IRS/Practitioner Liaison Group

PICPA Initiates IRS Comments on Using Retirement Funds to Start a Business

PICPA does have a voice in Washington. A number of PICPA members expressed concern about recent promoters of using retirement funds to help start or fund small businesses. If your client receives distributions from retirement funds in accordance with retirement plans rules, there is no problem. However, if your client uses retirement plan funds to invest directly in a small business, the prohibited transaction rules must be carefully evaluated.

IRS Stakeholder Liaison staff members were quick to respond to our concern and they elevated the issue to IRS headquarters. The IRS responded in its July 11, 2007, e-News for Small Business (Issue 2007-24) by saying the transaction may be considered a “prohibited transaction” by a “disqualified person.” Those terms are explained in IRS Publication 560, which is based upon IRC Section 4975, “Tax on Prohibited Transactions.” Section 4975 provides for an initial tax of 15 percent on any prohibited transaction, plus an additional 100 percent tax if the transaction is not corrected within the same taxable year.

If a new business owner used money from his or her retirement fund to invest in a small business, what’s the likelihood that person would have the cash available to “undo” a prohibited transaction? Not very likely. The business owner could easily face a 115 percent tax on the prohibited transaction and not have the cash to correct the transaction or pay the taxes. If the business owner cannot otherwise fund the cash requirement for the corrective action or taxes, the owner must consider IRS payment options and other alternatives for paying the taxes. Some small businesses could end up insolvent with very few alternatives to consider. Such an insolvent business owner could easily find themselves with large representation costs, little cash, and a loss of their retirement funds.

The U.S. Department of Labor has the final call on whether or not a transaction is prohibited. The DOL has pointed to two rulings to provide guidance to taxpayers considering those transactions: Advisory Opinion 2000-10A, issued July 27, 2000, and Advisory Opinion 2006-1A, issued Jan. 6, 2006. Those opinions appear to delineate very restrictive circumstances for the use of self-directed IRA funds.

If your client is considering one of those transactions please make sure you and your client have done your respective homework to be certain your transaction, as contemplated and how the funds will likely be handled in reality, are within the letter and meaning of IRC Section 4975. Remember, FIN 48 applies to all financial statements, which means accountants providing attest services to clients who engage in those transactions must consider the transaction as a tax position for tax accrual and financial statement disclosure purposes.

The IRS practitioner group meets quarterly to address systemic problems. Review submission guidelines and submit your question to the PICPA.