Zacky v. Commissioner, TC Memo 2004-130
The Zacky case involved three separate loans all of which were prohibited transactions under Section 4975(c)(1)(B), (D) and (E).
The taxpayer, Mr. Zacky, was the president and sole owner of Aspects Inc. (“Aspects”), a corporation that maintained a qualified profit sharing plan. Mr. Zacky was one of many participants under the plan and also served the plan’s sole trustee. Mr. Zacky borrowed funds (Loan #1) from the plan to pay Aspects payroll liability that was about to become due.
At some point thereafter the plan lent funds (Loan #2) to a related corporation, Inland Empire Properties, Inc. (“Inland”). Mr. Zacky was also the president and sole owner of Inland, which had no other employees. Inland owned and leased to Aspects and other tenants a commercial building. The purpose of Loan #2 was to enable Mr. Zacky to pay off an outstanding car loan, and to that end Mr. Zacky transferred title to the vehicle to Inland shortly after Loan #2 was made.
Subsequent to Loan #2, the plan made another loan to Inland (Loan #3) to enable Inland to pay mortgage and real estate taxes due on the building it owned.
No principal or interest had been paid on any of the loans. Moreover, Mr. Zacky, in his capacity as the plan’s trustee, did not seek nor attempt to compel repayment (but did require two loans to other participants to be repaid).
Mr. Zacky did not dispute that he was a disqualified person – he was disqualified as a fiduciary under 4975(e)(2)(A) and under (e)(2)(E) as the owner of Aspects, an employer any of whose employees are covered by the plan. Inland was also a disqualified person under 4975(e)(2)(G) because it was a corporation at least 50% of which (here, 100%) was owned by a fiduciary (Zacky). Nor did he dispute that the Aspects’ plan was a “plan” under 4975(e)(1)(A). Therefore, the Tax Court concluded that all three loans were prohibited transactions under Section 4975(c)(1)(B), (D) and (E). Under 4975(c)(1)(B), each loan involved a direct or indirect lending of money between a plan and a disqualified person (either Zacky or Inland). In addition, each loan was a direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of the plan in violation of 4975(c)(1)(D). Each loan benefitted Zacky, a disqualified person. Loan #1 was used to pay off his wholly owned company’s (Aspects) payroll liability. Loan #2 was used to pay off his personal car payment. Loan #3 was used to pay the mortgage and real estate taxes owed by his other wholly owned company (Inland). Finally, each loan was a direct or indirect act by a disqualified person who is a fiduciary (i.e., Zacky) whereby he deals with the income or assets of a plan in his own interest or for his own account.
In so ruling, the Tax Court rejected several arguments advanced by Zacky that the loans were not prohibited. Zacky first argued that the loans were permitted by the plan. Specifically, Sec. 7.4 of the plan permitted loans to participants under the following conditions: (1) loans were made available to all participants and beneficiaries on a reasonably equivalent basis; (2) loans shall not be available to highly compensated employees in an amount greater than the amount available to other participants and beneficiaries; (3) loans shall bear a reasonable rate of interest; (4) loans were adequately secured; and (5) loans provided for repayment over a reasonable period of time. The Tax Court determined that under these terms Loan #1 was not permitted as it had yet to be repaid (thereby not meeting the 5th requirement). Moreover, Loans #2 and 3 were not participant loans (they were loaned to Inland) and even if the plan allowed Loans #2 and 3, they were nevertheless prohibited transactions.
Zacky also argued that the bankruptcy court confirmed a reorganization plan for Aspects (which filed for bankruptcy) under which Aspects was to repay each loan, thereby making the loans permissible. This was of no relevance to the Tax Court. Moreover, the Tax Court did not find anything in the reorganization plan that persuaded it that Aspects would eventually repay loans because Aspects’ profit sharing plan was an unsecured creditor.
Finally, Zacky argued that the loans were made in the best interest of the plan and its participants. Factually, the Tax Court disagreed with this, and legally, even if it did agree it would have been irrelevant. In other words, if a transaction is prohibited it doesn’t matter if it was in the plan’s best interest.
4975(c)(1)(C): The direct or indirect furnishing of goods, services, or facilities between a Self-Directed IRA and a “disqualified person”
Example 1: Andrew buys a piece of property with his Self-Directed IRA funds and hires his father to work on the property.
Example 2: Rachel buys a condo with her Self-Directed IRA funds and personally fixes it up.
Example 3: Betty owns an apartment building with her Self-Directed IRA and hires her mother to manage the property.
4975(c)(1)(D): The direct or indirect transfer to a “disqualified person” of income or assets of a Self-Directed IRA
Example 1: Ken is in a financial jam and takes $32,000 from his Self-Directed IRA to pay a personal debt.
Example 2: John uses his Self-Directed IRA to purchase a rental property and hires his friend to manage the property. The friend then enters into a contract with John and transfers those funds back to John.
Example 3: Melissa invests her Self-Directed IRA funds in a real estate fund and then receives a salary for managing the fund.