Attorney-at-Law

ANY WHICH WAY YOU SLICE IT

In Uncategorized on 05/09/2013 at 16:31

 “Direct or indirect”, that is the question, and the ever-obliging jurist, Judge David Gustafson has the answer, namely and to wit, “any which way you slice it”, in Lawrence F. Peek and Sara L. Peek, 140 T.C. 12, filed 5/9/13.

The Peeks and their pals the Flecks think that putting out fires is the way to wealth, so they decide to buy a fire suppression company. They go to Chris Blees, CPA, who suggests each couple set up a traditional IRA, form a corporation, all of whose stock is split between the two trad IRAs, and buy the suppressor in the corporation.

But Chris warns against the Section 4975 prohibited transactions, which torpedo IRAs per Section 408, in general terms, not mentioning what Peek and Fleck eventually do (and never tell Chris about). The seller of the suppressor wants cash, which Peek and Fleck give via the corporation, but come up short. The corporation offers its note, but the seller wants personal guarantees from Fleck and Peek.

These they gave, and that’s when the trouble starts, but isn’t apparent for years.

Down the road, but before the suppressor hits the jackpot, Fleck and Peek each roll their stock from the trad to a Roth, paying minimal tax.

A few years later the suppressor goes big time, and the corporation sells the suppressor for mucho moolah, pays off the note, and parks the cash in the Roths.

IRS calls capital gains from Fleck and Peek personally, claiming the guarantees violate Section 4975(c)(1)(B): “any direct or indirect– * * * (B) lending of money or other extension of credit between a plan and a disqualified person”.

Peek and Fleck claim that the subsidiary corporation isn’t the plan, but agree that a guaranty is a “lending of money”.

Judge Gustafson: “This reading of the statute, however, would rob it of its intended breadth. Section 4975(c)(1)(B) prohibits ‘any direct or indirect * * * extension of credit between a plan and a disqualified person’. (Emphasis added.) The Supreme Court has observed that when Congress used the phrase ‘any direct or indirect’ in section 4975(c)(1), it thereby employed ‘broad language’ and showed an obvious intention to ‘prohibit[] something more’ than would be reached without it. Commissioner v. Keystone Consol. Indus., Inc., 508 U.S. 152, 159-160 (1993). As the Commissioner points out, if the statute prohibited only a loan or loan guaranty between a disqualified person and the IRA itself, then the prohibition could be easily and abusively avoided simply by having the IRA create a shell subsidiary to whom the disqualified person could then make a loan. That, however, is an obvious evasion that Congress intended to prevent by using the word ‘indirect’”. 140 T. C. 12, at p. 16.

So there was a prohibited act, terminating the trad IRA as of Day One of the year wherein the prohibited act occurred. But that’s not the year at issue. So Peek and Fleck claim the SNODs don’t cover that, and the termination year is closed.

Wrong, says Judge Gustafson: “The loan guaranties were not a once-and-done transaction with effects only in 2001 but instead remained in place and constituted a continuing prohibited transaction, thus preventing Mr. Fleck’s and Mr. Peck’s accounts that held the [corporation] stock from being IRAs in subsequent years. On January 1, 2006, it remained true that Mr. Fleck and Mr. Peek guaranteed the loan to [corporation]; if [corporation] defaulted, they would pay. By its nature, the loan guaranty that each man made put him and his account in an indirect lending relationship that would persist until the loan was paid off.” 140 T. C. 12, at p. 18 (footnote omitted).

So the conversion from trad to Roth was a nullity, because the trad was no longer an IRA when the purported “conversion” took place. And it probably is too late for Peek and Fleck to try to get back any tax they paid.

Now of course Peek and Fleck claim they relied on Chris, but Chris was a promoter, and besides they never proved they told Chris what they were doing with the guarantees.

“Direct or indirect”? Any which way you slice it.

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