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ROTH IRA CORPORATE OWNERSHIP

December 03, 2004

We begin our series on "listed transactions" with transactions "to avoid limitation on Roth IRA contributions." These became listed transactions via Notice 2004-8.

HOW TO SPOT THESE:

Any ownership of a C corporation by a Roth IRA should raise a little red flag. If IRAs only own a small percentage of the corporation, relax. If they own "substantially all" of the corporation, you need to see if the corporation does any business with entities controlled by Roth IRA beneficiaries. If it does, or if you can't be sure, it's time to file form 8886.

HOW IRS DESCRIBES THEM

These deals are described in Notice 2004-8:

   ...arrangements in which an individual, related persons
   described in § 267(b) or 707(b), or a business 
   controlled by such individual or related persons, 
   engage in one or more transactions with a corporation, 
   including contributions of property to such corporation, 
   substantially all the shares of which are owned by one 
   or more Roth IRAs maintained for the benefit of the 
   individual, related persons described in § 267(b)(1), or
   both. The transactions are listed transactions with 
   respect to the individuals for whom the Roth IRAs are 
   maintained, the business (if not a sole proprietorship) 
   that is a party to the transaction, and the corporation 
   substantially all the shares of which are owned by the 
   Roth IRAs. 

   Substantially similar transactions include transactions 
   that attempt to use a single structure with the intent 
   of achieving the same or substantially same tax effect 
   for multiple taxpayers. For example, if the Roth IRA 
   Corporation is owned by multiple taxpayers’ Roth IRAs,
   a substantially similar transaction occurs whenever 
   that Roth IRA Corporation enters into a transaction 
   with a business of any of the taxpayers if distributions 
   from the Roth IRA Corporation are made to that 
   taxpayer’s Roth IRA based on the purported business 
   transactions done with that taxpayer’s business or 
   otherwise based on the value shifted from that 
   taxpayer’s business to the Roth IRA Corporation.

WHERE THESE CAME FROM

Notice 2004-8 responds to an arrangement marketed by Grant Thornton, and probably others, in which taxpayers would set up C corporations owned by Roth IRAs. This would be done by establishing a corporation within a Roth IRA and funnelling income from another corporation to the Roth IRA corporation, often in the form of "management fees." The fees might be in just the amount needed to use up the lower corporation rate brackets, resulting in reduced current taxes. While the Roth IRA-owned corporation would be subject to tax, dividends and proceeds from the sale of corporate stock would be permanently tax free.

Grant Thorton got into a legal battle with the IRS over this transaction when the IRS sought a list of its clients using the transaction.

WHY IT MATTERS

Individual taxpayers who fail to report a listed transaction on form 8886 are subject to a non-waivable $100,000 penalty. The penalty for trusts, corporations and partnerships is $200,000. For more on these penalties, go here.

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