How NOT to use a Roth IRA
By Jordan Sheppherd
A little over a year ago, a court case came out involving a Roth IRA/Corporation structure, the facts of which are almost comical. The case is Polowniak v. Commissioner TC 2016-31. You can see it on the US Tax Court’s website here.
It is an entertaining read for those of us who understand the self-dealing rules of IRAs, and I would suggest everyone take the time to read through the tax court’s decision.
In a nutshell, this guy attempted to shift consulting income he had in his personally owned S-Corp, over to a C-Corp owned by his and his wife’s Roth IRAs.
Is this allowed? Um, no.
In 2001, this fellow Polowniak, created a Roth IRA and made a $2,000 contribution. He then created a C-Corp, had the Roth IRA buy 98% of the stock, while the other 2% was bought by one of his administrative assistants. At a later date, his wife also created a Roth IRA, and her Roth also bought stock in the C-Corp. Already at this point, he and his wife both engaged in prohibited transactions. Here’s why: he was probably fine when his Roth bought stock in the C-Corp and the rest was bought by his administrative assistant. As soon as his wife’s Roth bought into the C-Corp though, it triggered a PT (prohibited transaction) because his wife’s Roth IRA was essentially purchasing stock from his Roth IRA; so his Roth IRA was selling stock to his wife’s Roth IRA.
It gets better though.
As if this wasn’t bad enough, he took an S-Corp that he personally owned, and had it enter into a subcontracting contracting agreement with the Roth IRA owned C-Corp. Another prohibited transaction. Here’s why: he is a disqualified or prohibited person to his own IRA; he isn’t allowed to deal with his IRA or any company his IRA owns. Here he is executing a contract between his own personal S-Corp, and the C-Corp that is owned by his Roth IRA. This is clearly self-dealing.
During the course of the subcontracting contract, this fellow provided services to the Roth IRA owned C-Corp. His personal S-Corp also made a number of loans to the Roth IRA owned C-Corp. More prohibited transactions. Here’s why: As a disqualified person, he’s now offering services and loaning money to, a company owned by his Roth IRA. This is also clearly self-dealing.
Given that the statute of limitations had most likely expired on the prohibited transactions, the tax court focused on the improper dealings creating excess contributions to his Roth IRA. It didn’t turn out favorably for Mr. Polowniak.
There’s a lot in the case about excess contributions and some other technical stuff, but forget all that and focus on the idea of self-dealing. Once you read through it, I think you’ll agree that this is an amusing case. How this guy thought he could get away with this is beyond me.
Bottom line: don’t deal with yourself or your immediate family. Stay away from anyone who tells you otherwise, and use these structures the way they were intended to be used – by investing in non-traditional assets to increase your retirement savings.