Advanced Tax Strategies for Start-Ups Through a Roth IRA

New business owners seek to rapidly generate interest and excitement in their company, and in turn, raise significant capital through the sale of stock. This goal is crucial in order for many start-ups to even get off the ground.

One way to generate increased benefits for the founders is to maximize tax efficiency. By allowing the founders to use a Roth IRA to buy start-up shares at fair market value, founders can then sell the stock later at higher values and the sale of the stock would be free of taxes. This is possible because gains grow within a Roth IRA are free of taxes, and Roth IRA owners don’t owe capital gains taxes on the sale of stock.

If you’re considering this strategy, there are three important rules you must be aware of:

The IRS prohibits retirement plans from investing in certain businesses. Internal Revenue Code (“IRC”) Section 4975 states that a retirement plan such as a Roth IRA cannot invest in life insurance, collectibles, or any transaction involving the retirement plan and a “disqualified person” as outlined under IRC Section 4975. That last point can get tricky, and you should consult a business planning attorney on the specifics.

Valuation can be tricky… But the IRS has trouble pursuing cases of non-compliance. The IRS generally requires individuals to use fair market value rather than a liquidation value or another valuation method. But in some cases, liquidation values can be used. The IRS admits that valuation can be subjective, and the statute of limitations to pursue the cases is only three years. That makes it difficult to pursue non-compliant cases that span a long term of IRA investment.

You must avoid IRA “stuffing.” Anyone who seeks to have their Roth IRA purchase shares in their start-up should focus on fair market value. Otherwise, one could be accused of IRA stuffing, which involves making transactions that disguise Roth IRA contributions exceeding annual IRA limits.

Using retirement funds to invest in start-up businesses is absolutely allowed under the law and can potentially carry many benefits for founders. But the above rules point toward significant risks when transactions are not conducted carefully and with expert guidance. For more information on using a Roth IRA to fund your start-up, call our office before making any potentially risky decisions.

Picture of Michael Kimball, Esq.

Michael Kimball, Esq.

Mike Kimball offers practical, timely, and economical legal solutions that move projects along and allow you to focus more on your core business objectives. He has years of experience partnering with companies ranging from Silicon Valley startups to firms in aerospace, biotech, construction, and many more. Mike’s in-house experience includes Yahoo!, Krux Digital (acquired by Salesforce), and Commerce One. He has worked on transactions with Eurostar, Red Bull, Major League Baseball, NASDAQ, Goldman Sachs, Liveramp, Amazon, and NASCAR.