Savvy start-up owners have long recognized the potential investment and tax advantages of using a Roth IRA to invest in the company. Famous examples of wealthy business owners, essentially holding a large portion or even all of a company within a non-taxable Roth IRA, include Peter Thiel of PayPal ($5 billion), Robert Mercer ($31.5 million), Warren Buffett ($20.2 million), and Randall Smith ($252.6 million).

This situation arose from a loophole in tax law, which allows a Roth IRA to be invested into an early-stage growth business. Shares cannot be contributed in-kind to an IRA, and certain rules under the Prohibited Transactions in IRC Section 4975 set limits on from whom an IRA can purchase shares (Disqualified Persons). The IRA cannot purchase shares in the individual account owner’s solely owned company, or from close family members.

Additionally, even if the individual (and his/her family members) own more than 50 percent of shares in the company, the company cannot issue new shares to the IRA. The IRA must purchase any new shares from a non-Disqualified Person, and even then, the IRS sometimes looks sideways at the transaction.

Even still, a loophole exists for the creative and persistent start-up owner. Tax Court has repeatedly determined that a business has no owners prior to its formation and capitalization, and therefore is not owned by a Disqualified Person. Therefore, the company can, at this early time before its actual birth, issue 100 percent of shares to an individual’s Roth IRA.

It makes for an interesting (and highly tax-advantaged) workaround, that essentially allows entire untaxed corporations to exist. However, Congress is poised to close up the loophole. A tax package now making its way through the House would limit IRAS to trading only in publicly exchanged securities. The accounts would no longer be allowed to hold private equity, hedge funds, and other investments only available to insiders.

Current owners of IRAS utilizing this loophole would be required to sell such holdings within two years, and invest the funds into public, SEC-registered investments instead.

Finally, those holding $10 million in a traditional or Roth IRA would be prevented from making further contributions, and would be subjected to new withdrawal rules on these high-value accounts. Essentially, the law would limit non-taxable retirement accounts to $10 million, and eliminate tax-free corporations in the US.

If you have questions about the potential new law, call our office. We can help you determine if new regulations will impact you and your IRA, and decide how to proceed next.

 

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