Rollins v. Commissioner is an important case in the Self Directed IRA LLC context because it illustrates how one can engage in a prohibited transaction with an entity even if the entity is not a disqualified entity per se. The Rollins case also is important for examining whether a potential transaction could be considered an indirect prohibited transaction under Internal Revenue Code (IRC) 4975.
The Facts of the Rollins Case
The facts in Rollins are as follows: Mr. Rollins owned his own CPA firm. He was sole trustee of its 401(k) plan. Mr. Rollins caused his plan to lend funds to three companies in which he was the largest stockholder (9% to 33%), but not controlling, stockholder. The companies had 28, 70, and 80 other stockholders respectively. Mr. Rollins made the decision for the companies to borrow from his 401(k) plan. The loans were demand loans, secured by each company’s assets. The interest rate was market rate or higher. Mr. Rollins signed loan checks for his plan and signed notes for borrowers. All loans were repaid in full.
Mr. Rollins acknowledged that he is a disqualified person with regard to the plan because he owns Rollins, the CPA Firm, but he contends that (1) none of the corporations that were the borrowers was a disqualified person, (2) none of the loans was a transaction between him and the plan, and (3) he “did not benefit from these loans, either in income or in his own account.”
Download the PDF for the Rollins Case: T.C. Memo. 2004-260
Mr. Rollins further claimed that no prohibited transaction occurred because: (1) the interest rate was above market interest and was paid, (2) the collateral was safe and secure and the principle was repaid, and (3) the plan’s assets were thereby diversified and thus the plan’s portfolio’s risk level was “significantly lowered.”
The IRS Position
On the other hand, the IRS took the position that Mr. Rollins’s ownership interest in these companies created a conflict of interest between the plan and the companies, resulting in dividing his loyalties to these entities. This conflicting interest as a disqualified person who is a fiduciary brought petitioner within the prohibition against dealing “with the income or assets of a plan in his own interest or for his own account” – I.R.C. § 4975(c)(1)(E).
The Tax Court held that a IRC Section 4975(c)(1)(D) indirect prohibition did not require an actual transfer of money or property between the plan and the disqualified person. The fact that a disqualified person could have benefited because of the use of plan assets was sufficient. The Tax Court held that the transactions were uses by Rollins or for his benefit, and were assets of the plan. These assets of the plan were not transferred to Rollins. For each of those transactions, however, Rollins sat on both sides of the table. Rollins made the decisions to lend the plan’s funds, and Rollins signed the promissory notes on behalf of the borrowers.
Understanding the Prohibited Transaction Rules
One of the more interesting parts of the Rollins case was the Tax Court’s emphasis that as the taxpayer, the burden of proof as to whether an indirect prohibited transaction had occurred is the responsibility of the taxpayer. In other words, at its core, the Rollins case is a “burden of proof” case that illustrates the breadth of the application of 4975(c)(1)(D) as well as the difficulty of meeting that burden of proof. Mr. Rollins was not a majority owner of any of the borrowers, but he was the largest shareholder for each company. Further, he also signed the notes for each borrower.
Would the same decision have been made if Mr. Rollins was not the largest shareholder or had not, as the Court put it, “sat on both sides of the table” (e.g., by not signing the notes on behalf of the borrowers)? It’s not entirely clear if that would have influenced the Court since it was still Mr. Rollins’ burden (as the disqualified person) to prove that the transaction did not enhance or was not intended to enhance the value of his investments in the borrowers. That seems to be a very tough burden to meet. Moreover, as the Court noted, the fact that a transaction is a good investment for the plan has nothing to do with the problem.
The lesson is that caution should be exercised whenever a disqualified person is sitting on both sides of the table!
Conclusion
In general, one can use a Self-Directed IRA to transact with a business that they own a majority share of. However, the Rollins case is a good example of the type of argument the IRS could make if they believe the Self-Directed IRA made the investment and the investment did not exclusively benefit the retirement account. In other words, an IRA investor should not make any investment that in anyway directly or indirectly benefits themselves or any disqualified person personally.
In the Rollins case, if Rollins had better facts and was able to show that the companies had other loan options or did not need the loan to survive, the IRS would have had a far tougher time in proving their case that Mr. Rollins engaged in a self-dealing IRS prohibited transaction. It is all important to note that Mr. Rollins has the burden of proving by a preponderance of the evidence that the loans did not constitute uses of the plan’s income or assets for his own benefit.
The Rollins case is a great example of the importance of working with a company that has the expertise to structure a Self-Directed IRA investment without triggering the IRS prohibited transaction rules.
