Self Dealing in Tax Free and Tax Deferred IRA's
by Hugh Bromma
The most frequently asked questions relate to doing transactions which are
prohibited or self dealing. What is Self Dealing? Remarkably, the tax code makes
some sense in this area. The concept of self dealing within the context of an
IRA is easy: Your retirement plan is supposed to benefit when you retire, not
before then. Self dealing transactions are outlined in the code as prohibited
transaction, but clear examples of what is not prohibited are scarce.
To begin, we will explore what "You", Individual Retirement Account", and
"Disqualified Persons" are, and then what you can and can't do or simply what
"prohibited transactions" are.
Who Is "You" and Who Are "You" Not?
You. What is most important about "You" is who you are not. Your are not
the Individual Retirement Account. "You" establish a trust for your benefit in
an Individual Retirement Arrangement through a legally permitted entity, such as
a bank, savings association or non-bank trustee. An "Individual Retirement
Account" is a type of arrangement that allows tax deferrals or permits tax free
accumulations of money. This account (IRA) is opened so that transactions you
direct may be processed. Such transactions include contributions, purchases,
sales and distributions.
Contributions are those transactions in which you deposit money to your
account based on the legal limits in accordance with your earned income.
Purchases are the acquisition of assets which you direct through the trustee or
custodian of your IRA. You may never purchase an asset and then contribute them
to your IRA. Only cash may be contributed as noted previously.
Sales are those transactions which you direct the trustee or custodian of
your IRA to sell from your account. The proceeds of the sale may be in cash or
other property. It remains in your account until the assets in your account are
distributed.
Distributions are withdrawals from your account. You request those
withdrawals, in cash or in kind, from the trustee or custodian to be made to
you. If you ask that these assets be paid or conveyed to a third party, it still
counts as a withdrawal to you. Although not generally an issue with Roth IRAs,
it is important for traditional IRAs, where distributions or withdrawals are
taxable events.
As noted above "You" never "Buy" an IRA. You always open an Individual
Retirement Account. You then direct the purchase of an asset. This purchase is
either through the opening an account process or by a separate direction.
An Individual Retirement Account is also known as a Plan.
Now that you know that "You" and your IRA are different, and that your trustee
or custodian acts on your behalf based on your direction, what can't "You" do?
"You" and "Disqualified Persons" can't engage in prohibited transactions.
Generally, a prohibited transaction is any improper use of your IRA (or annuity)
by you or any disqualified person.
Disqualified Persons
Disqualified persons include:
- a fiduciary;
- a person providing services to the plan;
- an owner, direct or indirect, of 50 percent or more of
1.) The combined voting power of all classes of stock entitled to vote or the
total value of shares of all classes of stock of a corporation.
2.) The capital interest or the profits interest of a partnership.
- a member of the family (ascendants, descendants, but not siblings);
- a corporation, partnership, or trust or estate of which (or in which) 50 percent
or more of the combined voting power of all classes of stock entitled to vote or
the total value of shares of all classes of stock of such corporation, the
capital interest or profits interest of such partnership, or the beneficial
interest of such trust or estate, is owned directly or indirectly, or held by
persons described above;
- an officer, director (or an individual having powers or responsibilities similar
to those of officers or directors), a 10 percent or more shareholder, or a
highly compensated employee (earning 10 percent or more of the yearly wages of
an employer); a 10 percent or more (in capital or profits) partner or joint
venturer of a person.
What is Prohibited
So here's what's prohibited:
Your plan may not, directly or indirectly, sell, exchange or lease any property
with a you or disqualified person. This includes lending money or extending
credit. Your plan can't furnish goods, services or facilities to you or a
disqualified person. You or a disqualified person cannot transfer to each other,
use or benefit from the asset in the plan. An exemption.
There is an exemption which applies: Any contract, or reasonable arrangement,
made with a disqualified person for office space, or legal, accounting, or other
services necessary for the establishment or operation of the plan, if no more
than reasonable compensation is paid therefor.
The exemption may include servicing notes which you have directed to be
purchased and managing property which you have directed to be purchased. It does
not include leasing back property to yourself, or a disqualified person,
acquired by your direction in a plan. You may not be compensated for rehab work
which you or a disqualified person do to an asset in your plan. You may do all
of these things with any other person other than you, a or a disqualified
person. You may find a person who does similar type of investments with their
plan assets and arrange a mutually satisfactory deal to do what you mutually
agree to. Some people use their siblings to do what may be prohibited otherwise.
In summary there are numerous methods, which do not violate the law, which you
can use to meet your long term objectives, and get the most out of your plan. We
encourage the complete understanding of the rules, and the benefits available to
you.
Bio:
Hubert (Hugh) Bromma is CEO of Entrust Administration, Inc. He has decades of
experience on the cutting edge of investment education. His business philosophy
is providing quality education to enable his clients to enhance their
investments. Hugh has written several books on tax-free and tax-deferred
investing and has an extensive background in economics and investing.