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.

Entity Investments in Your IRA – Swanson v. Commissioner and the “Checkbook Control” IRA-Owned LLC

Estimated reading time: 6 minutesOne of the most popular ideas in the self-directed IRA industry today is the “checkbook control” IRA.  You may have wondered what exactly it means to have “checkbook control” over your IRA’s funds.  In this article we will examine the celebrated case of Swanson v. Commissioner, on which the idea of “checkbook control” is based.  The entire text of the Swanson case is available on our website at

The essential facts of Swanson are as follows:

1)         Mr. Swanson was the sole shareholder of H & S Swansons’ Tool Company (Swansons’ Tool).

2)         Mr. Swanson arranged for the organization of Swansons’ Worldwide, Inc. (Worldwide). Mr. Swanson was named as president and director of Worldwide.  Mr. Swanson also arranged for the formation of an individual retirement account (IRA #1).

3)         Mr. Swanson directed the custodian of his IRA to execute a subscription agreement for 2,500 shares of Worldwide original issue stock. The shares were subsequently issued to IRA #1, which became the sole shareholder of Worldwide.

4)         Swansons’ Tool paid commissions to Worldwide with respect to the sale by Swansons’ Tool of export property. Mr. Swanson, who had been named president of Worldwide, directed, with the IRA custodian’s consent, that Worldwide pay dividends to IRA #1.

5)         A similar arrangement was set up with regards to IRA #2 and a second corporation called Swansons’ Trading Company.

6)         Mr. Swanson received no compensation for his services as president and director of Swansons’ Worldwide, Inc. and Swansons’ Trading Company.

The IRS attacked Mr. Swanson’s setup on two fronts.  First, the IRS argued that the payment of dividends from Worldwide to IRA #1 was a prohibited transaction within the meaning of Internal Revenue Code (IRC) Section 4975(c)(1)(E) as an act of self-dealing, where a disqualified person who is a fiduciary deals with the assets of the plan in his own interest.  Mr. Swanson argued that he engaged in no activities on behalf of Worldwide which benefited him other than as a beneficiary of IRA #1.

The court agreed with Mr. Swanson, and found that the IRS was not substantially justified in its position.  The court said that section 4975(c)(1)(E) addresses itself only to acts of disqualified persons who, as fiduciaries, deal directly or indirectly with the income or assets of a plan for their own benefit or account.  In Mr. Swanson’s case the court found that there was no such direct or indirect dealing with the income or assets of the IRA.  The IRS never suggested that Mr. Swanson, acting as a “fiduciary” or otherwise, ever dealt with the corpus of IRA #1 for his own benefit.  According to the court, the only direct or indirect benefit that Mr. Swanson realized from the payments of dividends by Worldwide related solely to his status as a participant of IRA #1.  In this regard, Mr. Swanson benefited only insofar as IRA #1 accumulated assets for future distribution.

The second issue the IRS raises was that the sale of stock by Swansons’ Worldwide to Mr. Swanson’s IRA was a prohibited transaction within the meaning of section 4975(c)(1)(A) of the Code, which prohibits the direct or indirect sale or exchange, or leasing, of any property between an IRA and a disqualified person.  Mr. Swanson argued that at all pertinent times IRA #1 was the sole shareholder of Worldwide, and that since the 2,500 shares of Worldwide issued to IRA #1 were original issue, no sale or exchange of the stock occurred.

Once again, the court sided with Mr. Swanson.  The critical factor was that the stock acquired in that transaction was newly issued – prior to that point in time, Worldwide had no shares or shareholders.  The court found that a corporation without shares or shareholders does not fit within the definition of a disqualified person under section 4975(e)(2)(G).  It was only after Worldwide issued its stock to IRA #1 that petitioner held a beneficial interest in Worldwide’s stock, thereby causing Worldwide to become a disqualified person.  Accordingly, the issuance of stock to IRA #1 did not, within the plain meaning of section 4975(c)(1)(A), qualify as a “sale or exchange, or leasing, of any property between a plan and a disqualified person”.

On the surface it seems like the court endorsed the idea of an IRA holder being the sole director and officer of an entity owned by his IRA.  In other words, by having the IRA invested in an entity such as an LLC of which the IRA owner is the manager, the IRA owner gets to have “checkbook control” over his or her IRA’s funds.  This sounds like a great idea.  However, before jumping too fast into this area, there are some issues to consider.

One thing to remember is that the LLC does not insulate the IRA from the prohibited transaction rules.  Amazingly, the IRS and the court in Swanson v. Commissioner ignored completely the fact that Mr. Swanson’s non-IRA owned corporation, Swansons’ Tools, paid commissions to Worldwide, thereby reducing Swansons’ Tools’ taxable income and indirectly benefiting Mr. Swanson.  Especially after the recent case of Rollins v. Commissioner, it seems clear that this would be a prohibited transaction.  In the Rollins case, Mr. Rollins loaned money from his 401(k) plan to corporations in which he served as president but of which he owned only a minority interest.  The corporations were clearly not disqualified persons, but the court nonetheless held that there was an indirect benefit to Mr. Rollins, who was the largest shareholder and an officer of each corporation.

The IRS also might have argued that Mr. Swanson’s service as the president and sole director of Worldwide was a prohibited transaction as described in 4975(c)(1)(C), which prohibits the furnishing of goods, services or facilities between an IRA and a disqualified person.  Although Mr. Swanson stated that Worldwide had no “active” employees, one has to wonder at what point the services rendered to an IRA-owned entity become a problem.  Another question which was not raised in the Swanson case was whether or not an IRA owner having checkbook control over his IRA funds through a 100% IRA-owned entity violates IRC Section 408(a)(2), which requires that the custodian of an IRA be a bank or other qualified institution.  Why have that requirement at all if the IRA owner can get around it merely by having his or her IRA own 100% of an LLC managed by the IRA owner?

Although the Swanson case appears to be good case law, a great deal of care is merited when relying on this case.  Several questions which were not raised in the Swanson case remain unanswered.  As noted by the court, Mr. Swanson was “following the advice of experienced counsel.”  Even then, Mr. Swanson had to fight the IRS in tax court to win his case.  For most people, even getting into a battle with the IRS is a losing proposition.  Some people, perhaps through ignorance of the rules, appear to be abusing Swanson-type entities.  For example, in IRS Notice 2004-8 on abusive Roth transactions, the IRS states that it is aware of situations where taxpayers are using a Roth IRA-owned corporation which deals with a pre-existing business owned by the same taxpayer to shift otherwise taxable income into the Roth IRA.  If the IRS has become aware of the problem, there may come a day when they decide to go after these types of arrangements more actively.

When relying on the Swanson case to set up a checkbook control LLC or other entity, always use experienced legal counsel who is very familiar with how to set up this type of entity and who will be there to guide you on issues such as the prohibited transaction rules, the plan assets regulations, unrelated business income tax issues and the other rules and regulations which may apply.  What happens after the LLC is formed is just as important as the initial setup and can get you into just as much trouble.  To attempt a “checkbook control” entity without knowledge of all the rules and regulations or competent counsel to guide you is sort of like jumping out of an airplane without a parachute – it may be fun on the way down, but eventually you’re going to go SPLAT!