Tax Court Rules on ROBS Transaction

In late October, the U.S. Tax Court decided an important case with respect to self-directed IRAs.  In Ellis v. Commissioner, T.C. Memo. 2013-245, the U.S. Tax Court ruled that a “ROBS” transaction (i.e., rollover as business start-up) resulted in a prohibited transaction (PT) when the newly formed business (an LLC that elected to be treated as a C corporation for income tax purposes) paid compensation to the IRA owner.  The IRA owned 98 percent of the equity interests in the LLC.  The business was a used car business.  Compensation was paid shortly after entity formation.  Thus, it was very likely that the compensation was indirectly funded from the IRA initial equity contribution.   It is unclear whether the same result would have been reached had the initial investment been fully consumed prior to payment of compensation.  Interestingly, the equity transfusion was made in two tranches that were two months apart.  Citing Swanson v. Commissioner, 106 T.C. at 88, the Court had no problem with the multiple tranche investment.   (It would seem that the second tranche could have been a PT.)  Another PT issue existed in the case regarding leasing of property to the newly formed company by an LLC in which the IRA owner was a 50 percent member.  However, the Court did not need to consider that issue since it found that the compensation resulted in a PT (and it did not do so).  The IRA was deemed distributed on the first day of the year in which compensation was paid.  The taxpayer was also hit with substantial penalties.