The U.S. Court of Federal Claims held that a married couple's distribution from an individual retirement account (IRA) was not rolled over into another IRA, although they claimed to have used a vehicle similar to what the IRS has called a "rollover as a business startup," or ROBS. According to the court, no written plan for the new IRA existed, and, therefore, the amounts distributed were taxable because the funds were not deposited into a valid retirement plan.
Facts: James and Lucy Powell operated an energy business in Virginia. In 2004, they received $78,000 in IRA distributions that they reported as income on their 2004 joint federal income tax return. The taxpayers used the $78,000 to purchase commercial real estate. The couple later filed an amended return requesting a refund of $25,131, claiming the $78,000 had been rolled over into another IRA. The IRS rejected the claim. In 2010, the taxpayers filed a suit with the Court of Federal Claims requesting an award of the requested refund amount. The IRS filed a motion for summary judgment in 2013.
Issues: Generally, distributions from a traditional IRA are taxable unless the distributions are deposited into another IRA or retirement plan within 60 days. The taxpayers argued that the $78,000 distribution had been rolled over into a specific type of IRA called a business owners retirement savings account (BORSA) and therefore was not taxable in 2004. The court stated that BORSA appeared to be another name for what the IRS has described in a 2008 memo (available at irs.gov as ROBS. The IRS considers ROBS a questionable—but not always abusive—transaction and recommends that each ROBS be evaluated on its merits, based on determination letters.
Individuals use a ROBS to roll retirement funds tax-free into a startup business. The individual creates a C corporation that initially issues no shares but establishes a qualified retirement plan. The retirement plan document permits all participants to invest their entire account balances in the stock of the company. The individual becomes the only employee of the company and participant in the plan and then transfers amounts from an existing IRA or qualified plan, using a rollover or direct trustee-to-trustee transfer, to the new retirement plan. The individual/employee/sole participant then directs that the funds of the new retirement account be invested 100% in the corporation's stock. The money is then used to start a business venture.
The IRS argued that the taxpayers presented no evidence that their arrangement qualified as an IRA under Sec. 408. Even if it did, the IRS argued, Sec. 401 requires even a one-participant retirement plan to have a written trust instrument and other basic features, such as a trustee, of which the taxpayers had not provided documentation.
Holding: The court granted summary judgment to the IRS, holding the $78,000 IRA distribution was taxable. The taxpayers conceded that there was no written plan and no IRA trustee, and therefore the court concluded the arrangement lacked a qualified Sec. 401 trust and no new IRA existed in which to roll over the funds.
Although the court was not required to rule on the merits of the taxpayers' claimed BORSA or ROBS, the IRS has said such arrangements and transactions may violate anti-discrimination provisions because the benefits may not satisfy the benefits, rights, and features test of Regs. Sec. 1.401(a)(4)-4 and the rules against prohibited transactions between the plan and its sponsor due to improper valuation of the new employer stock.
- Powell, No. 10-381T (Fed. Cl. 3/15/16)
—By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.