Abusive Roth IRA Transactions
IRS Notice 2004-8

 

Illustration #1

---

Illustration #2

In this Notice 2004-8, the IRS indicates that it is aware of abusive structurings that are being pursued to avoid the annual limitations on contributions to Roth IRAs under Section 408A of the Internal Revenue Code. Contributions to a Roth IRA above the statutory limits generates a 6% excise tax (as described in Section 4973 of the Code), imposed each year until the excess contribution is eliminated. In each of the transactions noted above, the transaction has the effect of transferring value to the Roth IRA corporation comparable to a contribution to the Roth IRA (its shareholder). In these situations, the taxpayer controls the business and is the beneficial owner of all of the Roth IRA corporation, and therefore, is in a position to shift value from the business to the Roth IRA corporation.

The IRS intends on challenging these transactions on a number of grounds. First, the IRS could claim that the substance of the transaction is that the amount of the value shifted from the business to the Roth IRA corporation is a payment to the taxpayer, followed by a deemed contribution by the taxpayer to his Roth IRA and a contribution by the Roth IRA to the Roth IRA corporation. Under this rationale, the IRS will deny or reduce the deduction to the business, and if the business is a corporation, may compel the corporation to recognize gain on the transfer and may require inclusion of the payment in the income of the taxpayer (i.e., as a taxable dividend). The IRS may also apply Section 482 to allocate income from the Roth IRA corporation to the taxpayer, business, or other entities under taxpayer’s control. The IRS may also claim that the amount treated as a de facto contribution to the Roth IRA is subject to the applicable excise tax (to the extent of the excess contribution amount, and until eliminated). The IRS may also take the view that the transaction gives rise to one or more prohibited transactions with a disqualified person.

If you believe that you may have engaged in a transaction that is the same or substantially similar to the transaction described above, Federal law may require you to disclose your and other parties’ participation in any such “listed transaction” on IRS Form 8886. For more information about Federal law requirements, please contact us.