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The Employee Benefits & Executive Compensation attorneys at Chamberlain Hrdlicka represent public companies, large and closely-held private companies, tax-exempt organizations, and the fiduciaries who oversee those entities' employee benefit plans.  We understand incentives in the workplace, and we stand ready with an integrated approach to help you deal with them.

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Self Directed IRA Owners Be Aware!

Self-directed IRA distribution to Owner was taxable when it could have been avoided easily.

In Ball, TC Memo 2020-152, the Tax Court has held against a self-directed traditional IRA owner. The owner directly took an IRA distribution and then transferred the cash into the IRA owner's wholly-owned limited liability company. The distribution was redeposited into the IRA in a subsequent year. The Internal Revenue Service and the Tax Court held that the owner had taxable income in the year of the distribution.

All self-directed IRA owners should be very careful in how they invest the IRA’s property. I strongly recommend that owners use reputable third party administrators to help them from making the kind of mistakes Mr. Ball made. Mr. Ball could have easily avoided these consequences. As background, distributions from an IRA are taxable to the IRA owner under Internal Revenue Code § 408(d)(1). Some transactions can avoid taxation if done properly and an otherwise taxable IRA distribution is not includible in an owner's gross income when the owner acts as an agent or conduit on behalf of the IRA's custodian to carry out an investment. See Tax Court memos Ancira, (2002) 119 TC 135 and McGaugh, TC Memo 2016-28. Further, owners of self-directed IRAs are encouraged to avoid unfettered control over an IRA distribution which the Tax Court has held created taxable income in Vandenbosch, TC Memo 2016-29. The Tax Court found that, when an IRA owner had unfettered control over an IRA distribution, the owner of the IRA could not later claim that the owner was a mere conduit or an agent for the IRA custodian with respect to the distributed funds. See Tax Court memo Vandenbosch, TC Memo 2016-29.

Self-directed IRA owners should avoid what Mr. Ball did. Mr. Ball asked for and received a distribution from his IRA account totaling over $200,000. The transaction was completed by a traditional IRA withdrawal request form from the IRA's custodian. Mr. Ball had the IRA custodian, a bank, to pay him the monies. Mr. Ball checked a box stating the withdrawal was an early distribution with no exceptions to being taxable. Mr. Bell continued to go down the wrong path by telling the IRA custodian to make the distribution into a checking account at the same bank which Mr. Bell opened in the name of Ball LLC, a limited liability company. Mr. Ball was the manager and the sole member of Ball LLC. Finally, The Ball LLC account at that bank was not a retirement account.

Mr. Ball via Ball LLC lent the money to a third party. The third party repaid the loan to Ball LLC for a profit. Mr. Bell then instructed Ball LLC to deposit the loan proceeds with profit back into Mr. Ball's IRA as a rollover contribution. The IRA custodian, the bank, reported the distribution on a 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) as a taxable distribution. Mr. Ball reported the distribution on his individual tax return but said none of it was taxable. Mr. Bell took the position that the flow of funds from the IRA to the Ball LLC account and reverting same back to the IRA was a "conduit agency arrangement," like the facts in Ancira and McGaugh. Mr. Ball’s argument was that Ball LLC acted as a mere facilitator, moving funds from the IRA and the loan recipients.

The Internal Revenue Service did not agree and ruled that the distribution was a taxable distribution to Mr. Ball because he had complete control over Ball LLC. This line of arguing by the Internal Revenue Service is troubling as many self-directed IRAs have complete control over the LLCs they legitimately use to protect the IRA investment.

Although the Tax Court sided with the Internal Revenue Service, the Tax Court said that Ball LLC was not acting as an agent or conduit on behalf of the custodian of the IRA when Ball LLC received and made use of the distributions. Thus, the facts of Mr. Ball’s case were closer to those of Vandenbosch than to those of Ancira and McGaugh.

The lessons to be learned are to make sure that you think through how you are going to invest your IRA. If the Internal Revenue Service is continuing to go after self-directed IRAs, owners should consider using good custodians who educate owners on how to comply with IRA rules.

  • Joshua A. Sutin

    Joshua Sutin helps clients unravel complex legal and business issues related to employee benefit plans, tax-exempt organizations, and business tax planning. He counsels both businesses and not-for-profit organizations on the ...