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May 2016 Tip of the Month


It's just so tempting....tapping into your own retirement funds to finance a business.   We've advised quite a few entrepreneurs and even other advisors the dangers of using your qualified retirement accounts (i.e. IRA, 401k, pension, profit sharing plan, etc.) to invest in your closely-held business. We read a recent Tax Court Case (Thiessen v. Commissioner, 146 TC No. 7) that only highlights the dangers.

On the advice of a broker, a couple rolled over their retirement funds into two new IRAs and directed the accounts to buy all of the stock of a new company that they had formed for this purpose. The IRA-owned firm then purchased a business for cash and a note that was secured by the personal guaranties of the IRA owners.  The guaranties by the IRA owners violate the prohibited transaction rules, according to the Tax Court. That means the IRAs were terminated for tax purposes, and the owners wound up having to pay a substantial tax bill.

Could Abo and Company say it any better than Tax Court Judge Marvel when he found that a prohibited transaction resulted, disqualifying the IRA and triggering an $180,000 deficiency:

In closing, petitioners' participation in the prohibited transactions on or about June 18, 2003, caused petitioners' IRAs to cease to be IRAs as of the first day of petitioners' taxable year in which the prohibited transactions occurred....Furthermore, petitioners are deemed to have received distributions on that first day of amounts equaling the fair market values (on the first day) of the assets in petitioners' IRAs as of that first day... We also hold that petitioners are liable for the 10% additional tax...with respect to the $432,076 because neither petitioner was 59-1/2 years of age or older during 2003.

This case illustrates the dangers that can arise when IRA assets are not invested in traditional retirement plan investments (i.e., public company stocks, bonds, mutual funds, CDs, etc.).  Many people might not even think that a guaranty of a company's debt would be the indirect extension of credit to the company's shareholders.  However, a close reading of the applicable tax laws, regulations and cases supports this conclusion.  Such can be true even for a guaranty made with an IRA owned business' purchase of a piece of equipment (e.g., automobile, computer, machinery, copier, phone system, etc.), acquisition of a building for the business, or even entering into contracts for services.

Reading this provides us a good opportunity to echo what we've advised for years.  That is that the IRS continues to expand its scrutiny of retirement plans holding assets that do not have a readily ascertainable market value are in for more scrutiny by the Internal Revenue Service. The Service carefully looks at plans holding assets such as closely-held stock, real estate, limited partnerships, coins, and collectibles to determine whether these assets are being properly valued (and that warning is coming from a CPA firm that, in fact, appraises such closely held businesses).

The concern? Well, failure to obtain annual independent valuations can often lead to disqualification of the retirement plan. Thus, you need to have nontraditional assets valued by independent appraisals (like those valuations done by Abo Cipolla Financial Forensics).  We suggest you:

  • Ensure the appraisal is in writing. The valuation report  should identify who provided the valuation as well as their qualifications (go to for our listed credentials of ABV and/or CVA). 
  • Ensure the report describes the valuation methodology used in arriving at fair market value. 
  • Ensure that the appraiser is truly independent. Relatives, friends, and even the company's CPA may not be appropriate and "independent" for this purpose. 
  • Do not use tax assessment documents as a substitute for a bona-fide real estate appraisal. The IRS will look for a formal appraisal.
  • Consider the additional (and perhaps substantial) costs with getting an annual valuation in tandem with the increased likelihood of audit. Thus, give serious consideration to having the plan divest itself of such "problem" assets in favor of more traditional and marketable investments.