Prohibited Transactions and IRAs

 Recently we observed promotional and seminar materials that advocated putting your IRA to work for you or your business. A client also sent us a story from a newspaper in a major city extolling the virtues of using your IRA money to help in your business. While our experience is no measure of what is going on generally, we do think that the problems of putting IRA money to work directly or indirectly in an entity related to the IRA owner presents prohibited transaction issues. While DOL generally does not have jurisdiction over IRAs, it does have regulatory authority to determine whether a prohibited transaction exists in connection with an IRA. Given the fact that a prohibited transaction may disqualify the entire IRA, a cautious approach with IRA investments in the IRA owner’s business is warranted.

A DOL advisory opinion letter issued at the beginning of this year (AO 2006-01A) exemplifies the importance of looking for prohibited transactions in IRA investments in related entities. In the letter, H&W (husband and wife) owned 68% of S Corp. The remaining 32% was owned by G a third party. H proposed creation of an LLC which would be owned 49% by his IRA and the remainder owned by R. R was the comptroller of S Corp and DOL stated he could not be deemed independent. It was proposed that the LLC would purchase land, build a warehouse and lease the warehouse to S Corp. The lease terms would be determined by an independent expert to be arms length and at least as favorable to the LLC and its IRA Investors as an arms length transaction. The question posed to DOL was whether the arrangement created a prohibited transaction. In DOL’s view, H was a fiduciary since he exercised discretion over his IRA. As a fiduciary H was a disqualified person. DOL found that the lease would amount to an indirect prohibited transaction between H’s IRA and S Corp. in violation of Code sections 4975(c)(1)(A) and (D) and dealing with assets of the plan in the fiduciary’s own interest in violation of Code section 4975(c)(1)(E). Almost as a postscript DOL stated that the investment may also be a violation of the exclusive benefit rule of Code section 401(a)(2). Given DOL’s broad interpretations above, it seems to us that the use of self directed IRA’s to invest in or somehow support a business owned bythe IRA owner may be a very risky business. Jeffrey N. Clayton