For over 65 million Americans who have an IRA, the ability to take a salary or tax into their IRA in the most tax-efficient manner possible is an important consideration.  This article will explore the way an IRA owner can use their IRA for personal purposes, including whether one can take a salary directly from an IRA.

What Does the IRS Allow me to do with an IRA?

When it comes to making investments with a Self-Directed IRA or taking a salary from an IRA, the IRS generally does not tell you what you can invest in, only what you cannot invest in.  The types of investments that are not permitted to be made using retirement funds are outlined in Internal Revenue Code (“IRC”) Section 408 and 4975.  These rules are generally known as the “Prohibited Transaction” rules.  Other than life insurance, collectibles, and transactions that involve or directly or indirectly benefit the IRA holder or a “disqualified person,” one can use their IRA to make the investments.  A “disqualified person” is generally defined as the IRA holder and any of his or her lineal descendants and/or any entities controlled by such persons.  Note – siblings are not considered “disqualified persons.” Some of the most popular Self-Directed IRA investments include real estate, stocks, loans, notes, tax liens/deeds, investment funds, and even cryptocurrency.

Can I Take a Salary From My IRA?

The IRS prohibited transaction rules under IRC Section 4975 is clear that one cannot take a salary from their IRA. Internal Revenue Code Sections 4975 & 408 prohibit fiduciary and other Disqualified Persons from engaging in certain types of “prohibited transactions”. “Prohibited transactions” are any direct or indirect:

• Sale or exchange, or leasing, of any property between a plan and a disqualified person.
• Lending of money or other extension of credit between a plan and a disqualified person.
• Furnishing of goods, services, or facilities between a plan and a disqualified person.
• Transfer to, or use by, or for the benefit of, a disqualified person of the income or assets of a plan.
• Act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account; or
• Receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

In other words, to trigger an IRS prohibited transaction one must involve a retirement account and a “disqualified person.”  Hence, taking a salary directly from one’s IRA would clearly violate the IRS-prohibited transaction rules (see above).  However, what about taking a salary from a business owned less than 50% by an IRA? 

The remaining part of this article will explore the ways one can use IRA funds for personal purposes without triggering the IRS-prohibited transaction rules.

Minority Investments in a Business

The ability to take a salary from a business owned by your Self-Directed IRA is premised on the application of the IRS prohibited transaction rules. For example, if the IRA owner or any of their lineal descendants own more than 50% of the business, then the Self-Directed IRA would not be permitted to invest in the business as it would violate the IRS prohibited transaction rules under IRC Section 4975(c).  Besides, even if the IRA owner and/or any “disqualified person” owned less than 50% of the business, the Self-Directed IRA investment would need to 100% exclusively benefit the IRA and the IRA must pay fair market value for the business interest.  For example, if an IRA owner elected to invest as a minority owner of a business, the IRA investment must be done to exclusively benefit the IRA and cannot be made to in any way benefit the IRA owner personally or any “disqualified person.” Hence, the IRA investment cannot be made so that the IRA owner would receive a salary from the IRA.  Whereas, if the IRA owner was already an employee of the business and their salary would not be impacted by the IRA investment into the business, so long as the IRA paid fair value for the business interest and the IRA nor any “disqualified person” controlled the business, the IRA investment would likely not violate the IRS prohibited transaction rules.  

Self-Directed IRA 60-Day Rule

A distribution from an IRA to the individual for whose benefit the account or annuity is maintained is not taxable to the recipient if reinvested within 60 days in another IRA (other than an endowment contract) for the benefit of the same individual. The rule operates on an all-or-nothing basis. The entire amount received from the old IRA must be transferred to the transferee IRA. If anything is held back, the rollover rule does not apply, and everything received from the old IRA, including any amount transferred to another IRA, is treated as a taxable distribution. However, the distribution from the old IRA need not include the taxpayer’s entire interest. An IRA can be split, for example, by rolling a portion of it into a new IRA.

If property other than money is received from the old IRA, that property, not substitute property of equal value or the cash proceeds of the property’s sale, must be included in the transfer to the new IRA. According to the Tax Court, the rollover contribution must be of cash if the distribution is in cash.

The privilege of rolling over from IRA to IRA may be exercised only once in a 12-month period.

Roth IRA Contributions

In the case of a Roth IRA, one way to get tax-free and penalty-free use of the Roth IRA funds which can replicate a salary is taking a distribution of contributions made to a Roth IRA.

In general, all Roth IRA contributions can be taken as a distribution at any time and are not subject to tax. A “qualified Roth IRA distribution,” is a Roth IRA distribution where the Roth IRA owner is over the age of 591/2 and the Roth IRA has been opened at least five years. Whereas, a nonqualified distribution is the earnings on the Roth IRA contributions if the Roth IRA owner is under the age of 591/2 and the Roth IRA has been opened less than five years. An amount included in gross income on a nonqualified distribution may be subject to an additional 10 percent penalty tax under Internal Revenue Code Section 72t.

In the case of a Roth IRA contribution, the portion of one’s Roth IRA that consists of the Roth IRA contribution\ amount is never subject to income tax when it comes out – even if you take it out the day you contributed. That is because all contributions you made were nondeductible – meaning you already paid tax on the money.  In addition, any distribution you take from a Roth IRA is presumed to be a return of your contributions until you have withdrawn all contributions you made to it over the years.  In other words, all Roth IRA contributions all recovered tax-free before earnings before earnings are recovered.

The Rollover Business as Startup Solution

The rollover business start-up solution or ROBS 401(k) is the only legal solution that will allow one to take a salary from a business controlled by their 401(k) plan without triggering the IRS-prohibited transaction rules.

Internal Revenue Code Section 4975(c) includes a list of transactions that the IRS deems “prohibited”. However, Internal Revenue Code Section 4975(d) lists several exemptions to the prohibited transaction rules. Specifically, Internal Revenue Code Section 4975(d)(13) lists an exemption for the purchase of “qualifying employer securities” or C corporation stock by a 401(k) plan.  Note – the ROBS solution must involve a C corporation and a 401(k) plan.

The ROBS solution typically involves the following sequential steps:

1. An entrepreneur or existing business owner establishes a new C Corporation.
2. The C Corporation adopts a prototype 401(k) plan that specifically permits plan participants to direct the investment of their plan accounts into a selection of investment options, including employer stock, also known as “qualifying employer securities.”
3. The entrepreneur elects to participate in the new 401(k) plan and, as permitted by the plan, directs a rollover or trustee-to-trustee transfer of retirement funds from another qualified retirement plan into the newly adopted 401(k) plan.
4. The entrepreneur then directs the investment of his or her 401(k) plan account to purchase the C Corporation’s newly issued stock at fair market value (i.e., the amount that the entrepreneur wishes to invest in the new business); and
5. the C Corporation utilizes the proceeds from the sale of stock to purchase an existing business or to begin a new venture.

With the IRS-compliant ROBS solution, you can earn a reasonable salary from your new business or franchise. You can also use your new 401(k) Plan to make high tax-deductible employee deferral contributions – $23,000 or $30,500 if over the age of 50 for 2024.

Related: The Beginners Guide to ROBS 401(k)

Conclusion

The IRS prohibited transaction rules under IRC Section 4975 prohibit one from directly earning a salary from your IRA.  However, this article explored several tax-efficient options for tapping into one’s IRA for personal purposes without triggering a tax or penalty.  On the other hand, one should be prudent about tapping into one’s IRA as it is the most popular source of retirement savings for most Americans.