Loan Guarantees to Self-Directed IRA Results in Deemed Distribution and Penalties to Owners.

(Parker Tax Publishing APRIL 2016)

Loan guarantees made by a couple in transactions involving their self-directed IRAs and a corporation owned by the IRAs were prohibited transactions, resulting in deemed distributions to the couple to which the 10 percent penalty tax under Code Sec. 72(t) applied. Because the transactions were not disclosed on the taxpayers' individual tax return for the year the guarantees were made, the six-year statute of limitations period under Code Sec. 6501(e) also applied. Thiessen v. Comm'r, 146 T.C. No. 7.

Background

In 2002, a company that James Thiessen had been employed with for 30 years announced that it was moving to another state. Thiessen decided to leave the company and began searching for a new job in metal fabrication, an area in which he had a degree. His search included looking for a business that he and his wife could acquire. He subsequently learned that Ancona Job Shop (Ancona), an unincorporated business specializing in the design, fabrication, and installation of metal products, was for sale through the brokerage firm A.J. Hoyal & Co., Inc. (AJH).

Thiessen and his wife decided to acquire Ancona, and they and AJH began discussing the terms of the acquisition. Jay Hoyal, a broker at AJH, informed the Thiessens that they could use the funds in their retirement accounts to acquire Ancona. Specifically, he stated that the Thiessens could roll over their retirement funds into individual retirement accounts (IRAs), cause the IRAs to acquire the initial stock of a newly formed C corporation, and cause the C corporation to acquire Ancona.

Thiessen discussed the funding structure with a CPA and asked the CPA to help with implementing the acquisition of Ancona. Thiessen and his wife then hired an attorney to help them with the terms of the sale contract and with the terms of a financing arrangement in acquiring Ancona. The CPA helped the Thiessens establish the C corporation, Elsara Enterprises, Inc. (Elsara), that was eventually used to effect the IRA funding structure. On May 29, 2003, the CPA filed articles of incorporation for Elsara. The Thiessens were named as Elsara's officers and directors, and they (and no one else) have served in those positions ever since.

In June 2003, the Thiessens each established an IRA, with each retaining all discretionary authority and control concerning investments by his or her IRA (an arrangement referred to as a self-directed IRA). The Thiessens then rolled over their tax-deferred retirement funds of approximately $432,000 into the newly formed IRAs and caused the IRAs to acquire the initial stock of Elsara. Shortly thereafter, Elsara purchased the assets of Ancona for approximately $600,000. The purchase price included a promissory note to the seller of $200,000, guaranteed by the Theissens, and earnest money deposit of $60,000, which came from the Theissens' bank account. The rest came from the Theissens' IRAs.

On their 2003 joint tax return, the Theissens reported that they received IRA distributions of $432,000 which were the subject of a tax-free rollover. The 2003 joint return did not disclose the Theissens' guaranties of the loan or any other fact that would have put the IRS on notice of the nature and the amount of any deemed distribution resulting from the guaranties. The 2003 joint return also did not disclose or even mention Elsara or its 2003 corporate return.

In 2010, the IRS sent the Theissens a notice of deficiency as a result of their failure to report for 2003 a taxable distribution from their IRAs. The deficiency notice was sent after the expiration of the three-year statute of limitations. According to the IRS, the Theissens' guaranties were prohibited transactions under Code Sec. 4975(c)(1)(B), resulting in deemed distributions of the IRAs' assets under Code Sec. 408(e)(2) on January 1, 2003.

IRS and Taxpayer Arguments

In making its arguments, the IRS relied on the Tax Court's decision in Peek v. Comm'r, 140 T.C. 216 (2013), which involved a transaction similar to the one in which the Theissens engaged and even involved the same CPA. In Peek, the court held that a couple had engaged in a prohibited transaction by guaranteeing loans related to transactions involving their self-directed IRAs. Thus, the couple had a deemed distribution from their IRAs.

Code Sec. 408(e)(2) provides that an IRA ceases to be an IRA if the person for whose benefit the IRA is established (i.e., the IRA owner) or his or her beneficiary engages in a prohibited transaction with respect to the IRA. Under Code Sec. 4975(c)(1)(B), a prohibited transaction generally includes any direct or indirect lending of money or other extension of credit between a plan (e.g., an IRA) and a disqualified person. Under Code Sec. 4975(e)(2) and (3), a disqualified person includes a fiduciary and a fiduciary includes 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. Code Sec. 408(e)(2)(A) provides that, where the disqualified person is also the IRA owner or his or her beneficiary, the IRA ceases to be an IRA as of the first day of the IRA owner's tax year in which the prohibited transaction occurs.

The Theissens' asked the Tax Court to disregard or to distinguish its opinion in Peek. The Department of Labor, the Theissens argued, has the primary authority to interpret the prohibited transaction rules and the Tax Court in Peek interpreted those rules inconsistently with the interpretation of the Department of Labor. The Theissens also argued that the three-year statute of limitations applied because they disclosed on the face of their 2003 joint return that they rolled over their retirement fund distributions into the IRAs.

Tax Court's Holding

The Tax Court held that the Theissens' guaranties of the loan were prohibited transactions under Code Sec. 4975(c)(1)(B), and the IRAs' assets were deemed distributed to them on January 1, 2003. In reaching its conclusion, the Tax Court cited its decision in Peek. With respect to the Theissens' arguments to disregard the Peek decision, the court noted that Congress included provisions on prohibited transactions in both the Internal Revenue Code and Title 29 (i.e., Department of Labor rules), and President Carter gave the Department of Labor primary authority to interpret both sets of those provisions. However, the court said, that does not mean that the Department of Labor has the final word as to the interpretation of those provisions. The court emphasized that it is the province and duty of the judicial department to say what the law is.

The court further held that the Theissens' reporting that the rollover was nontaxable was insufficient to advise the IRS of the nature and the amount of the unreported income flowing from the deemed distributions from the IRAs on account of the loan guaranties. Thus, the six-year statute of limitation applied. Further, because neither of the Theissens were 59-1/2 the 10 percent penalty tax in Code Sec. 72(t) also applied.

For a discussion of prohibited transactions with respect to self-directed IRAs, see Parker Tax ¶134,505.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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