Under What Circumstances Can an IRA Invest in a Business Owned in Part by the IRA Owner and Members of The IRA Owner’s Family

Note: This is a discussion draft, and does not necessarily reflect the views of the author!

ARTICLE 1
ISSUES (AND EQUIVOCAL ANSWERS)

· Can an IRA form or invest in a partnership (or other entity) in which the IRA and other disqualified persons have more than a 50% interest in capital or profits without violating the prohibited transaction rules? Maybe, if Swanson[1] is followed.

· Can an IRA form or invest in a partnership (or other entity) in which the IRA and other disqualified persons have less than a 50% interest in capital or profits prior to formation, but who have more than a 50% interest in capital or profits after formation, without violating the prohibited transaction rules? Theoretically yes, according to PWBOpL 2000-10A and FSA 200128011.

· Can an IRA form or invest in a partnership (or other entity) in which the IRA and other disqualified persons have less than a 50% interest in capital or profits without violating the prohibited transaction rules? Probably, but great caution is called for.

· Is a partnership (or other entity) that is controlled by family members of the IRA owner a disqualified person? Yes, if the IRA is self-directed.

· Is an IRA trustee or custodian always a fiduciary? Yes

· Is an IRA owner always a disqualified person? Probably. However, if there is no power to self-direct investments, it is arguable that the IRA owner is not a fiduciary with respect to the IRA, and hence, is not a disqualified person.

ARTICLE 2
CONCLUSIONS

If Swanson[2] is good law, then the formation of an entity by an IRA, at the instigation and direction of the IRA owner, who not only controls the entity, but after formation serves as an officer and director, and the simultaneous transfer of IRA assets to the entity, is not a prohibited transaction per se. In fact, the Tax Court in Swanson not only held in favor of the taxpayer, but went further, and found that the assertion by the IRS that a prohibited transaction existed was so lacking in substantial justification as to justify charging the government with the costs of the litigation! Despite this, I have reservations about whether the case is correct.

Swanson clearly held that after the corporation was formed it would be a disqualified person, and we must assume this conclusion to be true.[3] If the entity held by the IRA is a disqualified person, any dealings between it and the IRA will be subject to the prohibited transaction rules of IRC §4975(c)(1). If the fact that an IRA owns a controlling interest in a partnership makes the partnership a disqualified person —as I think is the case, at least after the partnership is formed— then any further transfers to the partnership by the IRA (or perhaps by any other disqualified person or family member) would technically be prohibited. Why it is not prohibited by §4975(c)(1)(D) (a transfer to a disqualified person of the assets of the plan) when the transfer takes place at the time of formation is unclear to me, but Swanson clearly holds that formation alone is not prohibited. Everything hinges on Swanson being correct in this regard, unless the IRA and other disqualified persons maintain at all times a less than controlling position. For this reason I quote below extensively from this case. For now, I remain short of being fully persuaded.

I think it is reasonable to conclude that neither the receipt of partnership distributions by the participant or IRA, nor participation in management (arguably a “settlor” function), would alone constitute a prohibited transaction, since such receipt and management alone does not clearly violate any of the prohibitions described in §4975(c)(1)(A)-(F).[4] However, this conclusion too could be subject to dispute.

§4975(c)(1)(E) prohibits a fiduciary from dealing “with the income or assets of a plan in his own interest or for his own account.” This section could always be invoked, but it is possibly more likely to be invoked where it appears that the purpose for forming the partnership is to get a discount for income, estate, and gift tax purposes. Why else would an IRA form a partnership? (That was not a rhetorical question.) I imagine that many of the same business reasons applicable to the formation of any partnership are likewise present in varying measure where an IRA enters into a partnership.

If the formation of the partnership by the IRA alone, or between the IRA and unrelated parties, is not a prohibited transaction —a conclusion that Swanson[5] supports—, and if the participation in management and profits by the IRA is likewise not a prohibited transaction —a conclusion that Swanson implies—, and if a distribution of a partnership interest is not a prohibited transaction —a transaction specifically exempted by IRC §4975(d)(9)—, then an IRA ought to safely be able to form and later distribute a limited partnership interest, unless a court finds that such a course of action amounts to dealing “with the income or assets of a plan in his own interest or for his own account” in violation of §4975(c)(1)(E).

At the risk of being repetitious, I think that as long as the IRA and disqualified persons (including family members) own more than 50% of the capital or profits interest in a partnership, then the partnership is itself a disqualified person, and therefore any further dealings between the partnership and the IRA will have to stay on the sunny side of §4975(c). That may prove difficult but perhaps not impossible. If the assets of the partnership are plan assets, then any dealings with the partnership by any other disqualified person would be treated as dealings with the IRA, and thus, would also have to stay outside the purview of §4975(d). The performance of “settlor” functions, discussed later, should not be within these prohibition.

If the IRA was in a partnership that was controlled (50% or more) by persons other than the IRA itself, the IRA owner, and the IRA owner’s family (as defined by IRC §4975(e)(6)), then I think that the acquisition itself would probably be outside of §4975 and the prohibited transaction rules, but there are many operational hurdles that would have to be overcome to avoid a prohibited transaction following the initial investment.

ARTICLE 3
An Example

The following example was inspired by a short paper and talk given at the 10^th Annual SBOT Advanced Estate Planning Strategies Course, held April 1-2, 2004 in Santa Fe, New Mexico, entitled “Unusual Opportunities With Partnerships,” by James D. Spratt, Jr. of King and Spaulding, in Atlanta. Since I have been writing on and thinking about this subject for almost a decade, I was encouraged to see that others not on the lunatic fringe were seriously considering the same question and reaching similar conclusions.

The example that Mr. Spratt gave was of an elderly lady of independent means who also had a large IRA that she does not need. The IRA owner forms an LLC. Why the IRA could not form the LLC was unclear to me. I would be more comfortable if the IRA formed the entity in the first place. Perhaps the IRA sponsor did not share my comfort. In any case, the idea was that under Swanson the mere formation of an LLC by an incorporator, who could be the IRA owner’s attorney, is a non event (or in any case not a “transaction”). Next, the IRA contributes a portion of its assets to the LLC in exchange for all of the LLC units or stock. (In Texas this could create a franchise tax issue, but I do not see why a single member limited partnership could not have been formed with a wholly owned LLC as general partner. I assume that the entity would be disregarded for federal income tax purposes, which might not be all bad.)

Okay, so now the IRA is the 100% owner of a pass-through entity: in Spratt’s case an LLC. Any problem so far? Other than the general prohibition in IRC §4975(c)(1)(E), which defines a prohibited transaction as including an “act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account,” I cannot think of any. Regarding §4975(c)(1)(E), it could be invoked almost no matter what you do, and so it is a question of how far the courts are going to bend to apply it. So far, there have been few cases where they have stretched to do so.

Next, in the non-step-transaction, suppose that a distribution of a portion of the LLC units are made to the IRA owner. Any problem there? As discussed in detail below, although a disqualified person (including the IRA owner) is generally disqualified from buying or selling or otherwise dealing with the IRA, or even making a contribution in-kind in most cases, it is perfectly permissible to make a distribution in-kind. So I have to conclude that there is still no prohibited transaction.

Now, if the IRA owner gives the units away to family members, that ought to be okay, though it is clear that close family members will be disqualified persons, the same as the IRA owner. It occurs to me that it might be a little safer to distribute (and give away) non-voting units.

In the Spratt article, the IRA contracted with a third party to manage the investments in the LLC. I would rather see the IRA trustee do all of the investing, just in case the LLC is disregarded and the a nonqualified fiduciary is deemed to be in possession of the IRA assets. IRA assets are required to be held by an institutional trustee or custodian, such as a bank, in most cases.

Also, it was planned that no distributions from the LLC would be made for the period during which the LLC was held by the IRA. I am not sure that this is critical, but it couldn’t hurt. I asked the speaker about this, and he told me that they were not sure that it would hurt either, but planned not to make any distributions out of an abundance of caution.

Finally it was contemplated that the LLC would eventually be distributed to the IRA owner, presumably at a discount for both income and estate tax purposes. Think about it.

Test question: What problems do you see with this transaction and why?

ARTICLE 4
Are There Instutional IRA TRustees and Custodians that Will Permit Investments Such as the One Described in this Paper

I am compiling a list of institutions that will allow IRAs to invest in real estate and in assets other than publicly traded stocks and bonds. Please tell me if you know anymore.

I know for a fact that PENSCO is willing to allow IRAs to make unusual investments under certain circumstances, perhaps with the benefit of an opinion by counsel.

Tom Anderson

PENSCO Trust Company

104 Congress Street, Suite 402

Portsmouth, New Hampshire 03801

800 969-4472 x5608 (Business)

(866) 818-4IRA (4472)

603/433-2662 (FAX)

PENSCO7@mindspring.com

www.PENSCO.com

I have heard that Sterling Trust Company is willing to allow IRAs to make unusual investments under certain circumstances, perhaps with the benefit of an opinion by counsel.

Sterling Trust Company

7901 Fish Pond Road

P. O. Box 2526

Waco, Texas 76710

(800) 955-3434 (Business)

(254) 751-1505 (alternate)

IRA Services: 254/751.0872 (fax)

Qualified Plans: 254/772-9752 (fax)

Escrow Services: 254/741-9869 (fax)

Executive Offices: 254/751-7734 (fax)

Sales Offices: 254/776-1026 (fax)

If the IRA were sufficiently large, Texas Capital Bank, a personal favorite of mine, when it comes to IRA trustees, might be willing to allow IRAs to make unusual investments under certain circumstances, perhaps with the benefit of an opinion by counsel.

David A. Folz

Texas Capital Bank

5910 N. Central Expwy., Suite 1000

Dallas, TX 75206

(214) 932-6625 (Business)

214/ 890-5895 (FAX)

david.folz@texascapitalbank.com

ARTICLE 5
Governing Statutes

We begin with an overview of the application of the prohibited transaction rules to IRAs. The prohibited transaction rules, unfortunately, are found both in ERISA[6] and the IRC[7]. Although the rules are similar, they are not identical. We need not be too concerned with ERISA because most IRAs are outside of ERISA’s purview.

5.1 Prohibited Transaction Defined

IRC §4975(c)(1) defines a “prohibited transaction” as follows:

(1) General rule. For purposes of this section, the term “prohibited transaction” means any direct or indirect --

(A) sale or exchange, or leasing, of any property between a plan and a disqualified person [DQP];

(B) lending of money or other extension of credit between a plan and a disqualified person;

(C) furnishing of goods, services, or facilities between a plan and a disqualified person;

(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;

(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.[8]

5.2 Disqualified Person Defined

The IRC definition of a “disqualified person” is similar to the ERISA definition of a “party in interest.”

IRC §4975(e)(2) defines a disqualified person as follows:

(2) Disqualified person. For purposes of this section, the term “disqualified person” means a person who is --

(A) a fiduciary;

(B) a person providing services to the plan;

(C) an employer any of whose employees are covered by the plan;

(D) an employee organization any of whose members are covered by the plan;

(E) an owner, direct or indirect, of 50 percent or more of --

(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,

(ii) the capital interest or the profits interest of a partnership, or

(iii) the beneficial interest of a trust or unincorporated enterprise,

which is an employer or an employee organization described in subparagraph (C) or (D);

(F) a member of the family (as defined in paragraph (6)) of any individual described in subparagraph (A), (B), (C), or (E);

(G) a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of --

(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,

(ii) the capital interest or profits interest of such partnership, or

(iii) the beneficial interest of such trust or estate,

is owned directly or indirectly, or held by persons described in subparagraph (A) [Fiduciaries], (B) [Service Providers], (C) [Employers of Plan Participants], (D) [Employee Organizations], or (E) [Controlling Owners of a Business described in C or D] [Not (F), Family Members!!];

(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G); or

(I) a 10 percent or more (in capital or profits) partner or joint venture of a person described in subparagraph (C), (D), (E), or (G).

The Secretary, after consultation and coordination with the Secretary of Labor or his delegate, may by regulation prescribe a percentage lower than 50 percent for subparagraphs (E) and (G) and lower than 10 percent for subparagraphs (H) and (I).[9]

* * * *

5.3 Member Of The Family Defined

The definition of a member of the family under the IRC is identical to the definition of a relative under ERISA. It is noteworthy in both cases that the terms do not generally include collateral relatives (brothers and sisters, nephews and nieces). 4975(e)(6) defines the term “member of the family” as follows:

(6) Member of family. For purposes of paragraph (2)(F), the family of any individual shall include his spouse, ancestor, lineal descendant, and any spouse of a lineal descendant.[10]

Under both ERISA and the IRC, the 4975(e)(6)/4975(2)(F) members of the family are ignored in testing whether or not a corporation, partnership, etc. is controlled by disqualified persons. That is not the end of the story, however. 4975(e)(2)(F) includes within the list of disqualified persons certain family members:

(F) a member of the family (as defined in paragraph (6)) of any individual described in subparagraph (A) [Fiduciaries], (B) [Service Providers], (C) [Employers of Plan Participants], or (E) [Controlling Owners of a Business described in C or D];[11]

4975(e)(2)(G) includes within the list of disqualified persons certain partnerships:

(G) a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of --

(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,

(ii) the capital interest or profits interest of such partnership, or

(iii) the beneficial interest of such trust or estate,

As previously adumbrated, the exclusion for family members from the definition of control could be very important, depending on one’s analysis. A partnership, more than 50% of which is owned by fiduciaries, is a disqualified person in its own right, under 4975(e)(2)(G). What is curious, and perhaps misleading, is that 4975(e)(2)(G) conspicuously omits in the flush language any cross reference to 4975(e)(2)(F), the section that identifies members of the family as disqualified persons. But a close examination of 4975(e)(5) reveals—

(5) Partnerships; trusts. For purposes of paragraphs . . . (G) (ii) and (iii) [the section with which we are primarily concerned] . . . the ownership of profits or beneficial interests shall be determined in accordance with the rules for constructive ownership of stock provided in 267(c) (other than paragraph (3) thereof), except that section 267(c)(4) shall be treated as providing that the members of the family of an individual are the members within the meaning of paragraph (6). [Emphasis added.]

267(c) provides:

(c) Constructive ownership of stock. For purposes of determining, in applying subsection (b), the ownership of stock --

(1) Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries;

(2) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family;

(3) An individual owning (otherwise than by the application of paragraph (2)) any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner; ~~[12]~~

(4) ~~The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants;~~[13]~~~~ [but if we ignore this and substitute 4975(e)(6) as the last clause of (e)(5) tells us to do, then this paragraph would read “the family of any individual shall include his spouse, ancestor, lineal descendant, and any spouse of a lineal descendant.”[14]] and

(5) Stock constructively owned by a person by reason of the application of paragraph (1) shall, for the purpose of applying paragraph (1), (2), or (3), be treated as actually owned by such person, but stock constructively owned by an individual by reason of the application of paragraph (2) or (3) shall not be treated as owned by him for the purpose of again applying either of such paragraphs in order to make another the constructive owner of such stock.[15] [Emphasis added.]

ARTICLE 6
Case Law

6.1 Swanson v. Commissioner.

The most important case we have on our subject is James H. Swanson And Josephine A. Swanson, Petitioners v. Commissioner Of Internal Revenue, Respondent.[16] This case is very favorable to the taxpayer.

The taxpayers filed a joint return as husband and wife. However, the IRAs involved were solely the husband’s. At the instigation and direction of the husband, his IRA formed a domestic international sales corporation (a DISC), pursuant to a self direction of investment provision in the IRA. Another IRA formed another corporation which apparently transacted business with the DISC or vice-versa.

This case held that the formation of a company by an IRA is not a prohibited transaction, but that after the company is formed it would be a disqualified person.

The IRS position, as set forth in the opinion was—

Mr. Swanson is a disqualified person within the meaning of section 4975(e)(2)(A) of the Code as a fiduciary because he has the express authority to control the investments of *** [IRA #1].

Mr. Swanson is also an Officer and Director of Swansons' Worldwide. Therefore, direct or indirect transactions described by section 4975(c)(1) between Swansons' Worldwide and *** [IRA #1] constitute prohibited transactions.

Mr. Swanson, as an Officer and Director of Worldwide directed the payment of dividends from Worldwide to *** [IRA #1] *** The payment of dividends is a prohibited transaction within the meaning of section 4975(c)(1)(E) of the Code as an act of self-dealing where a disqualified person who is a fiduciary deals with the assets of the plan in his own interest. The dividend paid to *** [IRA #1] December 30, 1988 will cause the IRA to cease to be an IRA effective January 1, 1988 by reason of section 408(e)(1). Therefore, by operation of section 408(d)(1), the fair market value of the IRA is deemed distributed January 1, 1988. [Emphasis added.]

As further demonstrated by the revenue agent's report, respondent's second basis for disqualifying IRA #1 under section 408 was that:

In his capacity as fiduciary of *** [IRA #1], Mr. Swanson directed the bank custodian, Florida National Bank, to purchase all of the stock of Swansons' Worldwide. At the time of the purchase, Mr. Swanson was the sole director of Swansons' Worldwide.

The sale of stock by Swansons' Worldwide to Mr. Swanson's Individual Retirement Account constitutes a [pg. 82] prohibited transaction within the meaning of section 4975(c)(1)(A) of the Code. The sale occurred February 15, 1985. By operation of section 408(e)(2)(A) of the Code, the Individual Retirement Account ceases to be an Individual Retirement Account effective January 1, 1985.

Effective January 1, 1985 the Individual Retirement Account is not exempt from tax under section 408(e)(1) of the Code. The fair market value of the account, including the 2500 shares of Swansons' Worldwide, is deemed to have been distributed to Mr. Swanson in accordance with section 408(e)(2)(B) of the Code. Therefore, Mr. Swanson effectively became the sole shareholder of Swansons' Worldwide, Inc. with the loss of the IRA's tax exemption. [Emphasis added.]

Although the record is not entirely clear on the matter, it appears that respondent imputed to IRA #2 the prohibited transactions found with respect to IRA #1 and used similar reasoning to disqualify IRA #2 as a valid trust under section 408(a).

The taxpayer’s position, as set forth in the opinion was—

In their petition, filed September 21, 1992, petitioners stated with respect to respondent's determination of “prohibited transactions” that: (1) At all pertinent times IRA #1 was the sole shareholder of Worldwide; (2) since the 2,500 shares of Worldwide issued to IRA #1 were original issue, no sale or exchange of the stock occurred; (3) from and after the dates of his appointment as director and president of Worldwide, Mr. Swanson engaged in no activities on behalf of Worldwide [pg. 83] which benefited him other than as a beneficiary of IRA #1; (4) IRA #1 was not maintained, sponsored, or contributed to by Worldwide during the years at issue; (5) at no time did Worldwide have any active employees; and (6) Mr. Swanson engaged in no activities on behalf of Swansons' Trading which benefited him other than as a beneficiary of IRA #2.

* * * *

The procedural status on appeal, as set forth in the opinion was—

Petitioners filed a motion for partial summary judgment on March 22, 1993. In their motion, petitioners restated their position, as set forth in their petition, that no prohibited transactions had occurred with respect to IRA's #1 and #2.

On July 12, 1993, respondent filed a notice of no objection to petitioners' motion for partial summary judgment, thereby ending the controversy on the DISC and FSC issues. [17] [Emphasis added.]

At this point, we know what the issues were, and we know that the IRS dropped its original contention, but we don’t know how valid those contentions might have been if litigated. However, following the agreed summary judgment, the taxpayer requested and was granted an award for litigation costs against the government, on the grounds “that the position of the United States was ‘not substantially justified.’”

In the following extended excerpt from the case, the footnotes are the court’s.

Petitioners contend that respondent was not substantially justified in maintaining throughout the proceedings that prohibited transactions had occurred with respect to IRA #1, and by implication, IRA #2. We agree.

As stated previously, respondent based her determination of prohibited transactions on section 4975(c)(1)(A) and (E). Section 4975(c)(1)(A) defines a prohibited transaction as including any “sale or exchange, or leasing, of any property between a plan ¹¹[18] and a disqualified person”. ¹²[19] Section [pg. 88] 4975(c)(1)(E) further defines a prohibited transaction as including any “act by a disqualified person who is a fiduciary ¹³[20] whereby he deals with the income or assets of a plan in his own interest or for his own account”.

We find that it was unreasonable for respondent to maintain that a prohibited transaction occurred when Worldwide's stock was acquired by IRA #1. The stock acquired in that transaction was newly issued – prior to that point in time, Worldwide had no shares or shareholders. A corporation without shares or shareholders does not fit within the definition of a disqualified person under section 4975(e)(2)(G). ¹⁴[21] It was only after Worldwide issued its stock to IRA #1 that petitioner held a beneficial interest in Worldwide's stock, thereby causing Worldwide to become a disqualified person under section 4975(e)(2)(G). ¹⁵[22] Accordingly, the issuance of stock to [pg. 89] IRA #1 did not, within the plain meaning of section 4975(c)(1)(A), qualify as a “sale or exchange, or leasing, of any property between a plan and a disqualified person”. ¹⁶[23] Therefore, respondent's litigation position with respect to this issue was unreasonable as a matter of both law and fact.

We also find that respondent was not substantially justified in maintaining that the payments of dividends by Worldwide to IRA #1 qualified as prohibited transactions under section 4975(c)(1)(E). There is no support in that section for respondent's contention that such payments constituted acts of self-dealing, whereby petitioner, a “fiduciary,” was dealing with the assets of IRA #1 in his own interest. Section 4975(c)(1)(E) addresses itself only to acts of disqualified persons who, as fiduciaries, deal directly or indirectly with the income or assets of a plan for their own benefit or account. Here, there was no such direct or indirect dealing with the income or assets of a plan, as the dividends paid by Worldwide did not become income of IRA #1 until unqualifiedly made subject to the demand of IRA #1. Sec. 1.301-1(b), Income Tax Regs. Furthermore, respondent has never suggested that petitioner, acting as a “fiduciary” or otherwise, ever dealt with the corpus of IRA #1 for his own benefit.

Based on the record, the only direct or indirect benefit that petitioner realized from the payments of dividends by Worldwide related solely to his status as a participant of IRA #1. In this regard, petitioner benefited only insofar as IRA #1 [pg. 90] accumulated assets for future distribution. Section 4975(d)(9) states that section 4975(c) shall not apply to:

receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries.

Thus, we find that under the plain meaning ¹⁷ [24] of section 4975(c)(1)(E), respondent was not substantially justified in maintaining that the payments of dividends to IRA #1 constituted prohibited transactions. Respondent's litigation position with respect to this issue was unreasonable as a matter of both law and fact. ¹⁸[25] [26]

On the whole, Swanson is a very supportive case. One cause for concern, however, is the statement by the court that the IRS “never suggested that petitioner, acting as a ‘fiduciary’ or otherwise, ever dealt with the corpus of IRA #1 for his own benefit.”[27] This may have been an oversight by the IRS. Even if the taxpayer escapes the net cast by the specific litany of prohibited transactions, there is always the IRC §4975(c)(1)(E) and (F) catch-all provisions prohibiting a fiduciary from dealing “with the income or assets of a plan in his own interest or for his own account; or . . . [receiving] any consideration for his own personal account . . . in connection with a transaction involving the income or assets of the plan.” This attack was apparently not raised by the IRS in Swanson.

6.2 Etter v. Pease.

In Etter v. Pease,[28] a trust under a qualified plan, and the two trustees of the plan (Pease and Miller), acting for their own account, purchased an interest in a real estate venture. Pease personally contributed 56% of the purchase price, Miller 7%, and the Plan 37%. “The Plan realized a profit of $ 109,567.68, a 97% return on its investment over the 18-month period. The district court found the Glacier Ponds investment was not a prohibited transaction and that there was no breach of the duty to diversify because under the circumstances it was prudent not to do so.” Etter was a plan participant who objected to the joint investment.

Etter challenges the Plan's investment in the Glacier Ponds venture on two fronts. He argues the investment itself was a prohibited transaction and that the trustees breached their fiduciary duty to diversify because they invested so heavily in the Glacier Ponds venture. He, therefore, asks us to reverse the district court's conclusions of law that the transaction was not prohibited and that the Plan's failure to diversify was prudent under the circumstances.[29]

The court noted that “prohibited transactions do not per se mandate a remedy.”[30] Since the plan made a significant profit, there were no damages to award.

Etter claims the Plan's investment in Glacier Ponds constituted a use of the Plan's assets for the benefit of a party in interest and, thus, is prohibited by 29 U.S.C. §1106(a)(1)(D). He points out that Pease and Marvin Miller were both plan trustees and personal investors in the Glacier Ponds venture; therefore, he concludes they were parties in interest. In particular, (1) Pease and Miller personally invested 56% and 7%, respectively, in the Glacier Ponds venture, (2) the Plan invested 37% ($112,850) in the venture, (3) the Plan, Pease, and Miller also jointly and severally guaranteed a $260,000 note and mortgage on the property, (4) Pease had sufficient personal assets to purchase the Glacier Ponds property on his own, and (5) the Plan's net assets at the time were not sufficient, being a few dollars under $128,000. Etter argues that Pease and Miller benefited from the Plan's investment in that they secured various tax advantages while not risking as much of their personal assets. Conversely, appellees argue, as the district court found, that by contributing less than 100% of the purchase price Pease and Miller enabled the Plan to take advantage of a valuable opportunity.[31]

These two views of the evidence, as different as they may be, are both permissible, and the district court's account is plausible. Therefore, the finding of the district court “cannot be clearly erroneous.” Anderson v. City of Bessemer City, 470 U.S. 564, 574, 84 L. Ed. 2d 518, 105 S. Ct. 1504 (1985).[32]

This is a good example of the joint investment problem. It comes up all the time. It is a dangerous practice that might or might not be found to be a prohibited transaction.

ARTICLE 7
Administrative Rulings

7.1 ERISA Opinion Letter 89-03A

I alluded earlier to the joint jurisdiction of the IRS and the DOL in prohibited transaction matters, and that the DOL has the specific authority to issue exemptions from the application of the prohibited transaction rules,[33] but that the IRA prohibited transaction rules are exclusively within the jurisdiction of the Treasury.[34] What this means in actual practice is unclear to me, but in ERISA Op. 89-03A the taxpayers requested the IRS to rule whether the taxpayers could direct their IRAs to purchase stock in a corporation (Rock-Tenn) in which one of the taxpayers was an officer and both taxpayers owned a small interest (less than 2%). The IRS referred the matter to the DOL, and the DOL blessed the purchase in some respects, but withheld an opinion on others.[35]

The DOL determined that “Rock-Tenn is not a disqualified person with respect to the IRAs under section 4975(e)(2)(G) of the Code by reason of the Brown’s stock ownership in Rock-Tenn.” Note that 4975(e)(2)(G) requires a more than 50% interest, and the percentage involved in this case was well under that.

The DOL concluded its opinion on a cautionary note—

We note, however, that this conclusion does not preclude the existence of other prohibited transactions under section 4975 of the Code. Section 4975(c)(1)(D) of the Code prohibits any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan. Section 4975(c)(1)(E) of the Code prohibits a fiduciary from dealing with the income or assets of a plan in his own interest or for his own account. The Department will generally not issue advisory opinions with respect to inherently factual fn2[36] matters. We note, however, that Mr. and Mrs. Brown are fiduciaries with respect to their IRAs. In addition, Mr. Brown is an officer of Rock-Tenn and the Browns have stock ownership interests in Rock-Tenn. Accordingly, you may wish to consider whether the purchases of stock involve violations of section 4975(c)(1)(D) or (E) of the Code.

Like a private letter ruling, an ERISA opinion letter may not be relied upon by third parties.[37]

7.2 ERISA Opinion Letter 2000-10A, 07/27/2000

PWBOpL 2000-10A came as a surprise to many of us. On the surface it seems to be very favorable. It is a short case and I will quote profusely from it below.

This is in response to your request for an advisory opinion under section 4975 of the Internal Revenue Code (Code). Specifically, you ask whether allowing the owner of an IRA to direct the IRA to invest in a limited partnership, in which relatives and the IRA owner in his individual capacity are partners, will violate section 4975 of the Code.

You represent that the Fetner Family Partnership is a New York general partnership that is an investment club (the Partnership), in which Mr. Adler, through a general partnership known as Esponda Associates (Esponda), and various relatives of Mr. Adler invest. Through his investment in Esponda, which is a pass-through partnership, Mr. Adler owns a 12.11 percent interest in the Partnership [Fetner]. Mr. Adler presently owns a 30.38 percent interest in Esponda. The only other partner in Esponda is David Geiger, who is unrelated to Mr. Adler. Esponda currently owns a 39.85 percent interest in the Partnership. [12.10643=39.85*30.38, I checked.]

The other current partners of the Partnership [Fetner] are as follows: Steven Adler (Mr. Adler’s son) — 5.25%; Jack Fetner (Mr. Adler’s father-in-law) — 13.44%; Adam Nadel (Mr. Adler’s son’s brother-in-law); Fay Nadel (Mr. Adler’s mother-in-law) — 25.55%; Andrea Raskin (Mr. Adler’s daughter) — 5.33%; Lois Zoldon (Mr. Adler’s sister-in-law) — 7.57%.

The Partnership’s assets are managed by Bernard L. Madoff Investment Securities (Madoff), which is unrelated to Mr. Adler. Madoff requires entities to maintain a minimum capital account. You represent that the Partnership currently has an account with Madoff and has not received any notice that its does not meet minimum capital requirements for investment management by Madoff. The IRA’s assets are not necessary for the Partnership to continue its account with Madoff.

* * * *

You represent that Leonard Adler intends to open a self-directed individual retirement account (IRA) in the amount of approximately five hundred thousand ($500,000.00) dollars through Retirement Accounts, Inc. of Denver, Colorado. At the time Mr. Adler directs the IRA investment, the Partnership [Fetner] will become a limited Partnership. Mr. Adler will be the only general partner in the Partnership and will own 6.52%. Mr. Adler will not have any investment management functions with respect to the assets of the Partnership.

[After the reorganization: ] The limited partners and their percentage ownership interests will be as follows: Andrea Raskin — 1.35%; Steven Adler — 3.07%; Jack Fetner — 3.94%; Fay Nadel — 18.1%; Adam Nadel — 1.77%; Lois Zoldon — 5.55%; David Geiger — 20.31%; IRA of Leonard Adler — 39.38%. Messrs. Adler and Geiger will invest directly in the Partnership in the same percentages as they would have invested through Esponda, instead of investing through Esponda. Esponda will no longer invest in the Partnership.[38] [Emphasis added.]

There were several partnerships involved in this transaction. Esponda is the first partnership described under the facts. Adler owned 30.38% of Esponda, and the rest was owned by an unrelated person (Geiger). Esponda was a partner in Fetner Family Partnership. Esponda owned 39.85% of Fetner. Adler thus owned 12.11% (30.38*39.85) of Fetner by virtue of his 30.38% interest in Esponda. Adler’s son owned 5.25%, and his daughter owned 5.33% of Fetner. Together, father, daughter and son owned 22.69% of Fetner, by my calculations. At that point, Adler is not in control.

Fetner was then to be reorganized. After the reorganization, Esponda dropped out of the picture; Adler was to own 6.25%, individually, as general partner; his daughter was to own 1.35% as limited partner; and his son was to own 3.07% as limited partner. Adler’s IRA was to own 39.38%, as limited partner in the new partnership. This adds up to 50.32%, which is control under 4975(e)(2)(G)(ii). So although it is apparently true that Adler & Family did not have a controlling interest at the time the IRA acquired an interest, they were in control after the IRA became a limited partner. I believe that the new partnership would be a disqualified person under 4975(e)(2) after the reorganization, if Mr. Adler is treated as a fiduciary of his IRA. This makes the opinion rather like Swanson.[39]

The facts in PWBOpL 2000-10A were unique and the opinion would presumably not have been favorable if any of the key facts had been varied slightly.

The Partnership’s assets are managed by Bernard L. Madoff Investment Securities (Madoff), which is unrelated to Mr. Adler. . . . The IRA’s assets are not necessary for the Partnership to continue its account with Madoff.

. . . You further represent that all of the assets of the Partnership are liquid marketable securities. You also represent that none of the funds contributed by the IRA is required to be used, or will be used, to liquidate or redeem any other partner’s interest in the Partnership.

Finally, you represent that Mr. Adler does not and will not receive any compensation from the Partnership. He likewise will not receive any compensation as a result of the acquisition by the IRA of its limited partnership interest.

You ask whether the investment by the IRA in the Partnership will give rise to a prohibited transaction under section 4975 of the Code. Section 4975(e)(1) of the Code, in relevant part, defines the term “plan” to include an IRA, described in section 408(a) of the Code. Section 4975(e)(2) of the Code defines “disqualified person,” in relevant part, to include a fiduciary, a relative, and a partnership, of which (or in which) 50 percent or more of the capital interest or profits interest of such partnership is owned directly or indirectly, or held by a fiduciary. Section 4975(e)(3) of the Code defines the term “fiduciary,” in part, to include any person who exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control regarding management or disposition of its assets. In order for a prohibited transaction to occur under section 4975 of the Code, there must be a transaction involving a disqualified person with respect to a plan. Where none of the relationships described in section 4975(e)(2) of the Code are found to exist, an entity would not be a disqualified person with respect to a plan.

Section 4975(c)(1)(A) of the Code prohibits any direct or indirect sale or exchange or leasing, of any property between a plan and a disqualified person. Section 4975(c)(1)(D) of the Code prohibits any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan. Section 4975(c)(1)(E) of the Code prohibits a fiduciary from dealing with the income or assets of a plan in his or her own interest or for his or her own account. Section 54.4975-6(a)(5) of the Pension Excise Tax Regulations characterizes transactions described in section 4975(c)(1)(E) as involving the use of authority by fiduciaries to cause plans to enter into transactions when those fiduciaries have interests which may affect the exercise of their best judgment as fiduciaries.

As a trustee with investment discretion over the assets of his IRA, Mr. Adler is a fiduciary, and therefore, a disqualified person under section 4975(e)(2) of the Code. Mr. Adler is also a disqualified person in his capacity as the general partner of the Partnership to the extent he exercises discretionary authority over the administration or management of the IRA assets invested in the Partnership. In addition, although Mr. Adler, his son and his daughter are disqualified persons, you represent that the investment transaction is between the Partnership itself and the IRA, and not with Mr. Adler and his family, except as fellow investors in the Partnership. Mr. Adler owns only 6.5 percent of the Partnership, and therefore the Partnership itself is not a disqualified person under section 4975(e)(2)(G) of the Code which defines a disqualified person to include a corporation, partnership or trust or estate of which 50 percent or more of the capital interest is owned directly or indirectly, or held by persons described as fiduciaries.

Based solely on the facts and representations contained in your submissions, it is the opinion of the Department that the IRA’s purchase of an interest in the Partnership would not constitute a transaction described in section 4975(c)(1)(A) of the Code (prohibiting any direct or indirect sale or exchange or leasing of any property between a plan and a disqualified person).

Whether the proposed transaction would violate sections 4975(c)(1)(D) and (E) of the Code raises questions of a factual nature upon which the Department will not issue an opinion. A violation of section 4975(c)(1)(D) and (E) would occur if the transaction was part of an agreement, arrangement or understanding in which the fiduciary caused plan assets to be used in a manner designed to benefit such fiduciary (or any person which such fiduciary had an interest which would affect the exercise of his best judgment as a fiduciary). [Watch out for this one.]

In this regard, the Department notes Mr. Adler does not and will not receive any compensation from the Partnership and will not receive any compensation by virtue of the IRA’s investment in the Partnership. However, the Department further notes that if an IRA fiduciary causes the IRA to enter into a transaction where, by the terms or nature of that transaction, a conflict of interest between the IRA and the fiduciary (or persons in which the fiduciary has an interest) exists or will arise in the future, that transaction would violate either 4975(c)(1)(D) or (E) of the Code. Moreover, the fiduciary must not rely upon and cannot be otherwise dependent upon the participation of the IRA in order for the fiduciary (or persons in which the fiduciary has an interest) to undertake or to continue his or her share of the investment. Furthermore, even if at its inception the transaction did not involve a violation, if a divergence of interests develops between the IRA and the fiduciary (or persons in which the fiduciary has an interest), the fiduciary must take steps to eliminate the conflict of interest in order to avoid engaging in a prohibited transaction. Nonetheless, a violation of section 4975(c)(1)(D) or (E) will not occur merely because the fiduciary derives some incidental benefit from a transaction involving IRA assets.

Moreover, the Department notes that by virtue of the contemplated investment by the IRA in the Partnership, there will be significant investment in the Partnership by benefit plan investors. Accordingly, the Partnership will hold “plan assets”[40] within the meaning of that term in the Department’s regulations at 29 CFR §2510.3-101. As a result, any person who exercises discretionary authority or control with respect to assets of the Partnership will be fiduciary of the IRA and subject to the restrictions of section 4975(c)(1) of the Code, except to the extent a statutory or administrative exemption applies.[41] [Emphasis added.]

* * * *

Under Presidential Reorganization Plan No. 4 of 1978, effective December 31, 1978, the authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Code has been transferred, with certain exceptions not here relevant, to the Secretary of Labor and the Secretary of the Treasury is bound by the interpretations of the Secretary of Labor pursuant to such authority.

7.3 PLR 8717079.

PLR 8717079 clearly indicates that the IRS believes that the “employer” mentioned in §4975(e)(2)(C) is the employer with respect to the plan, and not just any employer any of whose employees are covered by any plan. This PLR 8717079, is, in my opinion, directly on point; and, it is favorable.

In this ruling, N was an employee, less than 1% owner, and director of Company M. N had a self-directed IRA, and proposed to cause the IRA to invest in shares of Company M. Presumably, the shares to be owned by the IRA would be attributed to the owner, but the facts recite that after the purchase, N would still own less than 1% of M. The ruling noted the following:

Section 4975(e)(2) of the Code defines, in part, the term “disqualified person” to include an employer any of whose employees are covered by the plan.

There is no further definition of the term “employer” under section 4975 of the Code. Nevertheless, section 3(5) of the Employee Retirement Income Security Act of 1974 (ERISA), which defines the term “employer” for plans within the jurisdiction of Title I, provides, in part, that an employer is any person acting as an employer in relation to an employee benefit plan. After using this section to help define the term employer for purposes of section 4975 of the Code, we consider an employer to be acting in relation to an IRA only when it is involved in maintaining, sponsoring, or contributing directly to the IRA. Company M is not, thus, an employer in relation to Individual N’s IRA under section 4975(e)(2) because, as the facts indicate, it has no involvement with Individual N’s IRA.

Therefore, we conclude that the purchase by the custodian on behalf of Individual N’s IRA, and at the direction of Individual N, from Company M of 100 shares of Company M stock will not constitute a prohibited transaction within the meaning of section 4975(c)(1)(A) of the Code.

This conclusion on whether the sale of stock is a prohibited transaction under section 4975(c)(1)(A) would not preclude the possibility of the sale being considered a prohibited transaction under another section 4975(c) depending upon the facts and circumstances.

7.4 ERISA Opinion Letter 89-03.

ERISA Opinion Letter 89-03, discussed in more detail later, is consistent with PLR 8717079:

Mr. and Mrs. Bowns are fiduciaries and, thus, disqualified persons with respect to their IRAs because of their authority under the IRAs to direct investments. Although section 4975 does not define the term employer, section 3(5) of ERISA provides, in part, that an employer is any person acting as an employer in relation to an employee benefit plan. You have stated that Rock-Tenn has no involvement with the establishment or maintenance of the IRAs. Therefore, it is the opinion of the Department that Rock-Tenn is not a disqualified person with respect to the IRAs under section 4975(e)(2)(C) of the Code. In addition, Rock-Tenn is not a disqualified person with respect to the IRAs under section 4975(e)(2)(G) of the Code by reason of the Bowns’ stock ownership in Rock-Tenn.

In accord with the above are DOL/PWBA Letter 4/09/1993, ERISA Opinion Letter 90-20A, ERISA Opinion Letter 88-18A, and Opinion Letter 85-17A. USCorp is a domestic subchapter S corporation. Father owns a majority (a%) of the shares of USCorp. Father's three minor children (individually “Child,” collectively “Children”) own the remaining shares of USCorp equally (each Child owns b% of the shares, Children own collectively c% of the shares). USCorp is in the business of selling Product A and some of its sales are made for export.

Father and each Child own separate IRAs, to which each of them made an initial contribution of $d. Each of the four IRAs acquired a 25% interest in FSC A, a foreign sales corporation (“FSC”) pursuant to sections 992(a)(1) and 927(b)(1) of the Code, by entering into a subscription agreement for newly issued shares, after FSC A was formed in Month A of Year 1.

USCorp entered into service and commission agreements with FSC A (“Agreements”) in Month A of Year 1. FSC A agreed to act as commission agent in connection with export sales made by USCorp, in exchange for commissions based upon the administrative pricing rules applicable to FSCs. USCorp also agreed to perform certain services on behalf of FSC A, such as soliciting and negotiating contracts, for which FSC A would reimburse USCorp its actual costs.

During Taxable Year 1, FSC A made a total cash distribution of $e to its IRA shareholders, out of earnings and profits derived from foreign trade income relating to USCorp exports. The IRAs owning FSC A each received an equal amount of V. Combined with previous distributions out of such earnings and profits by FSC A to the IRAs, and with the earnings by the IRAs on such distributions, the value of each IRA on Date 1 was more than $g.

7.5 Field Service Advice 200128011.

The facts are briefly summarized as follows.

USCorp was a domestic subchapter S corporation, in which Father owned a majority of the shares. Father's three minor children (“Children”) owned the remaining shares. USCorp was in the business of selling Product A.

Father and each Child owned separate IRAs. Each of the four IRAs acquired a 25% interest in FSC, a foreign sales corporation.

USCorp entered into service and commission agreements with FSC. “FSC agreed to act as commission agent in connection with export sales made by USCorp, in exchange for commissions based upon the administrative pricing rules applicable to FSCs. USCorp also agreed to perform certain services on behalf of FSC A, such as soliciting and negotiating contracts, for which FSC A would reimburse USCorp its actual costs.”

FSC paid dividends to its IRA shareholders “out of earnings and profits derived from foreign trade income relating to USCorp exports.”

The following is taken directly from the FSA. The boldfacing and other emphases are my own.

In this case, the tax imposed by section 511 on unrelated business income does not apply to the dividends received by the IRAs from FSC A because section 512(b)(1) generally excludes dividends from the definition of unrelated business taxable income for purposes of section 511.

We also consider whether there were prohibited transactions in this case. The issue of prohibited transactions, in circumstances similar to those in this case, was addressed in Swanson v. Commissioner, 106 T.C. 76 (1996). In that case, after initially alleging that prohibited transactions had occurred, the Service ultimately conceded the case. The U.S. Tax Court, in awarding litigation costs to the taxpayers under section 7430, held that the Service's position regarding prohibited transactions was not substantially justified.

In the Swanson case, Mr. Swanson, the sole shareholder of a subchapter S corporation, H&S Swansons' Tool Co. (Tool Co.), arranged in January 1985 for the organization of a DISC, Swansons' Worldwide, Inc. (Worldwide DISC), as well as for the formation of a self-directed IRA (IRA #1) for his benefit. Mr. Swanson was named director and president of Worldwide DISC. On the same day that IRA #1 was created, Mr. Swanson directed the IRA #1 trustee to execute a subscription agreement for 2,500 shares of Worldwide DISC's original issue stock. The shares were subsequently issued to IRA #1, which became the sole shareholder of Worldwide DISC.

For the years 1985 to 1988, Tool Co. paid commissions to Worldwide DISC with respect to the sale by Tool Co. of export property. In the same years, Mr. Swanson, as president of Worldwide DISC, directed Worldwide DISC to pay dividends to IRA #1. The dividends totaled $593,602 for the four years. Tool Co. stopped paying commissions to Worldwide DISC after December 31, 1988, as Mr. Swanson “no longer considered such payments to be advantageous from a tax planning perspective.” Id. at 79.

In 1989, Mr. Swanson directed the trustee of his IRA to transfer $5,000 to a new self-directed IRA (IRA #2) that he created for his benefit and, at the same time, created a FSC, H&S Swansons' Trading Co. (Trading FSC). Mr. Swanson directed the trustee of IRA #2 to execute a subscription agreement for 2,500 newly issued shares of Trading FSC. The shares were subsequently issued to IRA #2, which became the sole shareholder of Trading FSC. A dividend of $28,000 was paid by Trading FSC to IRA #2 in 1990.

The Service issued notices of deficiency to Mr. Swanson and his wife alleging that prohibited transactions had occurred with respect to each IRA and that each IRA ceased to be an individual retirement account pursuant to section 408 because of those transactions. The alleged prohibited transactions were (1) the sale of stock by Worldwide DISC and Trading FSC to the respective IRAs and (2) the payment of dividends by these companies to their IRA shareholders.

“Prohibited transactions,” include, inter alia, any “sale or exchange, or leasing, of any property between a plan and a disqualified person” (section 4975(c)(1)(A)); any “transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan” (section 4975(c)(1)(D)); and any “act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account” (section 4975(c)(1)(E)).

Section 4975(e)(2) defines “disqualified person” to include a fiduciary, an employer any of whose employees are covered by the plan, an owner of an employer, and certain officers and directors of an employer. Section 4975(e)(3) defines “fiduciary” to include any person who exercises discretionary control over the management of the plan assets. Section 4975(e)(1) defines “plan” to include IRAs.

The court in Swanson concluded that, when the initial issuance of DISC (or FSC) stock to the IRA was made, the issuing company was not a “disqualified person” because the newly issued stock was not owned by anyone at the time of the sale. Thus, the sale of stock to the IRA was not a sale or exchange of property between a plan (the IRA) and a disqualified person within the meaning of section 4975(c)(1)(A).

The payment of dividends by a DISC (or FSC) to an IRA was held not to be the use of IRA assets for the benefit of a disqualified person within the meaning of section 4975(c)(1)(D) because the dividends did not become IRA assets until they were paid.

The court also ruled that the actions of arranging for IRA ownership of DISC (or FSC) stock and for the subsequent payment of dividends by the DISC (or FSC) to the IRA, considered together, did not constitute an act whereby a fiduciary directly or indirectly “deals with income or assets of a plan in his own interest or for his own account,” within the meaning of section 4975(c)(1)(E). The court noted that the Commissioner had not alleged that the taxpayer had ever dealt with the corpus of the IRA for his own benefit, stating:

Based on the record, the only direct or indirect benefit that petitioner [Mr. Swanson] realized from the payments of dividends by [Worldwide FSC] related solely to his status as a participant of IRA #1. In this regard, petitioner benefited only insofar as IRA #1 accumulated assets for future distribution. Section 4975(d)(9) states that section 4975(c) shall not apply to:

Thus, we find that under the plain meaning of section 4975(c)(1)(E), respondent was not substantially justified in maintaining that the payments of dividends to IRA #1 constituted prohibited transactions. 106 T.C. at 89-90.

In light of Swanson, we conclude that a prohibited transaction did not occur under section 4975(c)(1)(A) in the original issuance of the stock of FSC A to the IRAs in this case. Similarly, we conclude that payment of dividends by FSC A to the IRAs in this case is not a prohibited transaction under section 4975(c)(1)(D). We further conclude, considering Swanson, that we should not maintain that the ownership of FSC A stock by the IRAs, together with the payment of dividends by FSC A to the IRAs, constitutes a prohibited transaction under section 4975(c)(1)(E).

Accordingly, this case should not be pursued as one involving prohibited transactions. We note, however, that similar transactions may be prohibited under section 4975, based upon the particular facts of such transactions. For example, while FSC A in this case is not a disqualified person, the owners of the IRAs are disqualified persons as fiduciaries with respect their IRAs and USCorp is a disqualified person with respect to the IRA owned by Individual A, the majority shareholder of USCorp. Thus, if a transaction is made for the purpose of benefiting USCorp, the IRA owners would violate section 4795(c)(1)(D). Also, if the facts were such that the IRA owners' interests in the transaction because of their ownership of USCorp affected their best judgments as fiduciaries of the IRAs, the transaction would violate section 4975(c)(1)(E).

7.6 ERISA Opinion Letter 2001-01A—Settlor Functions.

In analyzing whether the IRA owner, or of anyone else other than the IRA custodian or trustee, is dealing with the IRA or with plan assets, it is helpful to remember that not all activities that affect an IRA or qualified plan are fiduciary in nature. This issue comes up frequently when a plan terminates, and the company seeks to have the plan pay for the termination costs. This matter was recently discussed in ERISA Opinion Letter 2001-01A:

With regard to sections 403 and 404 of ERISA, we noted that, as a general rule, reasonable expenses of administering a plan include direct expenses properly and actually incurred in the performance of a fiduciary's duties to the plan. We also noted, however, that the Department has long taken the position that there is a class of discretionary activities which relate to the formation, rather than the management, of plans, explaining that these so-called “settlor” functions include decisions relating to the establishment, design and termination of plans and, except in the context of multiemployer plans, generally are not fiduciary activities governed by ERISA. Expenses incurred in connection with the performance of settlor functions would not be reasonable expenses of a plan as they would be incurred for the benefit of the employer and would involve services for which an employer could reasonably be expected to bear the cost in the normal course of its business operations. However, reasonable expenses incurred in connection with the implementation of a settlor decision would generally be payable by the plan.

In Advisory Opinion 97-03A, the Department expressed the view that the tax-qualified status of a plan confers benefits upon both the plan sponsor and the plan and, therefore, in the case of a plan that is intended to be tax-qualified and that otherwise permits expenses to be paid from plan assets, a portion of the expenses attendant to tax-qualification activities may be reasonable plan expenses. This view has been construed to require an apportionment of all tax qualification- related expenses between the plan and plan sponsor. The Department does not agree with this reading of the opinion. The opinion recognizes that, in the context of tax-qualification activities, fiduciaries must consider, consistent with the principles articulated in earlier letters, whether the activities are settlor in nature for purposes of determining whether the expenses attendant thereto may be reasonable expenses of the plan. However, in making this determination, the Department does not believe that a fiduciary must take into account the benefit a plan's tax-qualified status confers on the employer. Any such benefit, in the opinion of the Department, should be viewed as an integral component of the incidental benefits that flow to plan sponsors generally by virtue of offering a plan.

See also Hozier v. Midwest Fasteners, Inc., 908 F2d 1155 (3d Cir. 1990).

ARTICLE 8
Discussion of the Law

8.1 A Partnership is a Disqualified Person if Controlled by Family Members.

A tortured path eventually leads to the conclusion that a partnership is a disqualified person if 50% or more of the partnership is owned by fiduciaries and their family members. Moreover, in this special case, siblings are not treated as family members. A short form of the analysis is something like the following:

(1) An owner of an IRA is a fiduciary/disqualified person.

(2) Under 4975(e)(2)(G), a partnership, more than 50% of which is owned by fiduciaries, is a disqualified person.

(3) Under 4975(e)(2)(F), a member of the family of a fiduciary is a fiduciary, but this turns out to be largely irrelevant and potentially the source of a misleading diversion.

(4) In applying 4975(e)(2)(G), 4975(e)(2)(F) family members are not taken into account, but this turns out not to be as helpful as it first appears, because of (5), which is worse.

(5) 4975(e)(5) specifically provides that in determining control of a partnership under 4975(e)(2)(G) (ii) and (iii), the constructive ownership tests of 267(c) shall be used, and those rules require that partnership interests owned by certain family members (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant, but not siblings) will be used in determining whether the partnership is controlled by fiduciaries.

(6) Hence, a partnership will be a disqualified person if it is controlled by the IRA owner &/or members of the IRA owner’s family (as defined in 4975(e)(6)).

Now §267(c) is concerned with constructive ownership of stock. Does it apply to constructive ownership of partnership interests? I assume that it does, but maybe there is something there. Again, §4975(e)(5) states that “the ownership of profits or beneficial interests [in a partnership] shall be determined in accordance with the rules for constructive ownership of stock provided in 267(c).”

8.2 Is An IRA Trustee or Custodian Always a Disqualified Person(DQP)?

An IRA is not a legal entity, so technically we cannot speak of the IRA itself as being a DQP. However IRAs have to have either a custodian or a trustee (the IRA sponsor), and both can be DQPs, and probably are as a matter of law.[42] If the IRA custodian or trustee is a DQP, then any transaction between it and another DQP will be a prohibited transaction, absent an exemption.

Clearly, the sponsor of an IRA is a fiduciary, at least for some purposes.[43] And under IRC §4975(e)(2)(A), a fiduciary is a DQP.

Under 4975(e)(2)(G)(iii) a trust is a disqualified person if 50% of the beneficial interest is owned by a disqualified person. If the IRA owner is a DQP (e.g., a fiduciary), then a trusteed IRA would arguably be a DQP. Presumably a custodial IRA would fare no better. But this may beg the question of whether an IRA owner is always a DQP.

If we assume that the mere formation of an entity by an IRA is not prohibited (because it does not involve a transfer?), then would it make any difference if the IRA owner or a family member owned, say, 1% of the business, and the IRA owned 99%, instead of the IRA owning 100%? This will eventually lead us to the facts of the Swanson[44] case, which will be discussed later, but it is a subject worth keeping in mind.

In PWBOpL 2000-10A, discussed in detail later, gives the impression that a partnership not controlled by family members can be reorganized by transferring partnership units to an IRA, even though the partnership would be controlled by disqualified persons after the reorganization, assuming that the IRA owned by a partner is a disqualified person. (Prior to the reorganization the partnership was not controlled by family members because an in-law is not counted under 4975(e)(6) unless married to a descendant.)

FSA 200128011, also discussed in detail later, is even more explicit that formation alone is not a prohibited transaction.

8.3 Is an IRA Owner Always a DQP? Is an IRA Owner Always a “Fiduciary” With Respect to the IRA?

If an IRA owner is always a fiduciary, then the IRA owner will always be a DQP. Is an IRA owner always a “fiduciary” with respect to the IRA? Does it make any difference whether the IRA is a trusteed or custodial IRA? In an unsupported statement found in ERISA Opinion Letter 89-03A, the DOL stated rather perfunctorily:

Mr. and Mrs. Brown are fiduciaries and, thus, disqualified persons with respect to their IRAs because of their authority under the IRAs to direct investments.[45]

Would the Browns not have been fiduciaries, and hence not have been disqualified persons, had they not had investment authority? I suspect that the Browns would not have been fiduciaries if the IRA was trusteed and the Browns had no investment authority. Nevertheless, if the owner, whether or not a fiduciary, “engages in any transaction prohibited by section 4975 with respect to such account, such account ceases to be an individual retirement account as of the first day of such taxable year.”[46]

If, by analogy, an IRA owner is treated both as the employer and as the employer’s employee, with respect to the IRA, then the IRA owner could be considered a disqualified person under §4975(e)(2)(C), “an employer any of whose employees are covered by the plan.” This would seem to be quite a stretch, but the IRS sometimes conflates the owner of an IRA with an employee, and the IRA with the employer.[47] So perhaps we should look at this issue more closely.

8.4 Is an Employer of an IRA Owner a Disqualified Person With Respect to the IRA? No.

A series of DOL ERISA Opinion Letters establish to my complete satisfaction that the employer referred to in §4975(e)(2)(C) must be the sponsor of the plan in question. See discussion of Administrative Rulings above.

§4975(e)(2)(C) includes among the list of disqualified persons “an employer any of whose employees are covered by the plan.” This is troubling on the surface, but it is my opinion that the “plan” is intended to mean a plan of the employer, and not an IRA of an employee since the employer is not an employer with respect to the plan in question (the employee’s IRA). Note first that, if the employer of an IRA owner were per se a disqualified person with respect to the IRA, the IRA could never invest in GM stock if the IRA owner were an employee of GM. That is your first clue to what the rule must be.

8.5 Application Of Prohibited Transaction Rules To IRAs.

An IRA (excepting perhaps a SEP-IRA) is ordinarily outside the purview of ERISA. An IRA is not a qualified plan because it is not described in IRC §401(a). An IRA is generally not subject to Title I because an IRA does not constitute an employee benefit plan.[48] Further, an IRA is specifically exempted from Parts 2 (participation and vesting) and 3 (minimum funding) of ERISA.[49]

The IRC §4975 excise taxes on prohibited transactions do not apply to IRAs. Instead, and what is worse, an IRA that is involved in a prohibited transaction simply ceases to be an IRA, at which point income taxes and perhaps other excise taxes become due, as discussed elsewhere in this Article.

(3) Special rule for individual retirement accounts. An individual for whose benefit an individual retirement account is established and his beneficiaries shall be exempt from the tax imposed by this section with respect to any transaction concerning such account (which would otherwise be taxable under this section) if, with respect to such transaction, the account ceases to be an individual retirement account by reason of the application of section 408(e)(2)(A) or if section 408(e)(4) applies to such account.[50]

An individual retirement account (IRA) is a “plan” for purposes of the IRC’s prohibited transaction rules.[51] While the definition of “disqualified person” does not by its terms include either the creator or the beneficiary of an IRA,[52] IRC §408(e)(2) disqualifies an IRA where the individual who establishes the IRA,[53] or his beneficiary, engages in a IRC §4975 prohibited transaction with respect to the account.

(2) Loss of exemption of account where employee engages in prohibited transaction.

(A) In general. If, during any taxable year of the individual for whose benefit any individual retirement account is established, that individual or his beneficiary engages in any transaction prohibited by section 4975 with respect to such account, such account ceases to be an individual retirement account as of the first day of such taxable year. For purposes of this paragraph –

(i) the individual for whose benefit any account was established is treated as the creator of such account, and

(ii) the separate account for any individual within an individual retirement account maintained by an employer or association of employees is treated as a separate individual retirement account.

If the IRA is disqualified under §408(e)(2)(A) or §408(e)(4), then §4975(c)(3) exempts the IRA owner from the 15% and 100% excise taxes otherwise applicable under, which was thoughtful of Congress.

If the creator or beneficiary of an IRA engages in a prohibited transaction during the individual’s taxable year, the account ceases to be a tax-exempt IRA as of the first day of the taxable year.[54] In that case, a deemed distribution occurs on the first day of the taxable year to the extent of the fair market value of all assets in the account, and the distributee must include the entire amount in gross income under IRC §72.[55] The same disqualification results where the owner of an individual retirement annuity borrows any money under or by use of the contract:

(3) Effect of borrowing on annuity contract. If during any taxable year the owner of an individual retirement annuity borrows any money under or by use of such contract, the contract ceases to be an individual retirement annuity as of the first day of such taxable year. Such owner shall include in gross income for such year an amount equal to the fair market value of such contract as of such first day.[56]

If the creator of an IRA pledges a portion of the account as security for a loan, the individual treats only the pledged portion as a distribution:[57]

(4) Effect of pledging account as security. If, during any taxable year of the individual for whose benefit an individual retirement account is established, that individual uses the account or any portion thereof as security for a loan, the portion so used is treated as distributed to that individual.

8.6 Taxation of IRAs.

Taxation of IRAs is governed by IRC §408. §408(e) sets forth the basic scheme:

§408 (e) Tax Treatment of Accounts and Annuities.

(1) Exemption from tax. Any individual retirement account is exempt from taxation under this subtitle unless such account has ceased to be an individual retirement account by reason of paragraph (2) or (3). Notwithstanding the preceding sentence, any such account is subject to the taxes imposed by section 511 (relating to imposition of tax on unrelated business income of charitable, etc. organizations).

(2) Loss of exemption of account where employee engages in prohibited transaction.

(i) the individual for whose benefit any account was established is treated as the creator of such account, and

(ii) the separate account for any individual within an individual retirement account maintained by an employer or association of employees is treated as a separate individual retirement account.

(B) Account treated as distributing all its assets. —In any case in which any account ceases to be an individual retirement account by reason of subparagraph (A) as of the first day of any taxable year, paragraph (1) of subsection (d) applies as if there were a distribution on such first day in an amount equal to the fair market value (on such first day) of all assets in the account (on such first day).

(5) Purchase of endowment contract by individual retirement account. If the assets of an individual retirement account or any part of such assets are used to purchase an endowment contract for the benefit of the individual for whose benefit the account is established –

(A) to the extent that the amount of the assets involved in the purchase are not attributable to the purchase of life insurance, the purchase is treated as a rollover contribution described in subsection (d) (3), and

(B) to the extent that the amount of the assets involved in the purchase are attributable to the purchase of life, health, accident, or other insurance, such amounts are treated as distributed to that individual (but the provisions of subsection (f) do not apply).

(6) Commingling individual retirement account amounts in certain common trust funds and common investment funds. Any common trust fund or common investment fund of individual retirement account assets which is exempt from taxation under this subtitle does not cease to be exempt on account of the participation or inclusion of assets of a trust exempt from taxation under section 501(a) which is described in section 401(a).[58]

* * * *

8.7 DOL Jurisdiction Over IRAs.

Even though an IRA is not subject to ERISA, and thus is generally exempt from regulation by the Department of Labor (the DOL), the DOL has the specific authority to issue exemptions from the application of the prohibited transaction rules.[59] Enforcement of the IRA prohibited transaction rules are, however, exclusively within the jurisdiction of the Treasury.[60] Pursuant to Presidential Reorganization Plan No. 4 of 1978:

[T]he authority of the Secretary of the Treasury to issue interpretations regarding section 4975 of the Code, subject to certain exceptions . . . has been transferred to the Secretary of Labor and the Secretary of the Treasury is bound by such interpretations.[61]

8.8 Partial Relief From Cascading Excise Taxes.

As set forth in the statute just quoted, if the application of IRC §408(e)(2)(A) or (e)(4) results in treatment of an individual retirement account as a deemed distribution, the 15% and 100% excise taxes of IRC §4975 do not apply to the individual who establishes the IRA.[62] However, if a person other than the creator (e.g., a bank trustee) engages in an IRC §4975 prohibited transaction with respect to the account, the other person is subject to the 15% and 100% excise taxes.[63] Further, the 10% premature distribution tax of IRC §72(t) (e.g. certain distributions prior to age 59½), will apply, notwithstanding the IRA’s disqualification.

8.9 Catch-All Prohibited Transactions

Although it may appear that the definitions of what constitutes a prohibited transaction and who is a party in interest or disqualified person are very specific, there are two or three catch all provisions that might be applicable even though all of the other hurdles can be technically negotiated and even if a specific exception appears to apply.

First of all, ERISA §404(a) provides that a fiduciary must at all times act solely in the interest of the plan participants and their beneficiaries[64] and for their exclusive benefit.[65] This means that the fiduciary is to have no other motive for acting. Further, ERISA §406(b) has the following proscription:

(b) A fiduciary with respect to a plan shall not-

(1) deal with the assets of the plan in his own interest or for his own account,

(2) in his individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries, or

(3) receive any consideration for his own personal account from any party dealing with such plan in connection with a transaction involving the assets of the plan.

Technically, ERISA §§404(a)(1) and 406(b) are not directly applicable to an IRA. However, IRC 408(a) provides that “the term ‘individual retirement account’ means a trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries.” Moreover, IRC §4975(c)(1)(E) and (F), which do apply to IRAs as well as to qualified plans, prohibit a fiduciary from dealing “with the income or assets of a plan in his own interest or for his own account; or . . . [receiving] any consideration for his own personal account . . . in connection with a transaction involving the income or assets of the plan.”

8.10 Distributions And Contributions Of Property Other Than Cash From Or To An IRA.

Contributions of property other than cash to an IRA are generally prohibited:

Except in the case of a rollover contribution described in subsection (d)(3) in section 402(a)(5), 402(a)(7), 403(a)(4), or 403(b)(8), no contribution will be accepted unless it is in cash . . .[66] [Emphasis added.]

Any property distributed by a qualified plan (or its proceeds), which are acceptable to the IRA sponsor, may be rolled over, with a few important exceptions. An IRA cannot invest in insurance contracts, for example.

Because there are many investments that the IRA custodian may not be in a position to accept, it is permissible to sell property received in a distribution and reinvest and rollover “an amount equal to any portion of the proceeds.”^{^[67]}If this is done, no gain or loss on the sale will be recognized; the sales proceeds are treated as part of the distribution.^{^[68]}

Although an individual may sell property distributed from a qualified plan and rollover the proceeds, one may not keep the property and rollover equivalent value.^{^[69]} Nor may one receive cash, invest in stock, and rollover the stock.^{^[70]}

Although contributions of property are generally prohibited, distributions of property are not. This is because IRC §4975(d)(9) specifically exempts from the definition of a prohibited transaction the

(9) receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries. . .[71]

Treasury Regulations are explicit regarding how such distributions are to be valued for income tax purposes, viz., at fair market value on date of distribution.[72] Finally, we know that qualified plans can make distributions of property because the rules regarding the rollover of such property or its cash proceeds are detailed and comprehensive.[73]

8.11 Exemptions From the Prohibited Transaction Rules.

IRC §4975(d) exempts a number of transactions from application of the prohibited transaction rules, a few of which could be of importance to us.

(d) Exemptions.—The prohibitions provided in subsection (c) shall not apply to—

* * * *

(9) receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries;

(10) receipt by a disqualified person of any reasonable compensation for services rendered, or for the reimbursement of expenses properly and actually incurred, in the performance of his duties with the plan, but no person so serving who already receives full-time pay from an employer or an association of employers, whose employees are participants in the plan or from an employee organization whose members are participants in such plan shall receive compensation from such fund, except for reimbursement of expenses properly and actually incurred;

(11) service by a disqualified person as a fiduciary in addition to being an officer, employee, agent, or other representative of a disqualified person;

(12) the making by a fiduciary of a distribution of the assets of the trust in accordance with the terms of the plan if such assets are distributed in the same manner as provided under section 4044 of title IV of the Employee Retirement Income Security Act of 1974 (relating to the allocation of assets);

(13) any transaction which is exempt from section 406 of such Act by reason of section 408(e) of such Act (or which would be so exempt if such section 406 applied to such transaction);

(14) any transaction required or permitted under part 1 of subtitle E of title IV or section 4223 of the Employee Retirement Income Security Act of 1974, but this paragraph shall not apply with respect to the application of subsection (c)(1)(E) or (F); or

The exemptions provided by this subsection (other than paragraphs (9) and (12) shall not apply to any transaction with respect to a trust described in section 401(a) which is part of a plan providing contributions or benefits for employees, some or all of whom are owner-employees (as defined in section 401(c)(3)) in which a plan directly or indirectly lends any part of the corpus or income of the plan to, pays any compensation for personal services rendered to the plan to, or acquires for the plan any property from or sells any property to, any such owner-employee, a member of the family (as defined in section 267(c)(4)) of any such owner-employee, or a corporation controlled by any such owner-employee through the ownership, directly or indirectly, of 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock of the corporation. For purposes of the preceding sentence, a shareholder-employee (as defined in section 1379, as in effect on the day before the date of the enactment of the Subchapter S Revision Act of 1982), a participant or beneficiary of an individual retirement account, or an individual retirement annuity (as defined in section 408), and an employer or association of employees which establishes such an account or annuity under section 408(c) shall be deemed to be an owner-employee.[74]

8.12 UBTI Issues.

Before delving into this issue, bear in mind that if the partnership owned by the IRA is an investment partnership, not conducting a “trade or business,” then UBTI is not likely to be a problem. See also the discussion of this issue in FSA 200128011 treated above.

Income from any trade or business carried on by a qualified plan “or by a partnership of which it is a member” is automatically UBTI.

(b) Special rule for trusts. The term “unrelated trade or business” means, in the case of –

(1) a trust computing its unrelated business taxable income under section 512 for purposes of section 681; or

(2) a trust described in section 401(a), or section 501(c)(17), which is exempt from tax under section 501(a);

any trade or business regularly carried on by such trust or by a partnership of which it is a member.[75]

Although there is no counterpart to 513(b)(2) specifically singling out IRAs, §408(e)(1) makes it clear that IRAs are within the reach of §511.

Income that has already been taxed once is unlikely to be treated as UBTI. The statute therefore specifically excludes dividends, interest, annuities, royalties and most rental income.^{^[77]}

Dividends on a Real Estate Investment Trust (REIT) are excluded under the dividends exception.^{^[78]} The fact that a qualified plan or IRA is an inactive or limited partner will not prevent the partnership income from being UBTI to the plan or IRA, unless the partnership is a “publicly traded partnership” within the meaning of IRC §469(k)(2).^{^[79]}

Unrelated debt financed income is a type of UBTI.^{^[80]} Many clients have been surprised to find that buying securities out of a margin account can generate UBTI because the income is debt financed. Interest on a loan made by a plan will usually be UBTI.

Who pays the UBTI tax: the Plan, the IRA, or the participant? The answer to this question ought to be clear enough, but it is not. The instructions to Form 990-T say that the “fiduciary” is responsible. In the case of an IRA, the IRA owner may be a fiduciary, though even this is not clear from the statutes.[81]

If all the partnership does is hold and manage investment assets, such as publicly traded securities, it is doubtful that UBTI could be a problem.

8.13 What Exactly is an IRA? Can An IRA Form a Partnership?

Can an IRA form a limited partnership by itself? This would be impossible unless the IRA also formed an entity to act as general partner. Alternatively, the IRA could simply form a single member LLC. Is the mere formation of an entity by an IRA a prohibited transaction? Not unless (a) both the IRA and the partnership are disqualified persons and (b) formation of the entity is a transaction.

Once the partnership or LLC was formed, could limited partnership or LLC units be distributed by the IRA, in kind, to the IRA owner? Again, in-kind distributions are, in general, permitted. Would the distribution of LLC units by a single member LLC change the federal tax character of the entity from a sole proprietorship to a partnership? I assume it would, assuming further that the independent existence of the IRA owner and the IRA (a trust in which the IRA owner has 100% beneficial ownership) is respected. The fact that a single member LLC wholly owned by an IRA, and previously treated for federal income tax purposes as a sole proprietorship, becomes taxable as a partnership upon distribution of any of its units to the IRA owner is not a relevant event under state law. Initially, I do not see how a change in tax treatment could be a transaction between the IRA and the IRA owner, but I have not given this issue careful analysis yet.

What is an IRA? Is it a trust? Is it an entity? Is it the alter-ego of the IRA owner (though entitled to special income tax treatment)? These are questions that continue to disturb me, but I think that, on balance, an IRA is simply a trust (or at least a trusteed IRA is) that is tax exempt.

Compare the differences between IRS Form 5305 Individual Retirement Trust Account Form IRA, and IRS Form 5305-A Individual Retirement Custodial Account Form IRA. The only noticeable difference between the two forms is that one uses the term “Custodian” where the other uses the term “Trustee.” For purposes of IRC §408, it makes no difference whether the IRA is trusteed or not:

For purposes of this section, a custodial account shall be treated as a trust if the assets of such account are held by a bank (as defined in subsection (n)) or another person who demonstrates, to the satisfaction of the Secretary or his delegate, that the manner in which he will administer the account will be consistent with the requirements of this section, and if the custodial account would, except for the fact that it is not a trust, constitute an individual retirement account described in subsection (a). For purposes of this title, in the case of a custodial account treated as a trust by reason of the preceding sentence, the custodian of such account shall be treated as the trustee thereof.[82] [Emphasis added.]

The section referred to above is 408, but the Title is Title 26, which is the IRC.

Under IRC §2652(b), an IRA, even a custodial IRA, is probably considered a trust for GST tax purposes.

The question of state law is more problematic. Over time I have been more inclined to view a trusteed IRA as a true trust, though I resisted the inclination for quite a while. I still think that there are some important differences, and that state trust law, if it operates at all, must operate in some modified form here, but I am no longer so sure about how and why exactly.

In the case of a custodial IRA, I think that there is a difference, notwithstanding what the IRC says. There is a long and well established difference between a custodian and a trustee. It may be that both are fiduciaries, but their duties and powers are certainly not the same. I expect that this is an area of developing law in which we will see new cases arise in the not too distant future.

Under state law, we must know whether an IRA can be a partner. It at least appears that an IRA can be a partner under Texas law, because a “person” can be either a general or a limited partner,[83] and a person includes a trust, custodian and trustee.[84]

We may tentatively conclude, based upon the above analysis and authorities, that under the law of most states (1) an IRA can be either a general or limited partner, and (2) an IRA may distribute a partnership interest; provided, in each instance, that the partnership agreement allows for it.

Under state law, I presume that an IRA could not own all of the partnership interests, without a merger, because it takes two or more persons to form a partnership. The IRA could own all of the stock in a corporate general partner, including an LLC, and all of the other partnership interests directly, I presume. It could certainly acquire partnership interests from any unrelated third party, and in either case distribute the interest in kind.

It is extremely important that the IRA owner not become a creditor of the IRA.

ARTICLE 9
Application of the Law

With the foregoing as background, we may now proceed to analyze what would happen if an IRA formed or invested in a limited partnership. There is nothing that expressly prohibits an IRA from acquiring a limited partnership interest as an investment. There is, of course, an above average potential for incurring a tax on UBTI[85] as a result of such an investment, but there is no prohibition against the payment of the UBTI tax.

We have already discussed the question of whether the IRA owner is a fiduciary, and have concluded that at least in those cases where the IRA owner has the power to direct investments, the DOL believes that the IRA owner would be a fiduciary.^{^[86]} But what about the partnership itself? This is where the real vulnerability lies, in my opinion.

If the IRA owns a controlling interest in a partnership, is the partnership itself a disqualified person? The definition of a disqualified person is subject to several interpretations; nevertheless, it appears to me that the partnership will not be a disqualified person unless 50% or more of the capital or profits interest is owned by another disqualified person.

The definition of a disqualified person includes “a partnership . . . of which (or in which) 50 percent or more of . . . the capital interest or profits interest of such partnership is owned directly or indirectly, or held by” “a fiduciary . . . or an employer any of whose employees are covered by the plan.”^{^[87]}

Is the IRA itself a disqualified person? I think that the answer is always yes, because of §4975(e)(2)(G)(3)(iii).^{^[88]}In most cases, however, this question need not be asked. If the IRA has dealings with a person, the issue is whether the person, not the IRA, is a disqualified person. So, if the partnership is a disqualified person, then any dealings between it and the IRA will be subject to the prohibited transaction rules.

ARTICLE 10
Specific Questions Answered or Addressed

The following is a list of the 11 questions (indicated in italics) that generated this memo, followed by my answers.

10.1 Can an IRA Contribute Its Assets To A Limited Partnership Under Any Circumstances And If So, What Particular Limitations Could There Be?

If an IRA transfers “sells” assets to a limited partnership that is controlled by the IRA owner, there will be a prohibited transaction. If disqualified persons (e.g., the IRA owner and family members) own more than 50% of the capital or profits interest in the partnership, the partnership itself would be a disqualified person and any sale or exchange between it and the IRA would be prohibited by 4975(c)(1), which prohibits the direct or indirect “sale or exchange, or leasing, of any property between a plan and a disqualified person.”

If the partnership is not a disqualified person, then the IRA ought to be able to purchase an interest in it, provided it pays fair market value. If the partnership is not a disqualified person, but a partner is, then whether or not a purchase of an interest would be prohibited would depend on whether the partnership is treated as an aggregate or an entity. If partnership assets are treated as owned by the individual partners (contrary to Texas law, I believe), then a transaction with the partnership would be prohibited. I do not want to commit on this issue yet, but I think that so long as the partnership is not controlled by disqualified persons, the IRA ought to be able to transact business with it, even if a partner is a disqualified person.

10.2 Does the IRA Have To Be The General And Limited Partner?

The IRA does not have to be either a general or a limited partner. However, it would be better if it were only a limited partner, provided a non-disqualified person acted as general partner.

10.3 Can The Participant In The IRA Be The General Partner and If Not, Who Can?

§4975(e)(2)(H) includes within the class of disqualified persons:

(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G)[89]

§4975(e)(2)(I) includes within the class of disqualified persons:

(I) a 10 percent or more (in capital or profits) partner or joint venture of a person described in subparagraph (C), (D), (E), or (G).[90]

Presumably, the IRA owner is already a disqualified person with respect to the IRA and with respect to the partnership (assuming a controlling interest), whether or not the IRA owner is also a general partner. The question is whether the exercise of management powers by a general partner who is a disqualified person is, by and of itself, a prohibited transaction per se. My qualified opinion is that it does not violate 4975(e)(2)(A)-(D), but whether or not it violates the catch-all prohibitions of (E) or (F), no one can say for sure.

10.4 Could A Related Party And How Close A Related Party Serve As A General Partner Or Owner Of An Entity That Was Serving As A General Partner?

For the answer to this question see the memo in chief.

10.5 Can A Remote Beneficiary Be The General Partner? Can A Contingent Beneficiary Of The IRA Be The General Partner?

I do not think that a person who is named as a remote beneficiary is a disqualified person on that account.

10.6 Could A Charity Be The General Partner? Could The Limited Partnership Also Have Other Types Of Partners, Such As A Public Charity, A Church, A Community Foundation, A Charitable Lead Annuity Trust, A Charitable Remainder Unitrust; Or A Private Foundation?

Presumably, the fact that the general partner was an unrelated charity, church, etc., would not by and of itself be adverse. If the charity were controlled by disqualified persons under 4975(e)(2)(G), then the charity would be a disqualified person.

10.7 Assuming That An IRA Can Make Contributions To A Limited Partnership And There Can Be Other Partners To That Limited Partnership, Are There Any Percentage Limitations That These Other Partners Can Exceed Or Not Exceed In The Partnership?

It seems to me that, before a partnership can become a disqualified person, 50% or more of the capital or profit interests must be owned by disqualified persons. The IRA itself and the IRA owner are disqualified persons, but apparently (and unbelievably) it appears family members of the IRA owner are not. If the partnership itself is not a disqualified person, then the IRA ought to be able to freely deal with it, subject to 4975(e)(2)(E)&(F).

10.8 If The IRA Contributes To A Limited Partnership, Is The Custodian Of The IRA Required To Make Annual Valuations Of The Limited Partnership Interest?

A qualified plan is required to value its assets annually. I am not sure about an IRA.

10.9 What Reporting Requirements Or What Additional Reporting Requirements Might Be Necessary If The Only Asset Of The IRA Was A Limited Partnership Interest?

I do not know of any.

10.10 Is The Value Of The IRA For Mandatory Distributions On The Required Beginning Date The Discounted Value Of The Limited Partnership Interest?

The value to be used for all purposes is the fair market value on (a) the last day of the distribution calendar year (December 31 in the case of an IRA), and (b) the fair market value on the date or dates of distribution.

10.11 Can The Mandatory Distributions Be Satisfied By Distributions In Kind Of Limited Partnership Interests To The Participant?

Yes.

10.12 Can The Limited Partnership Redeem Limited Partnership Interests From The IRA By Putting Cash Into The IRA That Then Could Be Distributed To The Participant To Meet The Mandatory Distribution Requirements?

If the partnership is a disqualified person with respect to the IRA, any “sale or exchange, or leasing, of any property between a plan and” the IRA would be prohibited, as would any “transfer to, or use by or for the benefit of, [the partnership] of the income or assets of a plan.”

10.13 Is It True That an IRA Can Not Own Life Insurance?

Yes.

10.14 If The IRA Contributes Its Assets To A Limited Partnership, Could The Limited Partner Then Acquire Life Insurance On The Life Of The Participant, And If So Are There Any Other Prohibitions Or Limitations?

Presumably, if it is okay for the IRA to own a partnership interest, the partnership could invest in assets that the IRA could not. But this calls for an analysis of the question “what are plan assets,” and, as previously indicated, I have not explored that thoroughly yet.

10.15 Can Several Different Family Members Each Put Their Separate IRAs Into the Same Limited Partnership (i.e. husband, wife and children or father and children or brothers and sisters or any other combination to invest in this manner)?

If it is permissible for the IRA of one person to invest in a partnership, it ought to be permissible for the IRAs of two or more persons to do the same thing. Of course, all of the particular circumstances would have to be taken into account.

10.16 Can An IRA And A Roth IRA Both For The Same Participant Be Partners In The Same Limited Partnership?

Yes, absent other reasons. The interests in both IRAs would be aggregated, however, for purposes of determining control.

* * * *

ARTICLE 11
Practical Applications

11.1 If the IRA Owns all of the Limited and General Partnership Interest (the GP is an LLC), Are Valuation Discounts Appropriate?

It has been argued that if an individual owns both a GP and LP interest, that the two interests ought to be valued separately, and if consent of both the LPs and the GPs is required, neither interest has liquidation control for valuation purposes. Perhaps. But doubtful, in my opinion.

Does it make any difference? Maybe not, initially, and that might be good, because it might be a fiduciary breach for the IRA to invest in something that is worth less than what it paid for it. A distribution down the road of a partnership interest would be less likely to be treated as a fiduciary breach, particularly if no other assets were available for distribution.^{^[91]} However, the possibility of a fiduciary breach is always there. Even so, a breach of fiduciary duty ought not to disqualify the IRA in the absence of a prohibited transaction. Because ERISA does not apply, we ought to be able to look solely to §4975 to determine whether we have a prohibited transaction. So far, nothing that has been suggested remotely fits the usual laundry list of prohibited transactions —other than the initial formation of the entity and the transfer of assets to it. Of course, just about anything might be deemed to be a violation of §4975(c)(1)(E) and (F), which prohibit a fiduciary from dealing “with the income or assets of a plan in his own interest or for his own account; or . . . [receiving] any consideration for his own personal account . . . in connection with a transaction involving the income or assets of the plan.”

The IRA owner ought to be free to dispose of any property distributed by the IRA, including making a gift. Once that was done, it would seem that a lack of liquidation control discount ought to be applicable as a matter of course.

11.2 Valuation Theory.

The case law appears to sanction the formation of the entity by the IRA. This is good, because even though fair market value may seem to disappear in the transaction, it is hard to say that there has been an unequal exchange. On the other hand it is not impossible to say that there has been an unequal exchange, and I think that even in the non-IRA limited partnership area, this is a definite possible avenue of IRS attack. For example, if I exchange ten-million dollars in cash for a six-million dollar asset, it looks as if I may have made a gift to someone or perhaps, entered into a prohibited transaction, the same as if I took ten-million dollars in an IRA and purchased six-million dollars worth of stocks and bonds with it, to the detriment of the IRA. We are all aware of the counter arguments, reciprocal offsetting gifts, the fact that it is no different from a standard business transaction where the parties all contribute real estate, the facts of the Swanson case, etc.; however, in this area the situation is a little more sensitive where an IRA is involved. This loss in value is the reason that most estate planning transactions are structured by transferring property to an entity on formation, rather than purchasing an interest which already lacks liquidation power, after formation. A purchase after formation would have to be for fair market value, and that value would reflect lack of control.

11.3 It is Preferable Not to Have a Controlling Interest.

Swanson, PWBOpL 2000-10A and FSA 200128011 all hold that formation is not a prohibited transaction —essentially because it is not a transaction, or at least not a purchase and sale transaction. After formation, the situation is different. However, in order for the partnership or other entity to be a DQP, other DQPs must control it. Therefore, I suggest as an alternative that control simply be absent, and I suggest that my idea may have some application outside the IRA context.

Form the partnership without using the IRA. Make sure that the IRA owner does not have a controlling interest in it. (This could be difficult, but, if that can be accomplished, it does have the support of PWBOpL 2000-1-A.) If an IRA were to purchase liquidation control of the entity, from persons who were not DQPs, the value of the interest purchased by the IRA should be equal to the cash paid by the IRA for the interest. (Incidentally, it is simple enough to structure the partnership to give a liquidation right to less than a majority in interest.) This, at least, dispenses with one potential avenue of attack by the IRS. (Again, I think that this should be considered when forming a partnership, even where an IRA is not involved.) It is important in this context to realize that liquidation control for valuation purposes is not the same as the 50% control test of §4975.

At this point, there is no discount available to the IRA. We know that. Likewise, if no IRA were involved, the family member would own a partnership interest having full value, with no discount. It is worth what it was before the transaction, and all we are concerned about is that the purchase of the partnership interest did not violate any of the prohibited transaction rules. As discussed above, I think that it is very clear that if the transaction is structured properly, the purchase will not violate any of the per se prohibited transaction rules, though it might still violate, as just about anything could violate, the vague notion that IRA transactions are not supposed to benefit the owner.

What have we accomplished at this point? Nothing, yet. But when it comes time to make a distribution out of the IRA of less than the entire interest, the distribution, if it is in kind, will, almost of necessity, result in a discount for lack of control. At some point, the control premium in the IRA will disappear as well, as result of the distributions. If, despite the high fair market value in the IRA for the controlling interest, there is no actual, as opposed to a theoretical, market for the majority interest, the minimum distribution rules may be the operating force causing the loss of value, rather than anything that the IRA owner does or has control over (at least at that point). If the value of the IRA goes down because the tax laws mandate a distribution of the interest, the retention of which was required to maintain liquidation control, then it is very difficult for me to see how any distribution of that interest would be a prohibited transaction. I kind of like the idea myself and think it is slightly safer than the other, perhaps more initially beneficial, ways of structuring the transaction.

ARTICLE 12
The Plan Asset Problem

12.1 Can The IRA Owner be Treated Under The Attribution Rules As Owning Anything Owned by The IRA?

Can the IRA owner be treated under the attribution rules as owning anything owned by the IRA? It is possible that the IRA owner will be treated as owning (albeit indirectly) any interest owned by the IRA. If so, and if the IRA, or the IRA and the owner together, own more than 50% of the partnership, then the partnership would be a disqualified person in its dealings with the IRA, the IRA owner and with any other disqualified person. Further, if we look through the partnership to the plan assets in the IRA, the general partner could be a fiduciary.

Even the Swanson case, discussed in detail below, held that after an IRA had formed a corporation at the direction of the IRA owner, the corporation would be a disqualified person. I think it is all but inescapable that any partnership in which the IRA and the IRA owner together own more than 50% of the capital or profits interest will be deemed a disqualified person.

What gives me pause is the notion that if this analysis is correct, then an IRA could have no dealings with an entity that it owns entirely. But this may be correct after all, if all dealings are “settlor functions.”

What are the ramifications of the partnership being a disqualified person? This is most important. If the partnership is a disqualified person, then any dealings between it and the IRA would be prohibited if described in IRC §4975(c)(1). Recall that under that section the term “prohibited transaction” means any direct or indirect—

(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;

(B) lending of money or other extension of credit between a plan and a disqualified person;

(C) furnishing of goods, services, or facilities between a plan and a disqualified person;

(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;

(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

Would the mere receipt of partnership distributions or the activities of partnership management violate 4975(c)(1)? Not according to Swanson. Would the formation of the partnership followed by the contribution of IRA assets to it constitute a prohibited transaction? Again, if the partnership itself is a disqualified person, the answer to both these questions could be yes.

But if owning an entity that is a disqualified person is per se a prohibited transaction, by reason of the power to participate in voting (or perhaps to participate in management), and to receive distributions of dividends and other profits, then no IRA or qualified plan could ever own more than 50% of the stock or partnership interests in any entity (other than employer stock in a qualified plan under a special exemption which allows that). If neither the owner, a family member, nor the IRA owns a general partnership interest (i.e., they are all limited partners), the problem is certainly ameliorated, but it is more likely that one of the disqualified persons will be a general partner or otherwise involved in management decisions. In any case, so far as I am aware, neither the IRS nor the DOL has stated that participation in management is a per se prohibited transaction where both the IRA and the disqualified person have the requisite control. Interestingly, in the few cases where this issue has come up the outcome has been favorable to the taxpayer. This is probably because the “transactions” just described come under the umbrella or rubric of the exception for settlor functions. In other words, there may be an analogy between the exercise of management type decisions and the body of law, discussed above, that treats settlor functions as nonfiduciary in nature.

Recall ERISA Opinion Letter 2001-01A:

12.2 DOL Jurisdiction Over IRAs.

Even though this subject was treated briefly above, it bears repeating here: an IRA is not subject to ERISA, and thus is generally exempt from regulation by the Department of Labor (the DOL); nevertheless, the DOL has the specific authority to issue exemptions from the application of the prohibited transaction rules.[93] Enforcement of the IRA prohibited transaction rules are, however, exclusively within the jurisdiction of the Treasury.[94] Pursuant to Presidential Reorganization Plan No. 4 of 1978:

12.3 If the IRA Owner and the IRA Control a Partnership, Are Partnership Assets Plan Assets, and If So, For What Purposes?

12.3(a) ERISA Opinion Letter 2000-10A

ERISA Opinion Letter 2000-10A, discussed and quoted at length above, concluded:

Moreover, the Department notes that by virtue of the contemplated investment by the IRA in the Partnership, there will be significant investment in the Partnership by benefit plan investors. Accordingly, the Partnership will hold “plan assets” within the meaning of that term in the Department’s regulations at 29 CFR §2510.3-101. As a result, any person who exercises discretionary authority or control with respect to assets of the Partnership will be fiduciary of the IRA and subject to the restrictions of section 4975(c)(1) of the Code, except to the extent a statutory or administrative exemption applies.[96] [Emphasis added.]

Under the facts of ERISA Opinion Letter 2000-10A, transactions between the partnership and the fiduciary are clearly subject to the list of transactions prohibited by 4975(c)(1), but are the partnership assets literally “plan assets” such that assets that an IRA is prohibited from owning under §408, e.g., life insurance prohibited under 408(a)(3), or collectibles prohibited by408(m), cannot be owned by the partnership? I think that the answer is “no,” for the reason that the plan assets regulation “describes what constitute assets of a plan with respect to a plan's investment in another entity for purposes of Subtitle A, and Parts 1 and 4 of Subtitle B, of Title I of the Act and section 4975 of the Internal Revenue Code,” and presumably has no application for other purposes.

12.3(b) Subtitle A, and Parts 1 and 4 of Subtitle B, of Title I of ERISA.

Reproduced below are Subtitle A, and Parts 1 and 4 of Subtitle B, of Title I.

Subtitle A—General Provisions

Sec. 2. [USC §1001] Findings and declaration of policy
[Congressional findings and declaration of policy.]

Sec. 3. [USC §1002] Definitions

Sec. 4. [USC §1003] Coverage

Subtitle B—Regulatory Provisions

Part 1—Reporting and Disclosure

Sec. 101. [USC §1021] Duty of disclosure and reporting

Sec. 102. [USC §1022] Plan description and summary plan description

Sec. 103. [USC §1023] Annual reports

Sec. 104. [USC §1024] Filing with Secretary and furnishing information to participants
[Filing and furnishing of information]

Sec. 105. [USC §1025] Reporting of participant's benefit rights

Sec. 106. [USC §1026] Reports made public information

Sec. 107. [USC §1027] Retention of records

Sec. 108. [USC §1028] Reliance on administrative interpretations

Sec. 109. [USC §1029] Forms

Sec. 110. [USC §1030] Alternative methods of compliance

Sec. 111. [USC §1031] Repeal and effective date

Part 2—Participation and Vesting

* * * *

Part 3—Funding

* * * *

Part 4—Fiduciary Responsibility

Sec. 401. [USC §1101] Coverage

Sec. 402. [USC §1102] Establishment of plan

Sec. 403. [USC §1103] Establishment of trust

Sec. 404. [USC §1104] Fiduciary duties

Sec. 405. [USC §1105] Liability for breach by co-fiduciary

Sec. 406. [USC §1106] Prohibited transactions

Sec. 407. [USC §1107] 10 percent limitation with respect to acquisition and holding of employer securities and employer real property by certain plans

Sec. 408. [USC §1108] Exemptions from prohibited transactions

Sec. 409. [USC §1109] Liability for breach of fiduciary duty

Sec. 410. [USC §1110] Exculpatory provisions; insurance

Sec. 411. [USC §1111] Prohibition against certain persons holding certain positions

Sec. 412. [USC §1112] Bonding

Sec. 413. [USC §1113] Limitation on actions
[Limitation of actions]

Sec. 414. [USC §1114] Effective date
[Effective date and application]

12.3(c) The Plan Asset Regulations.

Here is the DOL regulation referred to in ERISA Opinion Letter 2000-10A.

Miscellaneous Nontax Regulations

29 CFR §2510.3-101 Definition of “plan assets” – plan investments.

(a) In general.

(1) This section describes what constitute assets of a plan with respect to a plan's investment in another entity for purposes of Subtitle A, and Parts 1 and 4 of Subtitle B, of Title I of the Act and section 4975 of the Internal Revenue Code. Paragraph (a)(2) of this section contains a general rule relating to plan investments. Paragraphs (b) through (f) of this section define certain terms that are used in the application of the general rule. Paragraph (g) of this section describes how the rules in this section are to be applied when a plan owns property jointly with others or where it acquires an equity interest whose value relates solely to identified assets of an issuer. Paragraph (h) of this section contains special rules relating to particular kinds of plan investments. Paragraph (i) describes the assets that a plan acquires when it purchases certain guaranteed mortgage certificates. Paragraph (j) of this section contains examples illustrating the operation of this section. The effective date of this section is set forth in paragraph (k) of this section.

(2) Generally, when a plan invests in another entity, the plan's assets include its investment, but do not, solely by reason of such investment, include any of the underlying assets of the entity. However, in the case of a plan's investment in an equity interest of an entity that is neither a publicly-offered security nor a security issued by an investment company registered under the Investment Company Act of 1940 its assets include both the equity interest and an undivided interest in each of the underlying assets of the entity, unless it is established that –

(i) The entity is an operating company, or

(ii) Equity participation in the entity by benefit plan investors is not significant.

Therefore, any person who exercises authority or control respecting the management or disposition of such underlying assets, and any person who provides investment advice with respect to such assets for a fee (direct or indirect), is a fiduciary of the investing plan.

(b) Equity interests and publicly-offered securities.

(1) the term “equity interest” means any interest in an entity other than an instrument that is treated as indebtedness under applicable local law and which has no substantial equity features. A profits interest in a partnership, an undivided ownership interest in property and a beneficial interest in a trust are equity interests.

(2) A “publicly-offered security” is a security that is freely transferable, part of a class of securities that is widely held and either –

(i) Part of a class of securities registered under section 12(b) or 12(g) of the Securities Exchange Act of 1934, or

(ii) Sold to the plan as part of an offering of securities to the public pursuant to an effective registration statement under the Securities Act of 1933 and the class of securities of which such security is a part is registered under the Securities Exchange Act of 1934 within 120 days (or such later time as may be allowed by the Securities and Exchange Commission) after the end of the fiscal year of the issuer during which the offering of such securities to the public occurred.

(3) For purposes of paragraph (b)(2) of this section, a class of securities is “widely-held” only if it is a class of securities that is owned by 100 or more investors independent of the issuer and of one another. A class of securities will not fail to be widely-held solely because subsequent to the initial offering the number of independent investors falls below 100 as a result of events beyond the control of the issuer.

(4) For purposes of paragraph (b)(2) of this section, whether a security is “freely transferable” is a factual question to be determined on the basis of all relevant facts and circumstances. If a security is part of an offering in which the minimum investment is $10,000 or less, however, the following factors ordinarily will not, alone or in combination, affect a finding that such securities are freely transferable:

(i) Any requirement that not less than a minimum number of shares or units of such security be transferred or assigned by any investor, provided that such requirement does not prevent transfer of all of the then remaining shares or units held by an investor;

(ii) Any prohibition against transfer or assignment of such security or rights in respect thereof to an ineligible or unsuitable investor;

(iii) Any restriction on, or prohibition against, any transfer or assignment which would either result in a termination or reclassification of the entity for federal or state tax purposes or which would violate any state or federal statute, regulation, court order, judicial decree, or rule of law;

(iv) Any requirement that reasonable transfer or administrative fees be paid in connection with a transfer or assignment;

(v) Any requirement that advance notice of a transfer or assignment be given to the entity and any requirement regarding execution of documentation evidencing such transfer or assignment (including documentation setting forth representations from either or both of the transferor or transferee as to compliance with any restriction or requirement described in this paragraph (b)(4) of this section or requiring compliance with the entity's governing instruments);

(vi) Any restriction on substitution of an assignee as a limited partner of a partnership, including a general partner consent requirement, provided that the economic benefits of ownership of the assignor may be transferred or assigned without regard to such restriction or consent (other than compliance with any other restriction described in this paragraph (b)(4) of this section;

(vii) Any administrative procedure which establishes an effective date, or an event, such as the completion of the offering, prior to which a transfer or assignment will not be effective; and

(viii) Any limitation or restriction on transfer or assignment which is not created or imposed by the issuer or any person acting for or on behalf of such issuer.

(c) Operating company.

(1) An “operating company” is an entity that is primarily engaged, directly or through a majority owned subsidiary or subsidiaries, in the production or sale of a product or service other than the investment of capital. The term “operating company” includes an entity which is not described in the preceding sentence, but which is a “venture capital operating company” described in paragraph (d) or a “real estate operating company” described in paragraph (e).

(d) Venture capital operating company.

(1) An entity is a “venture capital operating company” for the period beginning on an initial valuation date described in paragraph (d)(5)(i) and ending on the last day of the first “annual valuation period” described in paragraph (d)(5)(ii) (in the case of an entity that is not a venture capital operating company immediately before the determination) or for the 12 month period following the expiration of an “annual valuation period” described in paragraph (d)(5)(ii) (in the case of an entity that is a venture capital operating company immediately before the determination) if –

(i) On such initial valuation date, or at any time within such annual valuation period, at least 50 percent of its assets (other than short-term investments pending long-term commitment or distribution to investors), valued at cost, are invested in venture capital investments described in paragraph (d)(3)(i) or derivative investments described in paragraph (d)(4); and

(ii) During such 12 month period (or during the period beginning on the initial valuation date and ending on the last day of the first annual valuation period), the entity, in the ordinary course of its business, actually exercises management rights of the kind described in paragraph (d)(3)(ii) with respect to one or more of the operating companies in which it invests.

(2)

(i) A venture capital operating company described in paragraph (d)(1) shall continue to be treated as a venture capital operating company during the “distribution period” described in paragraph (d)(2)(ii). An entity shall not be treated as a venture capital operating company at any time after the end of the distribution period.

(ii) The “distribution period” referred to in paragraph (d)(2)(i) begins on a date established by a venture capital operating company that occurs after the first date on which the venture capital operating company has distributed to investors the proceeds of at least 50 percent of the highest amount of its investments (other than short-term investments made pending long-term commitment or distribution to investors) outstanding at any time from the date it commenced business (determined on the basis of the cost of such investments) and ends on the earlier of –

(A)

The date on which the company makes a “new portfolio investment”, or

(B)

The expiration of 10 years from the beginning of the distribution period.

(iii) For purposes of paragraph (d)(2)(ii)(A), a “new portfolio investment” is an investment other than –

(A)

An investment in an entity in which the venture capital operating company had an outstanding venture capital investment at the beginning of the distribution period which has continued to be outstanding at all times during the distribution period, or

(B)

A short-term investment pending long-term commitment or distribution to investors.

(3)

(i) For purposes of this paragraph (d) a “venture capital investment” is an investment in an operating company (other than a venture capital operating company) as to which the investor has or obtains management rights.

(ii) The term “management rights” means contractual rights directly between the investor and an operating company to substantially participate in, or substantially influence the conduct of, the management of the operating company.

(4)

(i) An investment is a “derivative investment” for purposes of this paragraph (d) if it is –

(A)

A venture capital investment as to which the investor's management rights have ceased in connection with a public offering of securities of the operating company to which the investment relates, or

(B)

An investment that is acquired by a venture capital operating company in the ordinary course of its business in exchange for an existing venture capital investment in connection with:

(1)

A public offering of securities of the operating company to which the existing venture capital investment relates, or

(2)

A merger or reorganization of the operating company to which the existing venture capital investment relates, provided that such merger or reorganization is made for independent business reasons unrelated to extinguishing management rights.

(ii) An investment ceases to be a derivative investment on the later of:

(A)

10 years from the date of the acquisition of the original venture capital investment to which the derivative investment relates, or

(B)

30 months from the date on which the investment becomes a derivative investment.

(5) For purposes of this paragraph (d) and paragraph (e) –

(i) An “initial valuation date” is the later of –

(A)

Any date designated by the company within the 12 month period ending with the effective date of this section, or

(B)

The first date on which an entity makes an investment that is not a short-term investment of funds pending long-term commitment.

(ii) An “annual valuation period” is a preestablished annual period, not exceeding 90 days in duration, which begins no later than the anniversary of an entity's initial valuation date. An annual valuation period, once established may not be changed except for good cause unrelated to a determination under this paragraph (d) or paragraph (e).

(e) Real estate operating company. An entity is a “real estate operating company” for the period beginning on an initial valuation date described in paragraph (d)(5)(i) and ending on the last day of the first “annual valuation period” described in paragraph (d)(5)(ii) (in the case of an entity that is not a real estate operating company immediately before the determination) or for the 12 month period following the expiration of an annual valuation period described in paragraph (d)(5)(ii) (in the case of an entity that is a real estate operating company immediately before the determination) if:

(1) On such initial valuation date, or on any date within such annual valuation period, at least 50 percent of its assets, valued at cost (other than short-term investments pending long-term commitment or distribution to investors), are invested in real estate which is managed or developed and with respect to which such entity has the right to substantially participate directly in the management or development activities; and

(2) During such 12 month period (or during the period beginning on the initial valuation date and ending on the last day of the first annual valuation period) such entity in the ordinary course of its business is engaged directly in real estate management or development activities.

(f) Participation by benefit plan investors.

(1) Equity participation in an entity by benefit plan investors is “significant” on any date if, immediately after the most recent acquisition of any equity interest in the entity, 25 percent or more of the value of any class of equity interests in the entity is held by benefit plan investors (as defined in paragraph (f)(2)). For purposes of determinations pursuant to this paragraph (f), the value of any equity interests held by a person (other than a benefit plan investor) who has discretionary authority or control with respect to the assets of the entity or any person who provides investment advice for a fee (direct or indirect) with respect to such assets, or any affiliate of such a person, shall be disregarded.

(2) A “benefit plan investor” is any of the following –

(i) Any employee benefit plan (as defined in section 3(3) of the Act), whether or not it is subject to the provisions of Title I of the Act,

(ii) Any plan described in section 4975(e)(1) of the Internal Revenue Code,

(iii) Any entity whose underlying assets include plan assets by reason of a plan's investment in the entity.

(3) An “affiliate” of a person includes any person, directly or indirectly, through one or more intermediaries, controlling, controlled by, or under common control with the person. For purposes of this paragraph (f)(3), “control”, with respect to a person other than an individual, means the power to exercise a controlling influence over the management or policies of such person.

(g) Joint ownership. For purposes of this section, where a plan jointly owns property with others, or where the value of a plan's equity interest in an entity relates solely to identified property of the entity, such property shall be treated as the sole property of a separate entity.

(h) Specific rules relating to plan investments. Notwithstanding any other provision of this section –

(1) Except where the entity is an investment company registered under the Investment Company Act of 1940, when a plan acquires or holds an interest in any of the following entities its assets include its investment and an undivided interest in each of the underlying assets of the entity:

(i) A group trust which is exempt from taxation under section 501(a) of the Internal Revenue Code pursuant to the principles of Rev. Rul. 81-100, 1981-1 C.B. 326,

(ii) A common or collective trust fund of a bank,

(iii) A separate account of an insurance company, other than a separate account that is maintained solely in connection with fixed contractual obligations of the insurance company under which the amounts payable, or credited, to the plan and to any participant or beneficiary of the plan (including an annuitant) are not affected in any manner by the investment performance of the separate account.

(2) When a plan acquires or holds an interest in any entity (other than an insurance company licensed to do business in a State) which is established or maintained for the purpose of offering or providing any benefit described in section 3(1) or section 3(2) of the Act to participants or beneficiaries of the investing plan, its assets will include its investment and an undivided interest in the underlying assets of that entity.

(3) When a plan or a related group of plans owns all of the outstanding equity interests (other than director's qualifying shares) in an entity, its assets include those equity interests and all of the underlying assets of the entity. This paragraph (h)(3) does not apply, however, where all of the outstanding equity interests in an entity are qualifying employer securities described in section 407(d)(5) of the Act, owned by one or more eligible individual account plan(s) (as defined in section 407(d)(3) of the Act) maintained by the same employer, provided that substantially all of the participants in the plan(s) are, or have been, employed by the issuer of such securities or by members of a group of affiliated corporations (as determined under section 407(d)(7) of the Act) of which the issuer is a member.

(4) For purposes of paragraph (h)(3), a “related group” of employee benefit plans consists of every group of two or more employee benefit plans –

(i) Each of which receives 10 percent or more of its aggregate contributions from the same employer or from members of the same controlled group of corporations (as determined under section 1563(a) of the Internal Revenue Code, without regard to section 1563(a)(4) thereof); or

(ii) Each of which is either maintained by, or maintained pursuant to a collective bargaining agreement negotiated by, the same employee organization or affiliated employee organizations. For purposes of this paragraph, an “affiliate” of an employee organization means any person controlling, controlled by, or under common control with such organization, and includes any organization chartered by the same parent body, or governed by the same constitution and bylaws, or having the relation of parent and subordinate.

(i) Governmental mortgage pools.

(1) Where a plan acquires a guaranteed governmental mortgage pool certificate, as defined in paragraph (i)(2), the plan's assets include the certificate and all of its rights with respect to such certificate under applicable law, but do not, solely by reason of the plan's holding of such certificate, include any of the mortgages underlying such certificate.

(2) A “guaranteed governmental mortgage pool certificate” is a certificate backed by, or evidencing an interest in, specified mortgages or participation interests therein and with respect to which interest and principal payable pursuant to the certificate is guaranteed by the United States or an agency or instrumentality thereof. The term “guaranteed governmental mortgage pool certificate” includes a mortgage pool certificate with respect to which interest and principal payable pursuant to the certificate is guaranteed by:

(i) The Government National Mortgage Association;

(ii) The Federal Home Loan Mortgage Corporation; or

(iii) The Federal National Mortgage Association.

(j) Examples. The principles of this section are illustrated by the following examples:

(1) A plan, P, acquires debentures issued by a corporation, T, pursuant to a private offering. T is engaged primarily in investing and reinvesting in precious metals on behalf of its shareholders, all of which are benefit plan investors. By its terms, the debenture is convertible to common stock of T at P's option. At the time of P's acquisition of the debentures, the conversion feature is incidental to T's obligation to pay interest and principal. Although T is not an operating company, P's assets do not include an interest in the underlying assets of T because P has not acquired an equity interest in T. However, if P exercises its option to convert the debentures to common stock, it will have acquired an equity interest in T at that time and (assuming that the common stock is not a publicly-offered security and that there has been no change in the composition of the other equity investors in T) P's assets would then include an undivided interest in the underlying assets of T.

(2) A plan, P, acquires a limited partnership interest in a limited partnership, U, which is established and maintained by A, a general partner in U. U has only one class of limited partnership interests. U is engaged in the business of investing and reinvesting in securities. Limited partnership interest in U are offered privately pursuant to an exemption from the registration requirements of the Securities Act of 1933. P acquires 15 percent of the value of all the outstanding limited partnership interests in U, and, at the time of P's investment, a governmental plan owns 15 percent of the value of those interests. U is not an operating company because it is engaged primarily in the investment of capital. In addition, equity participation by benefit plan investors is significant because immediately after P's investment such investors hold more than 25 percent of the limited partnership interests in U. Accordingly, P's assets include an undivided interest in the underlying assets of U, and A is a fiduciary of P with respect to such assets by reason of its discretionary authority and control over U's assets. Although the governmental plan's investment is taken into account for purposes of determining whether equity participation by benefit plan investors is significant, nothing in this section imposes fiduciary obligations on A with respect to that plan.

(3) Assume the same facts as in paragraph (j)(2), except that P acquires only 5 percent of the value of all the outstanding limited partnership interests in U, and that benefit plan investors in the aggregate hold only 10 percent of the value of the limited partnership interests in U. Under these facts, there is no significant equity participation by benefit plan investors in U, and, accordingly, P's assets include its limited partnership interest in U, but do not include any of the underlying assets of U. Thus, A would not be a fiduciary of P by reason of P's investment.

(4) Assume the same facts as in paragraph (j)(3) and that the aggregate value of the outstanding limited partnership interests in U is $10,000 (and that the value of the interests held by benefit plan investors is thus $1000). Also assume that an affiliate of A owns limited partnership interests in U having a value of $6500. The value of the limited partnership interests held by A's affiliate are disregarded for purposes of determining whether there is significant equity participation in U by benefit plan investors. Thus, the percentage of the aggregate value of the limited partnership interests held by benefit plan investors in U for purposes of such a determination is approximately 28.6% ($1000/$3500). Therefore there is significant benefit plan investment in T.

(5) A plan, P, invests in a limited partnership. V. pursuant to private offering. There is significant equity participation by benefit plan investors in V. V acquires equity positions in the companies in which it invests, and, in connection with these investments, V negotiates terms that give it the right to participate in or influence the management of those companies. Some of these investments are in publicly-offered securities and some are in securities acquired in private offerings. During its most recent valuation period, more than 50 percent of V's assets, valued at cost, consisted of investments with respect to which V obtained management rights of the kind described above. V's managers routinely consult informally with, and advise, the management of only one portfolio company with respect to which it has management rights, although it devotes substantial resources to its consultations with that company. With respect to the other portfolio companies, V relies on the managers of other entities to consult with and advise the companies' management. V is a venture capital operating company and therefore P has acquired its limited partnership investment, but has not acquired an interest in any of the underlying assets of V. Thus, none of the managers of V would be fiduciaries with respect to P solely by reason of its investment. In this situation, the mere fact that V does not participate in or influence the management of all its portfolio companies does not affect its characterization as a venture capital operating company.

(6) Assume the same facts as in paragraph (j)(5) and the following additional facts: V invests in debt securities as well as equity securities of its portfolio companies. In some cases V makes debt investments in companies in which it also has an equity investment; in other cases V only invests in debt instruments of the portfolio company. V's debt investments are acquired pursuant to private offerings and V negotiates covenants that give it the right to substantially participate in or to substantially influence the conduct of the management of the companies issuing the obligations. These covenants give V more significant rights with respect to the portfolio companies' management than the covenants ordinarily found in debt instruments of established, creditworthy companies that are purchased privately by institutional investors. V routinely consults with and advises the management of its portfolio companies. The mere fact that V's investments in portfolio companies are debt, rather than equity, will not cause V to fail to be a venture capital operating company, provided it actually obtains the right to substantially participate in or influence the conduct of the management of its portfolio companies and provided that in the ordinary course of its business it actually exercises those rights.

(7) A plan, P, invests (pursuant to a private offering) in a limited partnership, W, that is engaged primarily in investing and reinvesting assets in equity positions in real property. The properties acquired by W are subject to long-term leases under which substantially all management and maintenance activities with respect to the property are the responsibility of the lessee. W is not engaged in the management or development of real estate merely because it assumes the risks of ownership of income-producing real property, and W is not a real estate operating company. If there is significant equity participation in W by benefit plan investors, P will be considered to have acquired an undivided interest in each of the underlying assets of W.

(8) Assume the same facts as in paragraph (j)(7) except that W owns several shopping centers in which individual stores are leased for relatively short periods to various merchants (rather than owning properties subject to long-term leases under which substantially all management and maintenance activities are the responsibility of the lessee). W retains independent contractors to manage the shopping center properties. These independent contractors negotiate individual leases, maintain the common areas and conduct maintenance activities with respect to the properties. W has the responsibility to supervise and the authority to terminate the independent contractors. During its most recent valuation period

more than 50 percent of W's assets, valued at cost, are invested in such properties. W is a real estate operating company. The fact that W does not have its own employees who engage in day-to-day management and development activities is only one factor in determining whether it is actively managing or developing real estate. Thus, P's assets include its interest in W, but do not include any of the underlying assets of W.

(9) A plan, P, acquires a limited partnership interest in X pursuant to a private offering. There is significant equity participation in X by benefit plan investors. X is engaged in the business of making “convertible loans” which are structured as follows: X lends a specified percentage of the cost of acquiring real property to a borrower who provides the remaining capital needed to make the acquisition. This loan is secured by a mortgage on the property. Under the terms of the loan, X is entitled to receive a fixed rate of interest payable out of the initial cash flow from the property and is also entitled to that portion of any additional cash flow which is equal to the percentage of the acquisition cost that is financed by its loan. Simultaneously with the making of the loan, the borrower also gives X an option to purchase an interest in the property for the original principal amount of the loan at the expiration of its initial term. X's percentage interest in the property, if it exercises this option, would be equal to the percentage of the acquisition cost of the property which is financed by its loan. The parties to the transaction contemplate that the option ordinarily will be exercised at the expiration of the loan term if the property has appreciated in value. X and the borrower also agree that, if the option is exercised, they will form a limited partnership to hold the property. X negotiates loan terms which give it rights to substantially influence, or to substantially participate in, the management of the property which is acquired with the proceeds of the loan. These loan terms give X significantly greater rights to participate in the management of the property than it would obtain under a conventional mortgage loan. In addition, under the terms of the loan, X and the borrower ratably share any capital expenditures relating to the property. During its most recent valuation period, more than 50 percent of the value of X's assets valued at cost consisted of real estate investments of the kind described above. X, in the ordinary course of its business, routinely exercises its management rights and frequently consults with and advises the borrower and the property manager. Under these facts, X is a real estate operating company. Thus, P's assets include its interest in X, but do not include any of the underlying assets of X.

(10) In a private transaction, a plan, P, acquires a 30 percent participation in a debt instrument that is held by a bank. Since the value of the participation certificate relates solely to the debt instrument, that debt instrument is, under paragraph (g), treated as the sole asset of a separate entity. Equity participation in that entity by benefit plan investors is significant since the value of the plan's participation exceeds 25 percent of the value of the instrument. In addition, the hypothetical entity is not an operating company because it is primarily engaged in the investment of capital (i.e., holding the debt instrument). Thus, P's assets include the participation and an undivided interest in the debt instrument, and the bank is a fiduciary of P to the extent it has discretionary authority or control over the debt instrument.

(11) In a private transaction, a plan, P, acquires 30% of the value of a class of equity securities issued by an operating company, Y. These securities provide that dividends shall be paid solely out of earnings attributable to certain tracts of undeveloped land that are held by Y for investment. Under paragraph (g), the property is treated as the sole asset of a separate entity. Thus, even though Y is an operating company, the hypothetical entity whose sole assets are the undeveloped tracts of land is not an operating company. Accordingly, P is considered to have acquired an undivided interest in the tracts of land held by Y. Thus, Y would be a fiduciary of P to the extent it exercises discretionary authority or control over such property.

(12) A medical benefit plan, P, acquires a beneficial interest in a trust, Z, that is not an insurance company licensed to do business in a State. Under this arrangement, Z will provide the benefits to the participants and beneficiaries of P that are promised under the terms of the plan. Under paragraph (h)(2), P's assets include its beneficial interest in Z and an undivided interest in each of its underlying assets. Thus, persons with discretionary authority or control over the assets of Z would be fiduciaries of P.

(k) Effective date and transitional rules.

(1) In general, this section is effective for purposes of identifying the assets of a plan on or after March 13, 1987. Except as a defense, this section shall not apply to investments in an entity in existence on March 13, 1987, if no plan subject to Title I of the Act or plan described in section 4975(e)(1) of the Code (other than a plan described in section 4975(g)(2) or 4975(g)(3)) acquires an interest in the entity from an issuer or underwriter at any time on or after March 13, 1987 except pursuant to a contract binding on the plan in effect on March 13, 1987 with an issuer or underwriter to acquire an interest in the entity.

(2) Notwithstanding paragraph (k)(1), this section shall not, except as a defense, apply to a real estate entity described in section 11018(a) of Pub. L. 99-272.

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51 Fed. Reg. 41280, 11/13/86; 51 Fed. Reg. 47226, 12/31/86.

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[1] Swanson v. Commissioner, 106 T.C. 76 (1996).

[2]Swanson v. Commissioner, 106 T.C. 76 (1996).

[3] See also ERISA Opinion Letter 2000-10A, 07/27/2000.

[4] These sections are reproduced in the body of this article, about a page or so away.

[5]Swanson v. Commissioner, 106 T.C. 76 (1996).

[6]The Employee Retirement Income Security Act of 1974, 29 U.S.C. §1001, et seq., as amended.

[7]All references herein to the “IRC” are to the Internal Revenue Code of 1986, as amended, unless otherwise indicated.

[11] IRC §4975(e)(2)(F). Cf., ERSIA §3(14)(F).

[12] 4975(e)(5) says we use 267(c) “other than paragraph (3) thereof.” That is why I struck through this portion, because it should be irrelevant.

[13] 4975(e)(5) says we use 267(c) “except that section 267(c)(4) shall be treated as providing that the members of the family of an individual are the members within the meaning of paragraph (6).” That is why I struck through this portion, because it should be irrelevant.

[14]IRC §4975(e)(6). I interpret this as meaning one need not count one’s siblings under 4975(e)(5), even though for §267(c) purposes, generally, siblings are counted.

[16]Swanson v. Commissioner, 106 T.C. 76 (1996).

[17]Swanson v. Commissioner, 106 T.C. 76 (1996) at 78-79.

[18]A “plan” is defined by sec. 4975(e)(1) to encompass an individual retirement account as described under sec. 408.

[19]As applicable to the following discussion, sec. 4975(e)(2) defines a disqualified person as:

(A) a fiduciary;

***

(D) an employee organization, any of whose members are covered by the plan;

***

(G) a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of –

(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,

(ii) the capital interest or profits interest of such partnership, or

(iii) the beneficial interest of such trust or estate, is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);

***

(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G) *** [Emphasis added.]

[20]In pertinent part, a “fiduciary” is defined by sec. 4975(e)(3) as any person who:

(A) exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, [or]

***

At all relevant times, petitioner maintained and exercised the right to direct IRA #1's investments. Petitioner, therefore, was clearly a “fiduciary” with respect to IRA #1 and thereby a “disqualified person” as defined under sec. 4975(e)(2)(A). Furthermore, as petitioner was the sole individual for whose benefit IRA #1 was established, IRA #1 itself was a disqualified person pursuant to sec. 4975(e)(2)(G)(iii).

[21]Furthermore, we find that at the time of the stock issuance, Worldwide was not, within the meaning of sec. 4975(e)(2)(C), an “employer”, any of whose employees were beneficiaries of IRA #1. Although sec. 4975 does not define the term “employer”, we find guidance in sec. 3(5) of the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, 88 Stat. 829, 834. In pertinent part, ERISA sec. 3(5) provides that, for plans such as an IRA, an “`employer' means any person acting directly as an employer, or indirectly in the interest of an employer, in relation to an employee benefit plan *** .” Because Worldwide did not maintain, sponsor, or directly contribute to IRA #1, we find that Worldwide was not acting as an “employer” in relation to an employee plan, and was not, therefore, a disqualified person under sec. 4975(e)(2)(C). As there is no evidence that Worldwide was an “employee organization”, any of whose members were participants in IRA #1, we also find that Worldwide was not a disqualified person under sec. 4975(e)(2)(D).

[22]Sec. 4975(e)(4) incorporates the constructive ownership rule of sec. 267(c)(1), which states that:

Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries ***

Petitioner, as the sole individual for whose benefit IRA #1 was established, was therefore beneficial owner of all the outstanding shares of Worldwide after they were issued. Because petitioner, as the sole beneficial shareholder of Worldwide, was also a “fiduciary” with respect to IRA #1, Worldwide thus met the definition of a disqualified person under sec. 4975(e)(2)(G).

Contrary to respondent's representations, petitioner was not a “disqualified person” as president and director of Worldwide until after the stock was issued to IRA #1. Sec. 4975(e)(2)(H). Furthermore, petitioner was not a disqualified person under sec. 4975(e)(2)(H) solely due to his “shareholding” in Worldwide as the constructive attribution rules provided under sec. 267 are applicable only to sec. 4975(e)(2)(E)(i) and (G)(i). Sec. 4975(e)(4).

[23]Ordinarily, controlling effect will be given to the plain language of a statute unless to do so would produce absurd or futile results. Rath v. Commissioner, 101 T.C. 196, 200 (1993) (citing United States v. American Trucking Associations, 310 U.S. 534, 543-544 (1940)). As the Supreme Court has stated:

In the absence of a clearly expressed legislative intention to the contrary, the language of the statute itself must ordinarily be regarded as conclusive. Unless exceptional circumstances dictate otherwise, when we find the terms of a statute unambiguous, judicial inquiry is complete. [Burlington No. R. v. Oklahoma Tax Comm'n., 481 U.S. 454, 461 (1987); citations and internal quotation marks omitted.]

Accordingly, when, as here, a statute is clear on its face, we require unequivocal evidence of a contrary purpose before construing it in a manner that overrides the plain meaning of the statutory words. Rath v. Commissioner, supra at 200-201 (citing Halpern v. Commissioner, 96 T.C. 895, 899 (1991); Huntsberry v. Commissioner, 83 T.C. 742, 747-748 (1984)).

[24]See the discussion supra note 16 regarding application of a statute's plain meaning.

[25]In a letter accompanying the revenue agent's report, respondent stated that:

We believe the statutory Notice of Deficiency adequately describes the adjustments asserted therein. Moreover, during the course of the examination your client became fully cognizant of the transactions under scrutiny. However, as a convenience to you, enclosed is a copy of the revenue agent's report. Naturally, it is not the Service's intent by this letter to in any way limit the general language of the statutory notice. The Commissioner will stand on any ground fairly raised by the statutory notice as a basis for her determination.

In finding that respondent was not substantially justified with respect to the DISC issue, we have considered all grounds upon which respondent could fairly raise a question of prohibited transactions under sec. 4975.

[26]Swanson v. Commissioner, 106 T.C. 76 (1996) at 88-90.

[27]Swanson v. Commissioner, 106 T.C. 76 (1996) at 90.

[28]Etter v. Pease, 963 F.2d 1005 (7th Cir. 1992).

[29]Etter v. Pease, 963 F.2d 1005 (7th Cir. 1992) at 1006.

[30]Etter v. Pease, 963 F.2d 1005 (7th Cir. 1992) at 1009.

[31] (1) A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect . . . (D) transfer to or use by or for the benefit of, a party in interest, of any assets of the plan . . . . 29 U.S.C. § 1106(a)(1)(D).

[32]Etter v. Pease, 963 F.2d 1005 (7th Cir. 1992) at 1010.

[33]Presidential Reorganization Plan No. 4 of 1978, 3 C.F.R. 332(1979).

[38] ERISA Opinion Letter 2000-10A, 07/27/2000, p.1.

[39]Swanson v. Commissioner, 106 T.C. 76 (1996).

[41] ERISA Opinion Letter 2000-10A, 07/27/2000, end of letter.

[42] As a matter of convenience, I may occasionally lapse into speaking of the IRA as if it were an entity. If so, simply substitute trustee or custodian in place of the word IRA and my true meaning will be resolved.

[43] Treas. Reg. §1.408-2. And see Treas. Reg. §1.408-2 (e)(5)(viii)(A).

[44] Swanson v. Commissioner, 106 T.C. 76 (1996).

[47]Preamble to Prop. Treas. Reg. §1.401(a)(9)-1, Q&A’s D-5, 6 & 7. (re-Proposed 12/30/97).

[52]See IRC §4975(e)(2). Note, however, the owner-employee limitation on the statutory exemptions of IRC §4975(d) treats participants and beneficiaries of an IRA as owner-employees.

[53]IRC §408(e)(2)(A)(i) treats this individual as the creator of the account.

[59]Presidential Reorganization Plan No. 4 of 1978, 3 C.F.R. 332(1979).

[79]Section 13145 of the 1993 Revenue Reconciliation Act (1993 RRA), P.L. 103-66, repealed a provision of §512(c)(2)(A) that formerly would have taxed publicly traded partnership income.

[80]IRC §514. Elliot Knitwear Profit Sharing Plan v. Commissioner, 614 f. 2d 347 (CA 3, 1980), affg. 71 T.C. 765 (1979).

[83]Art. 6132a-1 §1.02(4)&(5). TRPA Art. 6132b-2.02(a).

[84]Art. 6132a-1 §1.02(12). TRPA Art. 6132b-1.01(14).

[88]The Swanson court agrees. See footnote 13, Swanson v. Commissioner, 106 T.C. 76 (1996) at 88.

[91] But if that were the case it might suggest a breach of the duty to diversity. However, a breach of a fiduciary duty is not necessarily a prohibited transaction.

[93]Presidential Reorganization Plan No. 4 of 1978, 3 C.F.R. 332(1979).

[96] ERISA Opinion Letter 2000-10A, 07/27/2000, end of letter.

ARTICLE 1 ISSUES (AND EQUIVOCAL ANSWERS)

ARTICLE 2 CONCLUSIONS

ARTICLE 4 Are There Instutional IRA TRustees and Custodians that Will Permit Investments Such as the One Described in this Paper

ARTICLE 5 Governing Statutes

ARTICLE 6 Case Law

6.1 Swanson v. Commissioner.

6.2 Etter v. Pease.

ARTICLE 7 Administrative Rulings

7.3 PLR 8717079.

7.4 ERISA Opinion Letter 89-03.

7.5 Field Service Advice 200128011.

7.6 ERISA Opinion Letter 2001-01A—Settlor Functions.

ARTICLE 8 Discussion of the Law

8.1 A Partnership is a Disqualified Person if Controlled by Family Members.

8.2 Is An IRA Trustee or Custodian Always a Disqualified Person(DQP)?

8.3 Is an IRA Owner Always a DQP? Is an IRA Owner Always a “Fiduciary” With Respect to the IRA?

8.4 Is an Employer of an IRA Owner a Disqualified Person With Respect to the IRA? No.

8.5 Application Of Prohibited Transaction Rules To IRAs.

8.6 Taxation of IRAs.

8.7 DOL Jurisdiction Over IRAs.

8.10 Distributions And Contributions Of Property Other Than Cash From Or To An IRA.

8.11 Exemptions From the Prohibited Transaction Rules.

8.12 UBTI Issues.

8.13 What Exactly is an IRA? Can An IRA Form a Partnership?

ARTICLE 9 Application of the Law

ARTICLE 10 Specific Questions Answered or Addressed

10.1 Can an IRA Contribute Its Assets To A Limited Partnership Under Any Circumstances And If So, What Particular Limitations Could There Be?

10.2 Does the IRA Have To Be The General And Limited Partner?

10.3 Can The Participant In The IRA Be The General Partner and If Not, Who Can?

10.4 Could A Related Party And How Close A Related Party Serve As A General Partner Or Owner Of An Entity That Was Serving As A General Partner?

10.5 Can A Remote Beneficiary Be The General Partner? Can A Contingent Beneficiary Of The IRA Be The General Partner?

10.6 Could A Charity Be The General Partner? Could The Limited Partnership Also Have Other Types Of Partners, Such As A Public Charity, A Church, A Community Foundation, A Charitable Lead Annuity Trust, A Charitable Remainder Unitrust; Or A Private Foundation?

10.7 Assuming That An IRA Can Make Contributions To A Limited Partnership And There Can Be Other Partners To That Limited Partnership, Are There Any Percentage Limitations That These Other Partners Can Exceed Or Not Exceed In The Partnership?

10.8 If The IRA Contributes To A Limited Partnership, Is The Custodian Of The IRA Required To Make Annual Valuations Of The Limited Partnership Interest?

10.9 What Reporting Requirements Or What Additional Reporting Requirements Might Be Necessary If The Only Asset Of The IRA Was A Limited Partnership Interest?

10.10 Is The Value Of The IRA For Mandatory Distributions On The Required Beginning Date The Discounted Value Of The Limited Partnership Interest?

10.11 Can The Mandatory Distributions Be Satisfied By Distributions In Kind Of Limited Partnership Interests To The Participant?

10.12 Can The Limited Partnership Redeem Limited Partnership Interests From The IRA By Putting Cash Into The IRA That Then Could Be Distributed To The Participant To Meet The Mandatory Distribution Requirements?

10.13 Is It True That an IRA Can Not Own Life Insurance?

10.14 If The IRA Contributes Its Assets To A Limited Partnership, Could The Limited Partner Then Acquire Life Insurance On The Life Of The Participant, And If So Are There Any Other Prohibitions Or Limitations?

10.15 Can Several Different Family Members Each Put Their Separate IRAs Into the Same Limited Partnership (i.e. husband, wife and children or father and children or brothers and sisters or any other combination to invest in this manner)?

10.16 Can An IRA And A Roth IRA Both For The Same Participant Be Partners In The Same Limited Partnership?

11.1 If the IRA Owns all of the Limited and General Partnership Interest (the GP is an LLC), Are Valuation Discounts Appropriate?

11.2 Valuation Theory.

11.3 It is Preferable Not to Have a Controlling Interest.

ARTICLE 12 The Plan Asset Problem

12.1 Can The IRA Owner be Treated Under The Attribution Rules As Owning Anything Owned by The IRA?

12.2 DOL Jurisdiction Over IRAs.

12.3 If the IRA Owner and the IRA Control a Partnership, Are Partnership Assets Plan Assets, and If So, For What Purposes?

12.3(a) ERISA Opinion Letter 2000-10A

12.3(b) Subtitle A, and Parts 1 and 4 of Subtitle B, of Title I of ERISA.

12.3(c) The Plan Asset Regulations.

ARTICLE 1
ISSUES (AND EQUIVOCAL ANSWERS)

ARTICLE 2
CONCLUSIONS

ARTICLE 4
Are There Instutional IRA TRustees and Custodians that Will Permit Investments Such as the One Described in this Paper

ARTICLE 5
Governing Statutes

ARTICLE 6
Case Law

ARTICLE 7
Administrative Rulings

ARTICLE 8
Discussion of the Law

ARTICLE 9
Application of the Law

ARTICLE 10
Specific Questions Answered or Addressed

ARTICLE 12
The Plan Asset Problem