IRAs hold retirement assets that continue to grow on a
tax-free basis. Income taxes only apply
when distributions are taken. Early
distribution penalties apply (10% penalty in addition to income taxes) if
distributions are taken before age 59 ½ unless an exception applies. Prohibited transactions (impermissible
transactions conducted by disqualified persons) can also cause a taxable IRA
event whereby the “tainted” IRA funds disqualify the IRA (it loses its
tax-deferred status and is no longer considered an IRA!). Those IRA funds are deemed a fully taxable
distribution. If under age 59½, an early
10% penalty may also apply. Ouch.
Unfortunately, some IRA owners still try to come up with
slick ways to get around the IRS’ prohibited transaction rules…newsflash, the
Tax Court is not usually going to be on your side.
In a recent Tax Court ruling, a married couple (the
taxpayers) engaged in what is commonly referred to as a ROB (rollover as
business start-up) with their IRA. Their
newly formed C corporation acquired assets from an existing business and they
guaranteed repayment of a loan during the purchase process. Using IRA assets to guarantee loans is a
prohibited transaction. The Tax Court
reminded them that they are “disqualified persons” and that indirectly
extending credit to a third party is not permitted. Their actions resulted in a deemed
distribution of all of the IRA
assets.
Are all ROBs bad?
No. But if you plan to engage in
one, make sure you know exactly what you’re getting into and exactly what you
can and cannot do.
Source: Thiessen,
(2016) 146 TC No. 7
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