole proprietor or private entity, including how to save for your future retirement.

To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE. Just because you own your own business doesn’t mean you can start saving now.

Owning a Checkbook Control IRA

Estimated reading time: 3 minutesCheckbook IRA is a term that makes reference to IRA accounts that gives holders of a certain account complete control of their investments by using a checking account. To do this, the person in control of the account makes sure things like a trust are created, and these are only able to be managed by the administrator for the account or the holder of the account. Then, a bank account is opened by the IRA, which leads to the owner receiving a checkbook for the account. Investments can now be made by writing a check. So what are the pros and cons of owning a checkbook IRA?


There are many pros to having a checkbook IRA, but the main benefit to having a checkbook IRA is how much control the owner of the account is given. If there is not a checkbook connected to the account, the holder of the account must regularly stay in contact with the manager of the account so that investments can be made. Checkbook IRAs can also create savings on custodial fees. Usually, a fee will be charged on each investment made using an IRA. Directly making investments allows an owner of an IRA account to avoid large fees that could be charged simply for investing money into their own personal account. Minimal fees may still be charged, but it will be smaller and it will only have to be paid annually.


Though paying less to make investments does sound really good, there will no longer be a custodian to look over any of your investments before they can be confirmed. Many problems could arise, but the most common problem is that an investment that is not allowed to be used towards IRA funds might be made, which could lead you to getting penalized by the IRA. You also have the option of running into misreports of investments around the time of taxes. Custodians are usually people who get paid for helping you go through with investments and make sure that you are paying your taxes. They are also in charge of your W-4 yearly.  If there are any mistakes with transactions, the custodian is likely to end up misreporting.

When to Use Checkbook IRAs

Though they seem easier to use, checkbook IRAs are not easy for everyone to use. The best people to use these accounts are people who have become very familiarized with how investments work and the processes behind tax accounting. This is a perfect account for someone like a Certified Public Accountant, and since many of them work in private practices, they are not likely to run accounts from an employer. They can still set up accounts for retirement, though. Since they are able to understand investments that are deferred from taxes and understand what can happen with their investments once a transaction goes through, a custodian may not be beneficial to them and further actions with investments. Being unfamiliar with the regulation could be dangerous to your IRA if you are self-directing it.

Checkbook Control IRA-Owned Entities Under Attack

Estimated reading time: 10 minutes

By: H. Quincy Long

 A very popular idea in the self-directed IRA industry is to have what some have termed a “checkbook control” IRA.  Basically this involves the following steps:  1) an IRA is formed with a self-directed IRA provider; 2) a brand new LLC or other entity is formed with the IRA owner as the manager or a director and officer; and 3) the IRA custodian is directed to invest the IRA funds in the newly formed entity.  Voila! The IRA owner has checkbook control over his or her IRA funds and can do deals quickly without anyone looking over their shoulder to see that the rules are being followed.  Admittedly, this sounds like a wonderful idea from the IRA owner’s perspective, but it is fraught with danger and traps for the unwary, as some taxpayers are now discovering.  The IRS has been attacking this type of setup, especially when they involve Roth IRAs.

             The genesis for the idea is largely attributable to the case of Swanson v. Commissioner, a Tax Court case which was decided in 1996.  In that case, Mr. Swanson set up a self-directed IRA at a bank and formed a corporation of which he was appointed the director and president.  He then directed the bank to subscribe to the original issue shares of the corporation so that his IRA became the sole shareholder.  Subsequently Mr. Swanson transacted business between his IRA owned corporation and his privately owned corporation.  These transactions were prohibited transactions, but the IRS’ litigation position was limited to arguing that the purchase by the IRA of the original issue shares and the payment of dividends from the IRA owned corporation back to the IRA were prohibited.  Mr. Swanson had very good lawyers, and the IRS eventually conceded the case as it related to the alleged prohibited transactions.

The Swanson case certainly generated a lot of excitement, but a careful examination of the case reveals that the Tax Court ruling is limited.  Far from approving the entire concept of a “checkbook control” IRA owned entity, as some people allege, Swanson v. Commissioner can only be relied on for two concepts:  first, that the purchase of the original issue stock of the corporation was not a prohibited transaction because prior to the IRA purchasing the stock there were, by definition, no owners, which meant that there could not have been a transaction between the IRA and a disqualified person (the court ruled that the corporation did not become a disqualified person until it was funded, which raises other interesting issues); and second, that the payment of dividends from the IRA owned corporation back to the IRA was not a prohibited transaction as a direct or indirect benefit to Mr. Swanson, since the only benefit of the dividend payments accrued to his IRA and not to Mr. Swanson personally.  As the Tax Court noted in Repetto v. Commissioner, discussed below, in the Swanson case “the central issue was whether the IRS was substantially justified in its litigation position for the purpose of determining whether the taxpayer was entitled to an award of reasonable litigation costs.” Mr. Swanson recovered from the IRS litigation costs in the amount of $15,780.  Significantly, what was not at issue in the Swanson case was the fact that Mr. Swanson did benefit personally from the business transactions between his privately owned corporation and the corporation owned by his IRA, since these transactions were not addressed by the IRS in their litigation position.

On December 31, 2003, the IRS released IRS Notice 2004-8, entitled Abusive Roth IRA Transactions.  The notice generally covers a situation which is very similar to Mr. Swanson’s, in that it typically involves the following parties:  (1) an individual who owns a pre-existing business such as a corporation or a sole proprietorship, (2) a Roth IRA that is maintained for the taxpayer, and (3) a corporation or other entity, substantially all the shares of which are owned or acquired by the Roth IRA.  The privately owned business and the Roth IRA owned entity enter into transactions which are not fairly valued and thus have the effect of shifting value into the Roth IRA in an attempt to avoid the statutory limits on contributions to a Roth IRA.  Also covered by Notice 2004-8 is any transaction in which the Roth IRA corporation receives contributions of property, including intangible property, by a person other than the Roth IRA without a commensurate receipt of stock ownership, or any other arrangement between the Roth IRA corporation and the taxpayer or a related party that has the effect of transferring value to the Roth IRA corporation comparable to a contribution to the Roth IRA.  Under these circumstances the setup is deemed to be a listed transaction, which means that the taxpayers must disclose the transaction to the IRS or face significant penalties.  These transactions may be attacked in a number of ways, including as an excess contribution under Internal Revenue Code (IRC) Section 4973, or in appropriate cases a prohibited transaction under IRC Section 4975.

On April 24, 2009, the Office of Chief Counsel for the Internal Revenue Service released Chief Counsel Advice (CCA) #200917030.  Like Advisory Opinion Letters from the Department of Labor, a CCA does not set legal precedent, but nonetheless they are instructive on how the IRS views the topic and can be influential in the way a case is handled by the IRS and in Tax Court.  This CCA covered a situation in which the taxpayers, a husband and wife, set up a corporation owned by their Roth IRAs into which they would direct payments for consulting, accounting, and bookkeeping services they provided to other individuals and businesses.  The taxpayers provided services to various clients, including the company for which the husband worked but did not own, through the Roth IRA corporation, purportedly as employees of the corporation, but without compensation.  When the Roth corporation filed its corporate income tax return it properly disclosed the listed transaction.  However, the taxpayers did not disclose the listed transaction on their individual tax return.  Instead, they only disclosed an excess contribution to their Roth IRAs on IRS Form 5329, which they said had been removed so as to avoid the 6% excess contribution penalty.  The CCA indicated that in this case, like the transaction described in IRS Notice 2004-8, the structure of the transaction purportedly allowed the taxpayers to create a Roth IRA investment that avoids the contribution limit by transferring value to the Roth IRA corporation comparable to a contribution to the Roth IRA, thereby yielding tax benefits that are not contemplated by a reasonable interpretation of the language and purpose of Section 408A (the Internal Revenue Code section pertaining to Roth IRAs).  Effectively, the taxpayers in this case were transferring the value of their services to the Roth IRA corporation, which in turn paid dividends back to their Roth IRAs.

In the recently released Tax Court Memo 2012-168, Repetto v. Commissioner, the IRS argued and the Tax Court agreed that the Repettos had entered into a listed transaction as contemplated by IRS Notice 2004-8, but had failed to report it properly.  The Repettos formed a partnership called Ozark Future LLC with a builder, Porschen Construction, Inc., to build spec homes.  Eventually the Repettos formed a Subchapter S corporation called SGR and transferred their ownership in Ozark Future to the newly formed corporation.  In 2003 the Repettos met with the CPA for Mr. Porschen and another person who was both an attorney and CPA.  The attorney suggested that the Repettos form 2 corporations, each of which would be owned 98% by their respective Roth IRAs.  The new Roth IRA corporations would provide services to SGR, and the relationship with between SGR and Ozark Future would remain the same.  Although the Repettos did not have a good understanding of the structure, they agreed to have the attorney set it up.  In order to set this up with Roth IRAs, the Repettos made an excess contribution to their Roth IRAs.  After the Roth IRAs and the corporations were set up, SGR entered into 10 year agreements for the Roth IRA corporations to provide services to SGR at SGR’s place of business, which was the Repettos’ home, including bookkeeping, marketing and other administrative functions.  The Roth IRA corporation owned by Mrs. Repetto’s IRA paid her a small salary in 2004-2006, and also had a medical and dental care expense reimbursement plan beginning in 2004.  The total dividends declared to Mr. Repetto’s Roth IRA were $117,600 and the amount declared to Mrs. Repetto’s Roth IRA was $127,400.  The Tax Court relied on the substance-over-form and sham transaction doctrines to find that the service agreements were nothing more than a mechanism for transferring value to the Roth IRAs.  The service agreements did not change who provided the services to SGR, since the Repettos continued to do all the work as they had done prior to when the purported service agreements were entered into. In the end, among other penalties the Repettos had to pay excise tax penalties under IRC Section 4973 based on the value of their Roth IRAs at the end of each year, plus additional penalties for failure to timely file a return since they failed to attach Form 5329 to their tax return to report their excess contributions, plus more penalties for having failed to properly report their participation in a listed transaction.  The Repettos’ reliance on the CPA and attorney who set up the plan did not save them from the penalties, since the advice was from the promoters of the investment or advisers who had a conflict of interest.

As of the writing of this article, there is another case pending before the Tax Court (Peek and Fleck v. Commissioner) involving a Roth IRA owned corporation which was formed by the Roth IRAs of two otherwise unrelated parties.  The corporation was originally owned by traditional IRAs which were later converted into Roth IRAs.  The IRA owned corporation purchased an operating business which was sold some years later for a significant capital gain.  The IRS is alleging that the taxpayers, who were employed by the corporation, violated the prohibited transaction rules by 1) guaranteeing personally a note signed by the corporation owned by their IRAs, and 2) having their IRAs invest in the corporation pursuant to an understanding or arrangement that the corporation would thereafter provide benefits to them as individuals, including the payment of wages to them and lease payments for facilities from the corporation to an LLC owned by their wives individually.  I will update this article when the final decision comes out, but it looks bad for the taxpayers at this time, in my opinion.

It is noteworthy that in each of these cases the IRA owners were actively involved in business activities which allowed them to shift value to their Roth IRAs from their personal services.  Two other issues could arise from checkbook control IRA owned entities, but these issues have not been litigated as far as I know.  First, the direct or indirect provision of goods, services, or facilities between a plan (including an IRA) and a disqualified person (including the IRA owner), is a prohibited transaction under IRC Section 4975(c)(1)(C).  At some point the IRS may allege a prohibited transaction under this section for someone who is a manager or director and officer of a company owned by their IRA.  Second, IRC Section 408(a)(2) requires the trustee of IRA funds to be a bank or non-bank custodian.  It is possible that attempting to avoid the proscription against IRA owners handling their own IRA funds with the simple imposition of an entity might be some day be attacked as invalid by the IRS.

Perhaps the only good news is that none of the attacks on IRA owned entities mentioned in this article have dealt with a situation where the entity only made investments as opposed to running a business and where no prohibited transactions were otherwise involved.  Even in this “perfect” scenario there is danger, as the prohibited transaction rules are somewhat complex and the IRA owner may inadvertently cause the IRA owned entity to enter into a prohibited transaction with complete innocence.  Yet, as stated in the case of Leib v. Commissioner, “good intentions and a pure heart are no defense” when it comes to the prohibited transaction rules.

One thing which is patently obvious to me about this area – if you are going to have your IRA own a checkbook control entity, you and/or your advisor had better have a very good understanding of 1) the prohibited transaction rules under IRC Section 4975, 2) the Plan Asset Regulations contained in 29 C.F.R. §2510.3-101, 3) Interpretive Bulletin 75-2, which is contained in 29 C.F.R. §2509.75-2, and 4) at least when it comes to a business or debt financed property owned by an IRA or an IRA owned entity, how Unrelated Business Income Tax (UBIT) contained in IRC Sections 511-514 comes into play.  If you are being advised by someone to set up a checkbook control IRA owned entity and they cannot explain how these rules apply to your entity clearly and how they interact with each other, then run the other way.  To fail to understand completely the rules is like jumping out of an airplane without a parachute – it may be incredibly fun on the way down, but eventually you’re going to go SPLAT!

© Copyright 2012 H. Quincy Long.  All rights reserved.

Self Directed IRA Myths – Groom Law Group

Estimated reading time: 16 minutes

Written by Richard Matta of Groom Law Group

A search of the internet quickly reveals that there are hundreds, if not thousands, of websites promoting one of the hottest financial concepts – the so-called “self-directed individual retirement account.” These range from sites offering simple “hands off” custody and recordkeeping services, to traditional broker-dealers marketing trading accounts, to promoters of “how to” books, to what amount to little more than modern-day snake-oil sales pitches. Similarly, bookstore shelves are lined with guides to building IRA wealth through nontraditional investments.

Many of these products are quite legitimate, and the sponsors work hard to provide meaningful information to help accountholders distinguish between legally acceptable investment practices and activities that may result in unfavorable tax consequences or, worse, complete loss of the tax-advantaged IRA status. Sometimes it is simply impossible to cover a subject in a comprehensive manner, and the materials warn accountholders to hire knowledgeable counsel. Nonetheless, in the opinion of the author, most of these materials perpetuate certain myths – even among the lawyers – that range from merely incomplete to outright wrong.

Why? In part, because neither the Internal Revenue Service (“IRS”) – which has jurisdiction over IRAs themselves – nor the Department of Labor (“DOL”) – which has jurisdiction over prohibited transactions – has in the past devoted significant resources to IRA issues, nor have the two agencies devoted much effort to coordinating their views. Thus, while a great deal of learning has developed under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), in connection with qualified retirement plans, in many cases this information has not carried over to IRAs. Until the last few years, most IRAs were small, and were marketed as “retail” products by different channels (and sometimes different financial institutions entirely) from those that dealt with the “institutional” ERISA market.

What are some of these myths? Mainly, they are concepts that have arisen in connection with the establishment of a limited liability company (“LLC”) as a wholly-owned subsidiary of an IRA, for the purpose of making non-traditional investments – what are often called “alternative investments” on the institutional side – i.e., things other than traditional mutual funds, stocks and bonds such as venture capital, real estate, derivatives and the like. These myths include the following, all taken verbatim from various self-directed IRA websites:

There appears to be no question that funding the LLC after the IRA’s initial purchase of shares constitutes a prohibited transaction because the LLC becomes a disqualified entity after funding

Comment: As discussed below, we believe this is simply wrong.

“Once the LLC is funded, you no longer need the custodian to write the checks. The LLC can write its own checks, and since you’re the manager, you have control

Comment: Though this may be the right answer, the author has not seen a single IRS ruling that confirms this is correct in the case of an LLC owned 100% by an IRA. (Where the IRA owns less than 100%, the authorities are somewhat clearer.) The Swanson case, discussed below, emphatically does not support this conclusion. There are good legal reasons why this may be false.

If you and your brother had a company and you owned 49.5%, then your IRA could buy, sell or loan to it without penalty.”

Comment: Wrong – this is a highly risky proposition. Ironically, the DOL advisory opinion most frequently cited as support for the proposition that this is not prohibited actually says that a prohibited transaction is likely to result.

Can I make a loan to my brother, aunt, cousin or stepchild so that they can use the money as a down payment on a home? Yes. According to IRC 4975, siblings, aunts, uncles, cousin and “step relations” are not included in the definition of disqualified persons. Thus any dealings between your IRA and these would not be a prohibited transaction.” (A variation on this is that you can hire your brother to manage real estate owned by your IRA, and pay him a salary with IRA assets.)

Comment: Also wrong. This is related to the prior question about a company owned by the accountholder and his/her brother, and the answer is the same – it very well  could be a prohibited transaction. Getting it wrong means loss of the IRA’s tax exempt status.

Each of these myths is discussed in more detail below.

Several of these concepts derive from Swanson v. Commissioner, 106 T.C. 76 (1996), cited by at least one IRA custodian as a “landmark” decision around which “an entire industry has been built” but which, in the opinion of the author, was much ado about nothing. The IRS raised the wrong arguments and failed to raise the right ones, and the tax court appears to have arrived at the “right” answer only by accident, via a nearly incomprehensible analysis. As discussed below, one key “holding” of the court was not a holding at all, and is also inconsistent with later authorities. Swanson is a weak foundation on which to rest a multi-billion dollar industry.

Myth No. 1: An entity 50% or more owned by an IRA is a disqualified person

The issue here at first blush appears to be rather straightforward. According to the tax court in Swanson (or as best we can understand the court’s reasoning):

Step 1. The IRA accountholder in that case was a fiduciary with respect to his own IRA. As a fiduciary, he was a “disqualified person” with respect to the IRA.

Step 2. The accountholder was also a “beneficiary” of the IRA. As such, he was deemed “beneficially” to own the shares of a corporation that was owned 100% by his IRA.

Step 3. Under the attribution rules of Code section 4975, any corporation owned 50% or more by a disqualified person (directly or indirectly) is also a disqualified person.

Consequently, once the IRA acquired 50% or more of the corporation, any subsequent dealings between the IRA and the corporation would be a prohibited transaction. Straightforward, yes, but erroneous. The court’s analysis rests upon the following constructive ownership rule:

Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries….

Swanson, 106 T.C. at 86, n. 15 (quoting Code section 267(c)(1)). Because the IRA was a trust, this means that the accountholder, as the trust’s sole beneficiary, was deemed constructively to own stock of any corporation held by his IRA. So far, so good. However, being a beneficiary alone did not make the accountholder a “disqualified person,” and neither would it make the corporation a disqualified person. Rather, the court found the accountholder was a disqualified person because he was a “fiduciary” with respect to his IRA. However – and this is an important but rather subtle point – a fiduciary acting only as such is not a disqualified person. A fiduciary is only a disqualified person when acting in his own interest, or in the interest of other persons, i.e. , “outside” the IRA.

This conclusion was spelled out rather plainly by the Department of Labor only one year after Swanson. And it is the DOL, not the IRS, that has primary jurisdiction to interpret these rules. Specifically, in 1997 DOL issued an advisory opinion to the Financial Institutions Retirement Fund regarding its holding of the stock of a wholly owned corporation named “Pentegra.” DOL Adv. Op. No. 97-23A (Sept. 26, 1997). The plan capitalized Pentegra with $400,000 in exchange for 100% of its stock. The plan’s trustees requested an advisory opinion that subsequent transactions between the plan and Pentegra would not be prohibited transactions. The concern was that because the trustees as plan fiduciaries held legal title to the Pentegra stock, 50% or more of Pentegra’s stock would be deemed “owned” by the trustees, causing Pentegra to become a party in interest and disqualified person with respect to the plan, under the exact same theory that was applied by the court in Swanson. DOL concluded that such ownership would not make Pentegra a party in interest (under ERISA) or disqualified person (under the Code):

Although, pursuant to ERISA section 3(14)(G), plan fiduciaries would hold all the value of Pentegra stock, they would hold such shares on behalf of the plan, not on behalf of themselves or a third party. As explained below, it is the opinion of the Department that, under the circumstances described, such transactions would not be prohibited because, under the terms of the “plan assets/plan investments” regulation (29 C.F.R. 2510.3-101), they would be treated as “intra-plan” transactions rather than transactions between a plan and a party in interest.

It is true that the Pentegra advisory opinion only addressed a 100% owned subsidiary (as did the Swanson case). However, nothing in the opinion suggested that it would not also apply where a plan owns 50% or more, but less than 100%, of the subsidiary entity (the 1980 DOL advisory opinion addressed a single fiduciary owning 100%, but on behalf of multiple plans). However, any remaining doubt was dispelled in a later opinion issued on behalf of Verizon Investment Management Corp. Adv. Op. No. 2003-15A (Nov. 17, 2003). In that case, Verizon set up an investment vehicle for various Verizon plans as well as plans of unaffiliated companies. The Verizon Master Trust, through its bank trustee (a fiduciary), owned more than 50% (but less than 100%) of the fund. Verizon sought confirmation that this ownership would not cause the fund to become a party in interest or disqualified person with respect to the Verizon plans. In confirming this conclusion, DOL noted that:

Consistent with section 3(14) of ERISA, a plan’s ownership of fifty percent or more of a partnership entity will not cause that partnership to become a party in interest with respect to that investing plan. In our view, the application of section 3(14)(G) should not change that result merely because a plan’s interests in a partnership are held by a fiduciary on behalf of the plan. Although [bank fiduciary] would hold more than fifty percent of the value of the [partnership] interests, it would hold such interests on behalf of the Verizon Plans, not on behalf of itself or a third party. As a result, it is the view of the Department that the [partnership] will not be a party in interest with respect to the Verizon Plans. Therefore, transactions between the Verizon Plans and the [partnership], including initial and subsequent contributions to the [partnership] by the Verizon Plans and distributions from the [partnership] to the Verizon Plans, would not be prohibited under section 406(a) of ERISA.

[Emphasis added.] Although the DOL cited only the relevant sections of ERISA, they noted in a footnote that this conclusion also extended to the parallel sections of Code section 4975, and thus it is directly applicable to LLCs or other entities owned by IRAs.

Myth No. 2: Putting your IRA assets into an LLC gives you “checkbook control.”

 Scores of websites tout the “Checkbook IRA LLC” or variations thereon as allowing the accountholder to take control of his or her IRA assets away from the custodian. Under this theory, the IRA accountholder directs the custodian to purchase “shares” (units) of the LLC, opens up a checking account in the name of the LLC, and thereafter simply signs the LLC’s checks without any participation of the custodian.

There are valid legal arguments why this might work if the IRA owns less than 100% of the shares of the LLC (which is a different and more complicated concept), but does it work where the IRA is the sole owner of the LLC? The answer is far from clear. IRS regulations state that an individual retirement account “must be a trust or custodial account” whose assets are “held by a bank” or by an approved non-bank custodian. Proponents of the LLC structure apparently argue that the “assets” of the IRA in this instance are simply the shares of the LLC (which are held by a bank), and that any checking account set up by the LLC belongs to the LLC, not the IRA. This is absolutely true under state law (and has important ramifications in terms of limited liability and asset protection.). But it does not follow that the IRS would agree for tax purposes. In fact, there are good reasons why it may not agree.

A similar issue arises under ERISA, and it is helpful to begin there. Under ERISA, assets of a retirement plan also must be held in trust. DOL has adopted “plan assets” regulations that determine under what circumstances you “look through” an entity (such as an LLC) to determine that its assets are deemed to be assets of a plan. These rules also apply to IRAs. In this case, the rules indicate that when a plan (including an IRA) owns 100% of the shares of an LLC, the LLC’s assets always are deemed to be assets of the plan (they may also sometimes be plan assets even if the plan owns less than 100%). Back to the trust rules – other ERISA regulations expressly state that in the case of a “plan assets” entity such as an LLC, assets held by the LLC (such as a checking account) are exempt from ERISA’s trust requirement.

The IRS has not adopted a similar exemption from the IRA trust/custody requirements. Nonetheless, most practitioners assume that the IRS would apply a similar analysis to IRA investments in plan assets vehicles, and there is certainly evidence that they have not challenged such investments in pooled plan assets funds (hedge funds, for instance).

However, there is a different reason to ask if the IRS would allow checkbook control in the case of a 100% owned LLC. The reason is simple – a single-member LLC that does not elect to be taxed as a corporation 5 is a “disregarded entity” for tax purposes. According to the IRS:

A disregarded entity is [one] that is treated as an entity not separate from its single owner. Its separate existence will be ignored for federal tax purposes unless it elects corporate tax treatment. In other words, for federal tax purposes – and we see no reason why this does not extend to the IRA custody rules – an IRA-owned LLC does not exist. Accordingly, in the eyes of the IRS, assets held in the name of the LLC are no different from any other assets of the IRA, and arguably remain subject to the IRA bank custody requirements.

What is the risk? In theory, the IRS could argue that “checkbook LLC” assets that are controlled by the IRA accountholder have been constructively distributed and are subject to immediate taxation.

Myth No. 3: So long as you own less than 50% of an LLC, you are not prohibited from transacting business between the LLC and your IRA 

In a 1988 advisory opinion, the DOL was asked whether a loan from an IRA to a corporation owned approximately 47% by the IRA accountholder would be a prohibited “lending of money or other extension of credit” under Code section 4975(c)(1)(B). Applying (correctly) the reasoning discussed above under Myth No. 1, the DOL concluded that the IRA accountholder was a “fiduciary” with respect to the IRA, and thus a disqualified person. However, DOL further acknowledged that the corporation was not a disqualified person because the accountholder owned (in his personal, rather than fiduciary, capacity) less than 50% of the corporation’s stock. Accordingly, DOL agreed that the loan was not a prohibited transaction under section 4975(c)(1)(B).

Citing this opinion, more than one website suggests that so long as you keep your ownership in an entity below 50%, you are free to transact business between the entity and your IRA.

However, although it is correct that the transaction was not a prohibited loan, it does not follow that it was not otherwise a prohibited transaction. To the contrary, the last paragraph of the advisory opinion reaches the opposite conclusion:

Accordingly, a prohibited use of plan assets for the benefit of a disqualified person under section 4975(c)(1)(D) or an act of selfdealing under section 4975(c)(1)(E) is likely to result if [the accountholder] directs the IRA to loan funds to the Corporation. [Emphasis added] It is not entirely obvious why DOL was not a bit clearer in pointing out that the applicant did not ask exactly the right question. One possible answer is that while the existence of a prohibited loan essentially is per se a prohibited transaction, whether a transaction involves a “use” of plan assets or “self-dealing” involves an element of subjective intent. However, if you caused your IRA to lend money (or buy, sell or lease assets, or pay fees) to a business in which you have any substantial interest, it is hard to imagine that it is not your intent to derive a personal benefit from the transaction. (Or at least it would be hard to prove.)

In a 2004 decision, the Tax Court concluded that a taxpayer engaged in a prohibited “use” of 401(k) plan assets when he cause the plan to loan money to three entities in which he owned minority interests (roughly 25 to 33%). Rollins v. Commissioner, T.C. Memo 2004-260 (Nov. 15, 2004). In a 1987 decision, the Second Circuit found (among other things) that the investment of a plan’s assets in a company in which two plan fiduciaries collectively owned approximately 11% (one was also president of the company) was an act of self-dealing. Lowen v. Tower Asset Management, Inc., 829 F.2d 1209 (2d Cir. 1987).

Can these cases be reconciled with Swanson, where the taxpayer caused a corporation he owned “outside” his IRA to pay commissions to a corporation owned by his IRA? Perhaps – one possible difference is that in Swanson the flow of funds was from the taxpayer’s personal account to his IRA, not the other way around. However, we may never know, as it is not clear that either the IRS or the court examined the underlying commission payments in that case except for unrelated business income tax purposes.

Myth No. 4: You are free to loan your IRA assets (sell or buy assets, etc.) to anyone so long as that person is not a disqualified person

 This is a variation on Myth No. 3. The idea seems straightforward enough: if a family member (or corporation, or LLC, etc.) is not a disqualified person, then it is not a prohibited transaction to use your IRA assets to loan money to, or buy property from, or pay a salary to, such person. True, the absence of a disqualified person means that there is no transaction “with” a disqualified person. But, the transaction can also involve “self-dealing,” which is a separate prohibited transaction.

How can it be self-dealing if the benefit flows not to me personally, but to my brother? Because the definition of self-dealing is far broader than is commonly understood. Code section 4975(c)(1)(E) provides that self-dealing means any “act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account .” [Emphasis added.] Regulations adopted pursuant to this rule note that:

These prohibitions [against self-dealing and kickbacks] are imposed upon fiduciaries [such as self-directed IRA accountholders] to deter them from exercising the authority, control or responsibility which makes such persons fiduciaries when they have interests which may conflict with the interests of the plans for which they act. In such cases, the fiduciaries have  interests in the transactions which may affect the exercise of their best judgment as fiduciaries. Thus, a person may not use the authority, control or responsibility which makes such person a fiduciary to cause a plan to pay an additional fee to such person (or to a person in which such fiduciary has an interest which may affect the exercise of such fiduciary’s best judgment as a fiduciary) to provide a service.

Treas. Reg. § 54.4975-6(a)(5). This regulation goes on to say that:

A person in which a fiduciary has an interest which may affect the exercise of such person’s best judgment as a fiduciary includes, for example, a person who is a disqualified person by reason of a relationship with such fiduciary described in section 4975(e)(2)(E), (F), (G), (H), or (I). [That is, certain disqualified persons such as family members and certain businesses in which the person is an owner, officer, director, etc.]

However, the mere fact that a family member or business enterprise is not a disqualified person does not mean that the accountholder does not have an interest in the person that may affect his/her best judgment as a fiduciary. The regulation clearly states that disqualified persons (including certain family members) are examples of persons in which you have an interest that may affect your judgment as a fiduciary. It does not follow that you do not have an interest in your brother, aunt, step-child, etc. DOL in one situation suggested that owning as little as 1.8% of a business was at least relevant to the question of whether a fiduciary had an impermissible interest. At best, some practitioners have suggested that the above regulation might shift the burden of proof from you (to prove you have no interest in a person) to the government (to prove that you do) – it is neither a bright line nor a safe harbor.

If I did make a loan to my brother, how could I prove that I did not have an impermissible personal interest in doing so? Perhaps I could demonstrate that that it was in the best interest of my IRA to make the loan, because he was a good credit risk and had other lenders lined up to make the same loan, or because he agreed to pay a higher-than-market rate of interest and provided excellent collateral. But, is it worth the risk, which could entail loss of the IRA’s tax exemption?


 Mr. Matta is a Principal with the Groom Law Group, Chartered. However, the views expressed herein are the personal opinion of the author and do not necessarily reflect official positions of his firm. The statements contained herein should not be considered legal advice and should not be relied upon by anyone without seeking advice of their own counsel. To comply with U.S. Treasury Regulations, we also inform you that, unless expressly stated otherwise, any tax advice contained in this memorandum is not intended to be used and cannot be used by any taxpayer to avoid penalties under the Internal Revenue Code, and such advice cannot be quoted or referenced to promote or market to another party any transaction or matter addressed in this memorandum.


Entity Investments in Your IRA – Advantages, Cautions and Legal Considerations

Estimated reading time: 5 minutesThis article is part of a series of articles discussing some issues arising when investing your IRA into an entity, such as a limited liability company, corporation, limited partnership, or trust.  Other articles in this series include prohibited transactions and disqualified person, unrelated business income (UBI) and unrelated debt-financed income (UDFI) as it relates to entity investments, the plan asset regulations and other regulations which may apply, and formation and management issues, including the “checkbook control” LLC which has become so popular in the self-directed IRA industry.

There are advantages, cautions, and legal considerations when investing in an entity within your IRA.  Advantages of having your IRA own an entity include:

1)         Your IRA’s funds may be held in the entity’s name at a local bank.  This can be an advantage when getting cashier’s checks for the foreclosure or tax lien auction, paying earnest money or option fees, or paying contractors who prefer local checks, among other things.

2)         Certain types of investments, such as real estate closings or investments at foreclosure auctions, may in some circumstances be easier to facilitate through an entity.

3)         Investing your IRA’s funds through an entity may give your IRA some asset protection.  Always check with local legal counsel!

4)         In certain limited circumstances, you may be able to act as a manager, director or officer of your IRA-owned entity without compensation.

5)         If the entity’s shares are all that the IRA owns, administration fees may be lower.

6)         If the director, officer or manager is a trusted friend, you may more easily control what happens with your IRA’s funds.

Cautions when investing your IRA through an entity include:

1)         Check with your CPA or tax advisor on the local, state and federal tax implications of the entity you want your IRA to invest in.

2)         Select competent legal counsel to guide you who is familiar with the restrictions imposed by the Internal Revenue Code, including the prohibited transaction rules of Section 4975, as well as the plan asset regulations.  Otherwise, you may inadvertently engage in a prohibited transaction.  Make sure that the investment in the entity is not prohibited in itself and also that the company is not structured in a way that the operations of the company will lead to a prohibited transaction.

3)         All fees for the formation of the entity and for the preparation of any necessary tax returns as well as any taxes due must be paid from funds belonging to the IRA.

4)         Unless the entity is taxable itself, to the extent it owns debt-financed property or operates as a business, unrelated business income tax (UBIT) may attach to the profits from the entity.  Remember, there is no distinction between general and limited partners.

5)         Your third party administrator generally does not review the formation document or the by-laws, operating agreement or partnership agreement.  The nature of a self-directed IRA is that the IRA holder is responsible for the contents of the agreement, and usually must read and approve the subscription agreement and operating or partnership agreement prior to the administrator signing.  Typically, the only review that is undertaken is to make sure that the ownership of the asset is correctly listed in the name of the IRA.  Also, bear in mind that the administrator does not review any investment for compliance with IRS guidelines, so the IRA holder and his or her advisers should be very familiar with any restrictions.

Other things for you and your legal counsel to consider include:

1)         You should review the entity agreements to make sure that an IRA or qualified plan is permitted to be a shareholder, member or partner.  The agreement should specify the voting procedure for shares held by an IRA or qualified plan.

2)         There should be no transfer or buy-sell restrictions that would restrict the shares if the IRA is distributed either because the IRA holder dies or because the shares are distributed as part of a Required Minimum Distribution (RMD), or if the IRA holder decides to move the shares to a different custodian or administrator.

3)         The IRA holder and other related disqualified persons generally cannot receive compensation from the company.

4)         Depending on the ownership percentage by the IRA and other disqualified persons, it may be a prohibited transaction to fund additional capital calls.  If so, only the amount of the initial commitment can be funded.  Many administrators or custodians have restrictions on future capital calls.  The concern is that if the IRA and other disqualified persons fund more than 50% of the entity the entity will become a disqualified person to the owning IRA and future capital contributions might be considered a “transfer to, or use by or for the benefit of, a disqualified person of the income or assets of the plan” in violation of Internal Revenue Code §4975(c)(1)(D).

5)         If the IRA holder is or may soon be subject to required minimum distributions, either the IRA holder must have sufficient resources left in the subscribing IRA or other traditional IRA’s to cover the RMD, unless there will be guaranteed sufficient distributions from the entity to fund the RMD.  Otherwise, shares of the entity may have to be distributed.  This would cause significant difficulties both for the IRA holder and for the entity.

6)         Because of the limited review by the custodian or administrator of the formation documents and the investment, the IRA holder and his or her advisor should do the normal due diligence on the company, including investigating all of the principals involved reviewing the financial strength of the company, verifying with the Secretary of State that the company is in good standing, and checking with the Securities and Exchange Commission , the Better Business Bureau and any other governmental or non-governmental agency to see if any complaints have been filed against the company.  The IRA holder is 100% responsible for evaluating the company and the investment.

Entity Investments in Your IRA – Prohibited Transactions and Disqualified Persons

Estimated reading time: 5 minutesThis article is part of a series of articles discussing some issues arising when investing your IRA into an entity, such as a limited liability company, corporation, limited partnership, or trust.  Other articles in this series include advantages and cautions when making entity investments, unrelated business income (UBI) and unrelated debt-financed income (UDFI) as it relates to entity investments, the plan asset regulations and other regulations which may apply, and formation and management issues, including the “checkbook control” LLC which has become so popular in the self-directed IRA industry.

As with any self-directed IRA investment, when investing your IRA in an entity you must know what transactions are prohibited and who is disqualified from doing business with your IRA or benefiting from your IRA’s investments. The general rule, as defined in Internal Revenue Code (“IRC”) Section 4975(c)(1), is that a “prohibited transaction” means any direct or indirect

A)       Saleor exchange, or leasing, of any property between a plan and a disqualified person;

B)        Lending of money or other extension of credit between a plan and a disqualified person;

C)        Furnishing of goods, services, or facilities between a plan and a disqualified person;

D)        Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of the plan;

E)        Act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

F)         Receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

Essentially, the prohibited transaction rules are intended to discourage disqualified persons from dealing with the assets of the plan in a self-dealing manner, either directly or indirectly. The assets of a plan are to be invested in a manner which benefits the plan itself and not the IRA holder (other than as a beneficiary of the IRA) or any other disqualified person.  Investment transactions are supposed to be on an arms length basis.  There are various exceptions and class exemptions to the prohibited transaction rules, but unless you know of a specific exception, the wisest course is to stay away from a transaction involving one of the above situations.

Note that the last two restrictions listed above (E and F) apply to a special class of disqualified persons who are also fiduciaries.  These two provisions are designed to ensure that the fiduciary does not participate in a transaction in which he or she may have a conflict of interest.  At least in the context of a self-directed IRA, the IRA holder is considered to be a fiduciary of the plan.  Other fiduciaries may include officers, directors and managers of entities owned by IRA’s.  Fiduciaries of retirement plans owe a duty of undivided loyalty to the plans for which they act.  The prohibitions are therefore imposed on fiduciaries to deter them from exercising the authority, control, or responsibility which makes them fiduciaries when they have interests which may conflict with the interests of the plans for which they act.  Any action taken where there is a conflict of interest which may affect the best judgment of the fiduciary is likely to be a prohibited transaction.

All prohibited transactions involve a plan and a disqualified person.  There are nine different classes of disqualified persons.  They are:

1)         A fiduciary, which is defined to include any person who – exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets; renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so; or has any discretionary authority or discretionary responsibility in the administration of such plan.

Note that this definition of a fiduciary is much broader than in traditional trust law, and at least with a self-directed IRA includes the IRA holder who exercises control over the management or disposition of its assets.

2)         A person providing services to the plan.  This can include attorneys, CPA’s and your third party administrator.

3)         An employer any of whose employees are covered by the plan.

4)         An employee organization any of whose members are covered by the plan.

5)         An owner, direct or indirect, of 50 percent or more of the voting power of stock in a corporation, the profits or capital interest in a partnership, or the beneficial interest in a trust or other unincorporated enterprise which is an employer or employee organization described above.

6)         A member of the family of any of the above individuals, which is defined to include only a spouse, ancestor, lineal descendant and any spouse of a lineal descendant.

Caution:  Although other members of the family are not disqualified persons (for example, brothers, sisters, aunts, uncles, step-children), dealing with close family members may still be a prohibited transaction because of the indirect rule.  For example, in the IRS Audit Manual it states:  “Included within the concept of indirect benefit to a fiduciary is a benefit to someone in whom the fiduciary has an interest that would affect his/her fiduciary judgement (sic).  An example would be the retention by the fiduciary of his/her son to provide administrative services to the plan for a fee.”  This is true even though the son’s provision of services to the plan may be exempt under the “reasonable compensation” exception.

7)         A corporation, partnership, trust, or estate owned 50% or more, directly or indirectly, by the first 5 types of disqualified persons described above.  Note that indirect ownership may include ownership by certain related parties such as spouses.

8)         An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person who is an employer or employee organization, the owner of 50% or more of an employer or employee organization, or a corporation, partnership, trust, or estate which is itself a disqualified person.

9)         A 10 percent or more (in capital or profits) partner or joint venturer of a person who is an employer or employee organization, the owner of 50% or more of an employer or employee organization, or a corporation, partnership, trust, or estate which is itself a disqualified person.

As I always say, “Don’t mess with the IRS, because they have what it takes to take what you have!” A Quest Trust Company self-directed IRA is an excellent tool to help your retirement savings grow, often at rates far exceeding those of ordinary IRA’s.  Knowing these rules is a critical step in learning to use your self-directed IRA in a way that will safely lead to vastly improved retirement wealth.

Entity Investments in Your IRA – Who Cares About the Plan Asset Regulations?

Estimated reading time: 5 minutesThis article is part of a series of articles discussing some issues arising when investing your IRA into an entity, such as a limited liability company, corporation, limited partnership, or trust.  In this article we discuss the plan asset regulations and how they may impact your investment in an entity.

What are the plan asset regulations and why should you care about them if you are investing your IRA through an entity?  If the plan asset regulations apply to your entity investment, there are two major effects.  First, your IRA is deemed to own not only the equity interest in the entity but also an undivided interest in the underlying assets of the entity for purposes of the prohibited transaction rules of Section 4975.  To see how this works, suppose you want to sell a piece of real estate to your IRA.  Unfortunately, the prohibited transaction rules say you cannot sell any property to your IRA.  So can you form an LLC owned by your IRA and sell the property to that LLC instead?  The answer is no, because under the plan asset regulations selling the property to your IRA-owned LLC is the same as selling it directly to your IRA, which is prohibited.

Second, if the plan asset regulations apply, the officers, directors and managers of an entity may be considered fiduciaries of the investing IRA, which means the prohibited transaction rules apply to them and other disqualified persons related to them.  This is a critical issue and has many implications.  Basically all of the prohibited transaction restrictions which are imposed on the IRA owner now also apply to the managers of the LLC.  As fiduciaries they are responsible for making decisions in the best interests of the IRA as opposed to their own best interests or the interests of parties related to them.  For example, suppose an LLC is formed which is subject to the plan asset regulations.  Because the manager of the LLC is now a fiduciary of the investing IRA, neither the manager nor any other disqualified person related to the manager may sell property to, exchange property with, or lease property from the LLC.

Because of the serious implications of these regulations, when investing your IRA through an entity you should evaluate whether or not they apply.  If you are forming an entity or advising clients as an attorney, knowing when these rules apply is crucial since it may affect how the entity is structured and whether or not you agree to accept retirement plan money.

When do the plan asset regulations apply?  The plan asset regulations apply to any investment which is not a publicly offered security or a mutual fund unless either 1) the entity is an operating company (essentially, a business), which can include a real estate operating company or a venture capital operating company or 2) equity participation in the entity by benefit plan investors is not significant (meaning total retirement plan investors own less than 25% of each class of securities).   This means that the plan asset regulations will apply unless the entity either is running a business (in which case the unrelated business income tax rules apply) or unless all retirement plan investors together own less than 25% of each class of securities.  Even if the entity meets the requirements for an operating company, the regulations still apply if an IRA or a related group of IRA’s own all of the outstanding shares of the entity.

According to an additional set of regulations which stem from the Department of Labor’s Interpretive Bulletin 75-2, even the investment in the entity itself may be a prohibited transaction if a fiduciary (including the IRA owner) causes the plan to invest in an entity and as a result of that investment the fiduciary or another disqualified person derives a current benefit.  For example, if the IRA invests in or retains its investment in an entity and as part of the arrangement it is expected that the entity will hire the fiduciary or a related disqualified person, such arrangement is a prohibited transaction.  Under those same regulations, if a transaction between a disqualified person and an IRA would be a prohibited transaction, then it will ordinarily be a prohibited transaction if the IRA and other disqualified persons collectively have voting control in the entity.

There is no doubt that this is a complex topic which is hard to explore in a short article.  In most cases, the plan asset regulations will apply to your IRA’s entity investment.  If so, you should be aware of the following implications:

1)         Your IRA’s assets include a proportionateinterest in each company asset.

2)         Company managers, directors, officers and advisers are likely fiduciaries of the IRA.

3)         Because they are likely fiduciaries, certain compensation and indemnification plans for officers and directors may give rise to prohibited transactions.

4)         Prohibited transactions may result if the company engages in business transactions with disqualified persons, including the company’s managers, directors, officers, advisers and related parties to them.

If you hire an attorney or a company to assist you in setting up an IRA-owned LLC or other entity, including the “checkbook control” LLC, make sure they have a complete understanding of the prohibited transaction rules of Section 4975 and the associated regulations, the plan asset regulations, and the regulations from Department of Labor’s Interpretive Bulletin 75-2.  Sadly, there is a perception that investing an IRA through an entity is somehow a “prohibited transaction washing machine” which will protect the IRA from all the pesky rules of Section 4975.  In fact, the opposite is true, since the additional layers of complexity make it more likely that an inadvertent prohibited transaction may occur.

For those who want to know more, the prohibited transaction rules may be found in Internal Revenue Code (26 U.S.C.) Section 4975.  The regulations for Section 4975 are in 26 C.F.R. 54.4975-6.  The plan asset regulations are in 29 C.F.R. 2510.3-101.  The regulations relating to Department of Labor Interpretive Bulletin 75-2 are found in 29 C.F.R. 2509.75-2.