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Expert Says Tax Court Sticks It to Franchisees on IRA Rollover Loans

After much discussion of the Internal Revenue Service’s investigation of franchisees funding their franchise purchases from rollover IRA retirement accounts, a recent tax court opinion has changed the rules.  

In the latest Franchise Valuations Reporter, New York tax expert Bruce Schaeffer says the ruling “sticks it to franchisees who funded their franchise purchase with funds from the Rollover IRA,” known as ROBS (Rollovers for Business Startups), and then guaranteed the business’ loans or lent money to the business.

The initiative focused on the details of the mass use of a technique to make IRA or 401(k) benefits available for investment in start-up businesses on a pre-tax, rather than after-tax basis - a 30-40% bonus of deferred taxes at today's rates.

Schaeffer explains that the technique is sold by economic advisers on a confidential "secret sauce" type basis and has been Tax Expert Bruce Schaeffer ignored by the IRS for the most part since then. But he says the issue has been resurrected because of the "prohibited transaction" rules which totally disqualified a ROBS IRA in the recent case of Peek v. Commissioner.

Schaeffer outlines how the taxpayers in the court case set up their business structure using their traditional IRAs. After personally guaranteeing a $200,000 promissory note to the seller, and rolling over the stock in the original IRAs to Roth IRA accounts, they determined that their Roth accounts were not taxable. 

The Tax Court disagreed and said the original loan transaction destroyed the tax exempt status of the ROBS IRA from the date of the loan guarantee because that was a "prohibited transaction" under IRC Section 4975 and disqualified the IRA . . . 

Schaeffer further states that a 20% undervaluation penalty was upheld “in the face of the taxpayers’ argument of reasonable reliance on expert advice.”

Because the certified public accountant on whose advice the taxpayers claimed to have relied was, as noted by the Court, not a disinterested professional but a promoter of the very plan employed by the taxpayers, the penalty was sustained under [IRS] Code Sec. 6664(c).

Related Article:

Tax Court Warns Owners in Using IRA ROBS

Franchise Valuations Reporter June 2013.pdf260.38 KB
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