Investing your retirment funds into a business? First Understand Peek v Commissioner | Frank Selden Law

Investing your retirment funds into a business? First Understand Peek v Commissioner

This post by an attorney cautions against creating a rollover business startup (ROBS) transaction. His reason? The Peek and Fleck v. Commissioner case means rollover business startups are potentially fraught with prohibited transaction peril. It might, if Peek and Fleck was a ROBS case. But it isn’t. Peek and Fleck is a self-directed IRA case. If you are going to use either, you need to understand the difference.

Peek v Commissioner – History

In 2001, the Peek and Fleck used their self-directed IRAs to fund the purchase of Abbott Fire & Safety, Inc. from an unrelated third party. At that time, Abbott was a successful business specializing in the sale of fire alarms, sprinklers, and other fire suppression equipment. The taxpayers acquired Abbott through a newly formed corporation – FP Company – which the taxpayers capitalized exclusively with their IRA assets. Each of the taxpayers’ IRAs transferred cash to FP Company in exchange for the company’s stock. Following the transaction, the taxpayers’ IRAs collectively owned 100 percent of FP Company. FP Company then acquired Abbott using that cash (i.e., the proceeds from the stock sale to the IRAs), cash from a bank loan and promissory notes.

The sellers required the taxpayers to personally guarantee the promissory note FP Company made to them. In subsequent years, the taxpayers rolled over the FP Company stock from traditional IRAs to Roth IRAs, which resulted in income to the taxpayers during those years. In 2006, the taxpayers sold FP Company for a substantial profit, which the taxpayers claimed was permanently shielded from tax on account of the FP Company stock being held by taxpayers’ Roth IRAs. To see the appellate case click here.

Peek v Commissioner – a ROBS arrangement?

No. It is an IRA investment, and the differences are exactly why the IRS found that Peek and Fleck committed a prohibited transaction when they guaranteed the loans and disqualified their IRAs.

Their defense included the argument that they used a ROBS setup and that such guarantees are allowed. The court disagreed.

ROBS transactions typically involve the following sequential steps:

  1. establish a new corporation;
  2. the corporation adopts a 401(k) plan that specifically permits plan participants to direct the investment of their plan accounts into a selection of investments options, including employer stock;
  3. client elects to participate in the new 401(k) plan
  4. client directs a rollover or trustee-to-trustee transfer of retirement funds into the newly established corporate plan;
  5. client then directs the investment of his or her 401(k) plan account to purchase the corporation’s newly issued stock; and
  6. the company utilizes the proceeds from the sale of stock to purchase an existing business or to begin a new venture.

Had Peek and Fleck used a proper ROBS setup, instead of directly investing into their corporation with their IRAs, they could have guaranteed the loans without creating a prohibited transaction.

Abraham Lincoln is quoted as asking "If you call a sheep's tail a leg, how many legs will a sheep have?" Four. Calling a tail a leg doesn't make it one, and calling an SDIRA setup a ROBS arrangement doesn't make it one either.

Peek v Commissioner – the Promoter Issue

On appeal, Peek and Fleck argued that they “relied in good faith on the advice of their accountant, Mr. Blees.” The Tax Court held that the transactions at issue were prohibited and that Appellants were liable for accuracy-related penalties. The Tax Court rejected Appellants’ argument that they had reasonably relied on Mr. Blees’ advice in failing to accurately report their gains. The court made several supplemental factual findings, including that Mr. Blees was a “promoter” and not “a disinterested professional” under these circumstances.

Hiring a promoter increases your liability for accuracy-related penalties if they screw up. Why would you use one rather than a disinterested professional (such as Frank Selden Law, PS)?

I also believe, if you are going to use an attorney, use one who knows the difference between a self-directed IRA case and a ROBS case.

Do You Want an SDRIA or a ROBS?

If you want to invest retirement funds into a business, understand the differences. Your objectives will direct you to either an SDIRA or a ROBS. They are mutually exclusive.

Self-directed IRAs have some distinct advantages over ROBS, but are not the proper format for all investments. A ROBS arrangement would not have created the tax-free growth that Peek and Fleck wanted. However, their personal guarantee violated the IRA rules. Discuss your goals with someone who knows all of the rules for both concepts before you involve your qualified funds.

To discuss SDIRAs, call John Park at PGI Agency. (602-684-2922) John is well versed in discussing your investment goals. If an SDIRA is a good fit, he will help you choose a custodian and create an IRA account on their platform. He loops me in for legal questions and to create the legal framework (such as an LLC or Trust) that best fits your goals for your IRA.

To discuss a ROBS setup, call me at 401K ROBS PROS (206-249-7979). You can also download our ebook at our website, and book an appointment directly on my calendar.


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