Peek v Commissioner Revisited

I discussed the Peek v Commissioner case a year ago. I am revisiting it today because of another post by an attorney who cautions against creating a rollover business startup (ROBS) transaction. His reason? The Peek and Fleck v. Commissioner case points to prohibited transaction issues with rollover business startups. It might, if that 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 know the difference.

Peek v Commissioner Revisited
Peek v Commissioner Revisited

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.

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 finally
  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.

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.

If you want to invest retirement funds into a business, understand the differences. Do you need an SD-IRA or a ROBS?

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. That’s what I offer. Call me. 425.990.1021

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