Individual 401k Rules

The Federal Circuit Court decided that when a plan owner receives compensation or salary from his IRA LLC, it is considered a prohibited transaction. IRA plan owners are recommended to review and understand the rules and regulations to keep their plan in compliance.

What is an IRA LLC?

The IRA LLC is set up to give the plan owner total control over his or her retirement plan. For an IRA, typically a qualified custodian is required to set up and manage the account. In the IRA LLC structure, the special purpose LLC established and the IRA funds are used to purchase shares of this LLC. The plan owner will be named as the manager of the LLC, therefore, can make investment decisions.

In this setup, the IRA account owners truly act as the sole decision makers. With this power, however, come certain responsibilities. Plan owners cannot engage in a prohibited transaction, for example.

The Ellis v. Commissioner case

In this case, the IRA plan owner pays himself a salary from the LLC, for the management work that he performs for this IRA. The plan owner argues that the compensation should be considered as a “reasonable compensation” exemption. In IRC § 4975 (d)(10), a reasonable compensation can be paid from the IRA to a disqualified person for the performance of plan duties. Such compensation is an exception to the prohibited transaction rules.

However, in this case, the court ruled that the management of the LLC business activities cannot be considered a plan duty.

By paying himself from the LLC, the plan owner engages in an indirect prohibited transaction. According to the IRS regulations, the IRA cannot invest in a business entity from which a disqualified person can gain personal benefit or compensation.

What it means to IRA plan owners

From this case, it is decided that an IRA plan owner or any other disqualified person should never receive compensation from the IRA LLC. Other disqualified persons also include the spouse, parents and children of the IRA plan owner.

While this should be stated in the plan documents itself, as the plan fiduciary, plan owners need to understand their responsibilities and restrictions. It is not a good idea to rely entirely on the plan custodian or administrator. In the self-directed IRA structure, plan owners assume full responsibility. When in doubt, it is best to consult a professional tax attorney.

The self-directed IRA LLC is still a fully legitimate investment vehicle that can provide powerful control to the IRA plan owners. However, the plan only works when set up and managed properly.

Related Search Terms:

• Self directed IRA
• IRA LLC
• IRA Rules
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