Thiessen v Commissioner: A Self-Directed IRA or a Self-Inflicted Wound

Thiessen v Commissioner: A Self-Directed IRA or a Self-Inflicted Wound

Recently, myself and another attorney in the firm met with accountants from a well-established practice with several offices. When I inquired about the biggest problems they encountered in tax season, they replied that it was the use of self-directed IRAs to finance business acquisitions. They described the problem as an epidemic caused by the sluggishness of the economy in the parts of New Jersey served by their offices.

Self-directed IRAs are not new nor are they prohibited. The facts in Thiessen v Commissioner, a Tax Court case, are typical of the circumstances described to us in that recent meeting.

The Facts of Thiessen v Commissioner

In Thiessen v Commissioner, taxpayers did not want to accept a transfer to a Kroger location in another state. Taxpayers rolled over their respective Kroger 401K account balances to self-directed IRAs. Taxpayers looked for a business to acquire and encountered a broker who located one suited to their skills. A friend recommended a CPA who advised an acquisition structure whereby the 401K account balances would be rolled over to self-directed IRAs (“IRAs”). These transfers in 2003 were reported as tax-free rollovers. The CPA formed a C corporation for the taxpayers. Then, the taxpayers directed the IRAs to purchase all of the stock of a C corporation and then cause the C corporation to acquire the business.

The taxpayers had an attorney to represent them regarding the purchase but he did not participate in establishing the structure, nor did he have ties to the CPA or the broker. The CPA was not involved in drafting the contract of sale nor in the negotiation of the financing terms.

Issues down the road

The taxpayers transferred $432,000 to their IRAs and then directed the IRAs to purchase of all shares of stock of the new corporation. The contract of sale called for a purchase price of about $600,000 consisting of $60,000 of a deposit, a $200,000 Note (the “Note”) and the $340,000 balance in cash from the IRAs (presumably from the C corporation). The deposit came from the personal bank account of the taxpayers and the government did not raise the source of these funds as a tax issue. The Note required and contained the personal guarantee of the taxpayers.

In 2010, seven years after the acquisition, the taxpayers received a tax deficiency notice for $180,000 based upon the disqualification of the IRAs in 2003. Disqualification was based upon the fact that the guarantee of the Note by the taxpayers was a prohibited transaction. A prohibited transaction includes the indirect lending of money or extension of credit between a plan and a disqualified person. The later term includes a fiduciary who is one who exercises discretionary authority or control over plan assets. The court held that the guaranties constituted indirect extensions of credit between the taxpayers and the IRAs. The distinction here is that the taxpayer guaranties added to the value of the assets held in the IRAs and circumvented contribution limitations.

The irony here is that the CPA was also involved in a 2013 case, Peek v. Commissioner, that taxpayers also lost. One should also know that the government had other arguments that the Court did not rule upon. A reader should not read Thiessen as giving the government only one line of attack.