IRA’s FMV includible in income: assets used to fund business, pay salary

A taxpayer engaged in a prohibited transaction when he caused his IRA to invest a substantial majority of its value in the taxpayer’s new business with the understanding that the taxpayer would receive compensation for his services as general manager, the U.S. Court of Appeals in St. Louis (CA-8) has ruled. Thus, the IRA lost its status as an individual retirement account and its entire fair market value (about $321,000) was includible in income.


The taxpayer formed a limited liability company (LLC) to sell used cars. Ninety-eight percent of the LLC was owned by the taxpayer’s IRA, which in turn was funded largely by rollovers from a 401(k) the taxpayer had established with a previous employer. The LLC paid the taxpayer a total of about $40,000 in two years of operation, which the taxpayer reported as income.

Prohibited transaction

The IRS determined, and the Tax Court agreed, that the taxpayer engaged in prohibited transactions under Code Sec. 4975(c) by (1) directing his IRA to acquire a controlling interest in the car dealership with the expectation the company would employ him and (2) receiving wages from the company.

The Eighth Circuit agreed that the payment of wages was a prohibited transaction. By directing the company to pay him wages from funds the company received from his IRA, the court explained, the taxpayer engaged in the indirect transfer of the income and assets of the IRA for his own benefit and indirectly dealt with such assets for his own interest.
The appellate court rejected the taxpayer’s assertion that the payment of wages was exempt under Code Sec. 4975(d)(10). This exemption, the court explained, applies only to compensation for services rendered in the performance of plan duties.

Source: Ellis v. Commissioner (CA-8).

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