Peek Vs. Commissioner highlights IRA prohibited transaction rules for a personal loan guarantee but allows for investment through a self-directed IRA.
The recent Tax Court case Peek v. Commissioner (140 T.C. No. 12, May 9, 2013) reinforced the ability for a retirement account investor to use retirement funds to invest in a wholly owned entity without triggering a prohibited transaction. In the Peek case, the U.S. Tax Court ruled that a taxpayer’s personal guaranty of a loan by a corporation owned by the individual’s IRA is a prohibited transaction under section 4975(c)(1)(B). The Court found that the taxpayers had provided an indirect extension of credit to the IRAs, a prohibited transaction under Internal Revenue Code § 4975 that disqualified the IRAs. The Tax Court did not, however, have an issue with the taxpayer forming a special purpose corporation to make the investment as well as serve as director and registered agent of the corporation.
“Even though the Peek case centered on the IRA prohibited transaction rules, the Tax Court could have argued that establishing a special purpose entity wholly owned by a self directed IRA and managed by the IRA holder is a prohibited transaction, but it did not,” stated Adam Bergman, a tax attorney with the IRA Financial Group. “The Peek case is yet another Tax Court case that confirmed that an individual can use IRA funds to invest in a newly established entity and manage it without triggering the IRA prohibited transaction rules.”
Section 4975(c) prohibits specified transactions between (i) various plans including IRAs and (ii) “disqualified persons” (or “parties in interest” under the ERISA version of these rules), which in the case of an IRA includes the IRA owner. Subject to certain exemptions, pursuant to Internal Revenue Code Section 4975, a disqualified person cannot engage in transactions with the plan that, among other things, constitute direct or indirect: (i) Sales, exchanges, or leasing of property; (ii) Lending of money or other extension of credit; (iii) Furnishing of goods, services, or facilities; or (iv) Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan.
In the Peek Case, two taxpayers, Mr. Lawrence Peek and Darrel Fleck sought to use self-directed IRAs to acquire a business. The taxpayers established self-directed IRAs using 401(k) rollovers, created a new company (FP Company), and then directed the IRAs to purchase the common stock of FP Company with the cash in the IRAs. FP Company then sought to purchase the business. To consummate the purchase, in addition to the cash and other credit lines, FP Company provided a promissory note to the sellers. This promissory note was backed by the personal guarantee of the taxpayers, and the guarantees were then backed by the deeds to the taxpayers’ homes. The IRS argued that Mr. Fleck’s and Mr. Peek’s personal guarantee of a $200,000 promissory note from FP Company to the sellers of the business in 2001 as part of FP Company’s purchase of the business assets were prohibited transactions. Tax Court agreed with the IRS and found that the taxpayers had committed prohibited transactions.
“The Peek case also adds to the limited guidance on the situations in which “indirect” transactions fall within Internal Revenue Code Section 4975, “ stated Mr. Bergman
According to Mr. Bergman, “Peek highlighted the importance of working with independent tax attorneys who can properly advise on a proposed investment. Mr. Peek and Mr. Fleck relied on the advice of Mr. Blees, a CPA, who was also the promoter of the transaction. As a result, Mr. Blees did not warn Mr. Peek and Mr. Fleck about personally guaranteeing the business loan for their IRA investment.”
The IRA Financial Group was founded by a group of top law firm tax and ERISA lawyers who have worked at some of the largest law firms in the United States, such as White & Case LLP and Dewey & LeBoeuf LLP.
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