Checkbook IRAs are on the IRS Radar

MARCH 05, 2012
Lee R. Phillips, Counselor United States Supreme Court
Don’t use checkbook IRA schemes. They’ve become very popular as a way to take control of an IRA, but you’ll be very sorry some day.

IRAs are a huge source of investment capital. Every financial planner is drooling over your IRA money, and their goal is to get as much IRA money under management as possible. In order to lure more people into investing their IRA money, self directed IRA trustees have become very aggressive at making promises to potential clients.

Self directed IRA custodians will allow the IRA owners to invest in a wide range of investments other than the standard stocks and mutual funds. Real estate, gold, horses, almost anything can become the object of an IRA investment, if the IRA trustee will allow the investment.

However, self directed IRA trustees are often slow to respond to the needs of an IRA owner, and they charge for every transaction. So the past few years have seen the rise of what are known as “checkbook IRAs.” Checkbook IRAs give the IRA owner “checkbook authority” over the IRA money and let the owner transact business without the interference of any IRA trustee.

There are several forms of the checkbook IRA structure, but there’s one basic pattern that they all seem to follow.


First
, funds from the IRA are moved from the current IRA trustee (generally a bank or brokerage house) into a self directed IRA account with a self directed IRA trustee that promotes checkbook IRAs.

Of course, if the time limits are followed or the transfer is a trustee-to-trustee transfer, there won’t be any tax consequences to moving the IRA money. You have every right to change your IRA trustee, and everything is perfectly legal.

Second, the IRA owner will set up an entity, such as a Limited Liability Company (LLC) or a corporation. Most people use a LLC, because it is a “pass through” entity for tax purposes. The structure is often called an LLC IRA or IRA LLC. Note that an IRA can’t own stock in a subchapter S corporation, so the corporation has to be a C corporation.

Third, stock in the corporation or membership interests in the LLC are then sold to the IRA. The IRA pays money for the stock or membership interests, and in exchange the IRA gets a stock certificate or a membership certificate. There is no tax consequence to the IRA or the LLC.

Note that the IRA money has now been moved to the entity, and all that’s left in the IRA is a stock certificate or membership certificate. It is perfectly legal for an IRA to buy stock or membership interests. IRAs are one of the largest players in the stock market and mutual funds.

Fourth, the IRA owner is voted in as the president of the little corporation or the manager of the little LLC. Now the IRA owner controls all the money in the entity. By simply depositing the little company funds received from the IRA into a checking account, the IRA owner has checkbook control over the IRA money.

With checkbook control, the IRA owner can spend the money any way he or she wants. Usually, they are going to make good investments in real estate or some other asset that will yield a good return, because any return on investment goes directly back into the IRA. However, they could take the money and have a business meeting on some Caribbean island.

Promoters of the checkbook IRA advertise that you can access your IRA money at any time without any penalty. You can search the internet and find dozens of self directed IRA trustees that will let you do a checkbook IRA.

Equity Trust Company is one of the nation’s biggest self directed IRA trustees. Jeff Desich, CEO of Equity Trust, states that the promoters of checkbook IRAs will advertise anything in order to get more money under management.


You can check on the internet and find at least nine websites that use the exact language: “Tap the purchasing power of your IRA before retirement age without incurring early distribution taxes or penalties!”

Yes, the checkbook IRA is flying high today, but the IRS knows exactly what is going on, although it is very slow to react. Someday down the road it will start challenging all checkbook IRA structures. The IRS considers the checkbook IRA to be one of its top targeted scams.

The IRS calls the checkbook IRA type structure a ROBS
RollOvers as Business Start-ups — and looks at it as if you are starting a business, either as an LLC or a corporation.

“The government, specifically the IRS and [Department of Labor] have weighed in on the checkbook control concept, and they don’t like the concepts,” Desich says. You can look at the official statement by the IRS.

“We are on the side of the government on this issue and share their concerns,” states Desich. “Which has led us to not to allow checkbook control investments at Equity Trust.”

Clark Gardner, CPA, asks the question, “Do you really think the IRS is going to let you spend your IRA money any way you want before retirement age without any taxes or penalties?'

Promoters will always cite the Swanson case as authority for the checkbook IRA. Swanson is a 1996 tax court case where a tax payer, Swanson, set up two LLCs. One he operated as a business making carpenter tools and the other he operated as the sales arm for the tool business. The sales business was owned by his IRA. Commissions from the sales of Swanson’s tools went through his sales LLC into his Roth IRA.

After Swanson had put over a million dollars into his IRA, the IRS stopped him and the lawsuit followed. The short story is the IRS lost.


Since Swanson, the IRS has put a lot of regulations in place and has tried to get Congress to pass legislation preventing an IRA from owning membership interests in LLCs. The LLC IRA is a deadly structure, because money can be made and pass through the LLC to the IRA. If the IRA is a Roth IRA, then the owner can spend the money without ever having it taxed.

Today, Swanson probably wouldn’t be able to do what he did in the late 1990s.

Jonathan Cavender, an attorney who has dealt with LLC and IRA issues over the past decade, points out that the Swanson decision basically has nothing to do with the concept of a checkbook IRA. The case’s discussion of prohibited transactions and self dealing are not on point with the checkbook IRA prohibited transactions and self dealing issues, says Cavender.

There’s pretty much no question that the standard checkbook IRA and its variations are violating a number of IRS laws dealing with prohibited transactions and self dealing. It sounds great to be able to access your IRA money today without any tax or penalty, but it won’t work. The checkbook IRA structures will eventually be officially declared illegal by the IRS. The penalty can be as high as the loss of your entire IRA.

No, you won’t find people crying of the loss of their IRA yet, but the IRS is serious. On the list of the top 12 tax shams the IRS is targeting this year you can see that the IRA LLC combination is at the top, 

Establishing a checkbook IRA structure is definitely a case of buyer beware.

Read more:
Valuable Planning Tools You Haven’t Heard Of
Put Your Retirement Plan on Steroids


Lee R. Phillips is a United States Supreme Court Counselor who for the past 30 years has helped high income individuals control their taxes and protect their assets. Call (800) 806-1998 or visit LegaLees.com.

Related Sites
MJH Associates
AJMC
Cure Today
OncLive
OTC Guide
Specialty Pharmacy Times
Targeted Oncology
Rare Disease Report
Copyright © 2017 - 2018 Intellisphere, LLC. All Rights Reserved.