Posted on January 16th, 2014

IRA’s ownership of taxpayer’s business resulted in disastrous tax consequences.  Harsh tax consequences resulted where an individual taxpayer had his IRA own the shares of his business, a limited liability company (LLC). Agreeing with the IRS, the Tax Court held that the LLC’s payment of compensation to the taxpayer for his services to the LLC was a prohibited transaction under the rules governing IRAs. As a result, the IRA was retroactively disqualified and its assets were deemed distributed to the taxpayer and taxed to him as ordinary income. One purpose of the prohibited transaction rules is to prevent taxpayers from using their IRA to engage in transactions for their own account that could place plan assets and income at risk of loss before retirement. The taxpayer argued that he did not engage in a prohibited transaction when he caused the LLC to pay him compensation because the amounts it paid to him did not consist of plan income or assets of his IRA but merely the income or assets of a company in which his IRA had invested. However, the Court disagreed, finding that in causing the LLC to pay him compensation, the taxpayer engaged in the transfer of plan income or assets for his own benefit, in violation of the rules.

It is far better for the individual to be the owner of the business, as there are extensive difficulties in having a pension own the business. It is enticing to have the pension/IRA to fund the business, but very dangerous in both the taxes but the pension money is really there to protect you when you cannot work. To invade that nest egg is not wise.