Peek v. Commissioner – IRA Loan Rules
Section 4975(c) prohibits certain transactions between (i) various plans including IRAs and (ii)“ disqualified persons.” A disqualified person is a “party of interest” under the ERISA version of these rules. In the case of an IRA, this includes the IRA owner. A disqualified person cannot engage in transactions with the plan that, among other things, constitute direct or indirect: Sales, exchanges, or leasing of property Lending of money or other extension of credit Furnishing of goods, services, or facilities Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan However, certain exceptions do apply that allow a disqualified person to engage in such transactions. Peek v. Commissioner – The Court’s Opinion In 2001, two taxpayers, Mr. Lawrence Peek and Darrel Fleck sought to use Self-Directed IRAs to acquire a business. They established a Self-Directed IRA using 401(k) rollovers to create a new company (FP Company). Then, they directed the IRAs to purchase the common stock of FP Company with funds in the IRAs. FP Company then sought to purchase the business. To consummate the purchase, FP Company provided a promissory note to the sellers. This is in addition to the cash and other credit lines. This promissory note was backed by the personal guarantee of the taxpayers/ The guarantees were then backed by the deeds to the taxpayers’ homes. In 2003 and 2004, the taxpayers converted their traditional IRAs to Roth IRAs. In 2006 and 2007, the IRAs sold FP Company for a gain.
Peek v. Commissioner: A Crucial Legal Precedent
In the Peek v. Commissioner case, decided on May 9, 2013, the U.S. Tax Court delivered a significant verdict. Here are the key points:
Background:
- The case involved two taxpayers: Mr. Lawrence Peek and Darrel Fleck.
- Their objective was to use Self-Directed IRAs to acquire a business venture.
The Self-Directed IRA Setup:
- Mr. Peek and Mr. Fleck established a Self-Directed IRA by rolling over funds from their 401(k) accounts.
- They then created a new company called FP Company and directed their IRAs to purchase its common stock.
The Business Purchase:
- FP Company aimed to acquire an existing business.
- To finalize the purchase, FP Company issued a promissory note to the sellers.
- This note was backed by the personal guarantee of the taxpayers themselves, with their homes’ deeds as collateral.
The Prohibited Transaction:
- The U.S. Tax Court ruled that the taxpayers’ personal guarantee of the loan (via FP Company) constituted an indirect extension of credit to the IRAs.
- Why is this significant? Because it falls under the category of a prohibited transaction according to Internal Revenue Code (IRC) Section 4975.
- As a result, the IRAs were disqualified.
Understanding Prohibited Transactions:
- IRC Section 4975© prohibits specific transactions between plans (including IRAs) and disqualified persons.
- Disqualified persons include parties of interest, such as the IRA owner.
- The prohibited transactions encompass sales, exchanges, lending of money, furnishing goods or services, and more.
Exceptions and Compliance:
- While certain exceptions allow disqualified persons to engage in specific transactions, it’s crucial to navigate these rules carefully.
- The Peek case underscores the need for vigilance in maintaining IRA compliance.
Conversion to Roth IRAs:
- Subsequently, in 2003 and 2004, the taxpayers converted their traditional IRAs to Roth IRAs.
- In 2006 and 2007, the IRAs sold FP Company, resulting in a gain.
Takeaway:
- The Peek ruling serves as a stark reminder that self-directed IRAs must adhere to IRS guidelines to preserve their tax-deferred status.
- Personal guarantees involving IRA-owned entities can trigger prohibited transactions, leading to disqualification.
