I. RITA best practices regarding Prohibited and Abusive pension plan and IRA transactions. e. Required reporting process for listed transactions

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1 I. RITA best practices regarding Prohibited and Abusive pension plan and IRA transactions II. Internal Revenue Service Notice a. History b. The Parties c. Sample abusive transactions d. Consequences and Penalties e. Required reporting process for listed transactions III. Office of Chief Counsel, Internal Revenue Service, Memorandum Number: (Release Date: 4/24/2009) a. Issues b. IRS conclusions c. Facts on which the IRS ruled d. Discussion IV. Rollovers to Start Businesses (ROBS) V. Other areas of potential abuse a. Roth Conversions b. Checkbook control 1

2 VI. Summary 2

3 I. RITA best practices regarding Prohibited and Abusive pension plan and IRA transactions The Retirement Industry Trust Association and its membership are committed to the highest standards in the administration of self-directed retirement plans and IRAs. We are dedicated to informing the public of the opportunities inherent in self-directed plans as well as the potential pitfalls associated with prohibited transactions. As a result, RITA proactively seeks to help its members understand the rules and regulations regarding self-directed retirement accounts, and to thereby assist its members in their endeavors to comply with all Treasury Department and Internal Revenue Service rules and regulations regarding retirement plans including Roth IRAs. RITA is diligent in staying abreast of all new IRA regulations and in promulgating related information to its membership. In 2004, the IRS identified a tax avoidance strategy that it has classified as abusive and has consequently designed punitive, preventive measures to discourage its use. All RITA members are aware of these rules and regulations and use a best efforts approach to prevent any transactions that may give rise to potential abusive Roth transactions. As recently as March 16, 2010, the IRS issued their list of the Dirty Dozen Tax scams, one of which is categorized under Abusive Retirement Plans. Specifically: 3

4 The IRS continues to find abuses in retirement plan arrangements, including Roth Individual Retirement Arrangements (IRAs). The IRS is looking for transactions that taxpayers use to avoid the limits on contributions to IRAs, as well as transactions that are not properly reported as early distributions. Taxpayers should be wary of advisers who encourage them to shift appreciated assets at less than their fair market value into IRAs or companies owned by their IRAs to circumvent annual contribution limits. Other variations have included the use of limited liability companies to engage in activity that is considered prohibited. The first thing the reader should be aware of is that the previous statement generally envelopes a number of potential abusive and prohibited transactions. Therefore, we are only able to present some hypothetical examples and share some specific cases that the IRS has published. The discussion which follows is not intended to cover all potentially prohibited transactions or all potentially problematic scenarios within the topics that are discussed. But rather, the following covers some of the most apparent violations of existing rules and regulations. The reader is advised to consult with their own legal or financial adviser, and/or the Government regulations themselves concerning their specific investment scenario to determine if there is any potential inherent conflict with existing rules. RITA members are committed to helping their clients avoid prohibited transactions, and will not knowingly participate in any prohibited transaction 4

5 on behalf of their clients. In the course of reviewing and executing selfdirected transactions on behalf of their clients, RITA members may become aware of investment scenarios that are in direct violation of existing IRS and Department of Labor rules and regulations regarding IRAs and pension plans. RITA members will make their clients aware of such conflicts and will assist them in avoiding such conflicts by providing information about the conflict(s) and alternative approaches that would not create the otherwise prohibited transaction. We do not provide investment, tax or legal advice, only information pertaining to IRA and plan rules and regulations. Again, however, RITA members will not proceed until any known or suspected prohibited transaction scenarios are resolved so that a prohibited transaction can be avoided. It must be understood that it is neither the self-directed custodians responsibility nor duty to ascertain the existence of a potential prohibited transaction planned by one or more of their clients. The self-directed investor is responsible to make such determination and is free, and encouraged by RITA members, to consult their own legal and investment advisers who are legally qualified to offer investment and or legal advice regarding self-directed retirement account investment decisions. Regardless, RITA members are heavily involved in assisting their clients and other professionals to become aware of both available and knowledgeable professional resources as well as the rules and regulations. 5

6 Most RITA members are proactive in educating their clients and other professionals about the rules and regulations specifically for the purpose of preventing either deliberate or inadvertent violations. RITA members perform frequent educational seminars, web-site based educational materials, webinars, newsletters, blogs, articles, media (e.g., TV and radio) interviews aimed at informing the public and investment community about potential problematic investment scenarios. Within the context of what may or may not be prohibited, RITA members have adopted best practices that deliberately avoid the creation of prohibited transactions: 1) RITA members will not knowingly participate in (execute at the client s direction) a transaction within the ROBS scenario (see detailed discussion which follows) whereby a client rolls their pension plan over to a new individual pension plan (e.g., 401(k)) which invests in the company which sponsors it and is entirely funded by the rollover funds, and then hires the plan owner and pays him a salary. It is our view that this scenario constitutes a prohibited transaction, and in violation of both IRC 4975 and the Plan Asset rule. 2) RITA members also will not knowingly engage in a similar transaction where the plan owner is hired by his plan-owned corporation, is not compensated, but who also provides personal services material (not merely ministerial) to his corporation, as this would (violation of IRC

7 and the rules inherent in IRS Publication 590 and IRC 401 and 408 regulations regarding contributions) also be prohibited as doing so could constitute an illegal contribution to the plan. 3) Currently, most RITA members will not engage in transactions to create socalled single-member LLCs or other corporations (owned by a single IRA or plan), otherwise known and marketed by some industry related businesses as checkbook control vehicles, unless the plan or IRA owner agrees contractually to engage a professional (attorney or CPA who is also contractually bound) to review all corporate transactions prior to execution for the purpose of avoiding prohibited transactions. It should also be noted that some RITA members have chosen to not engage in any single-member entities. 4) In the course of reviewing instructions by their client, RITA members may identify a potential prohibited transaction. In such cases, RITA members will proactively inform their clients, in advance of execution if the issue has already been identified, and will not proceed unless the transaction is abandoned, or altered to avoid the prohibited attributes, or they are presented with a legal opinion that supports the legality of the planned transaction. 5) The RITA organization will not accept any new member that is not regulated, not committed to the avoidance of prohibited transactions, and not committed to adhering with RITA s best practices. 7

8 RITA and its members are continually engaged in the evolving regulatory and legal changes effecting transactions conducted within pension plans and IRAs. We are dedicated to always being aware of existing and new rules, and interpretations of such rules and regulations. We conduct ongoing educational and informational dialogue with legal experts and Government agencies, aimed at protecting the public retirement system and our clients retirement savings. Members regularly interact with regulatory agencies, and other industry experts to stay abreast of all rules and interpretations. In addition, RITA principals meet regularly to discuss both current and emerging rules and regulations and, in many instances, have participated in the formation of new rules and regulations by providing both written and verbal testimony to the agencies creating new rules and regulations. II.The Internal Revenue Service Notice ( The IRS published Notice to provide guidance and information regarding the potential abuses of Roth IRAs. Distributions from Roth IRAs are free from income tax since the contributions were previously taxed prior to being placed into the Roth IRA. The IRS has expressed concern over the potential for Roth IRA abuses and is stepping up its review of transactions in which taxpayers may self-deal between or among personal funds, IRA funds, Roth IRA funds and corporations, LLCs or sole proprietorships that are controlled by the IRA/Roth owner. These concerns 8

9 are shared by all IRA custodians interested in the well-being of their clients retirement accounts. The IRS also seeks to identify any over-contributions to Roth IRAs in violation of annual contribution limits that would allow taxpayers to maximize their tax-free distributions from Roth IRAs. Tax avoidance can occur when assets coming into a Roth are devalued and then become highly valued once inside the Roth only for distributions to be taken out tax- free. a. History Section 408A was added to the Internal Revenue Code (IRC) by Section 302 of the Taxpayer Relief Act of This section created Roth IRAs as a new type of nondeductible IRA. The maximum annual contribution to Roth IRAs is the same maximum amount that would be allowable as a deduction under Section 219 of the IRC with respect to the individual for the taxable year over the aggregate amount of contributions for that taxable year to all other IRAs. Neither the contributions to a Roth IRA nor the earnings on those contributions are subject to tax on distributions, if the distribution is considered qualified as described in 408A (d) (2). Specifically, in Notice , the IRS defines the types of Roth transactions that will be considered abusive or potentially abusive and outlines a required reporting process for transactions which that do not violate the 9

10 letter of the law but which may violate the intent of the rules and, therefore, are potentially abusive. To begin a discussion of , the IRS defines the parties: b. The parties There are typically at least three parties that participate in an abusive Roth transaction. They are: 1. An individual (the taxpayer) who owns a pre-existing business such as a corporation of a sole proprietorship (the business). 2. A Roth IRA within the meaning of IRC 408A that is maintained for the taxpayer. 3. A corporation (the Roth Corporation) substantially all the shares of which are owned or acquired by the Roth IRA. [Note: abusive transactions can also occur between individuals as well as entities]. The business and the Roth IRA Corporation enter into transactions in which the acquisition of shares, the transactions or both are not fairly valued and effectively shift value into the Roth IRA. c. Sample abusive transactions The IRS is likely to consider a transaction abusive when: 1) the Roth IRA Corporation (or individual) acquires property, such as accounts receivable, from the Business for less than fair market value; 10

11 2) contributions of property are made, including intangible property, by a person other than the Roth IRA, without a commensurate receipt of stock ownership; 3) or as a result of any other arrangement between the Roth IRA Corporation and the Taxpayer, a related party described in 267(b) or 707(b), or the Business that has the effect of transferring value to the Roth IRA Corporation comparable to a contribution to the Roth IRA. For example, a disguised contribution could occur if a business owned by the individual could sell its receivables for less than fair value to a shell corporation (the Roth Corporation) owned by the individual s Roth IRA. This artificially shifts taxable income away from the individual s business (the business) into the shelter of the Roth IRA thereby reducing the individual s tax due. Note, that such a transaction would automatically be considered prohibited if the business was owned 50% or more by the IRA owner and/or collectively 50% or more by the IRA owner and other disqualified person such as the spouse, ascendants, descendants, etc. pursuant to IRC 4975, regardless of the value of the property. Another example regarding contributions of property would be when a building that is owned by the taxpayer in a sole proprietorship and is currently valued at $50,000, is transferred to a Roth Corporation and then put into his Roth IRA while indicating a $5,000 value for the contribution. 11

12 Once again, be aware that the business (as a sole proprietorship) is a disqualified person in this case if the asset is owned by him personally, unless the transfer is as a result of a qualified distribution from his retirement account. In the latter case, even though the ability to transfer (from the plan to the Roth) would not be in itself prohibited, the transaction would still be considered abusive if executed as described (below fair market value). In effect, these types of transactions disguise contributions into the Roth IRA and shift less than the true value of an asset into the Roth to avoid the tax otherwise due on the distributions (e.g., transfers). d. Consequences and penalties These transactions involving indirect contributions to Roth IRAs have several possible penalties. The entire IRA may be disqualified if an abusive transaction is identified. The IRS may impose an excise tax on the transactions between the IRA and the individual for whom the IRA is maintained or other disqualified persons with respect to the IRA. The amount of the excise tax is 6% for each year until the excess contribution is eliminated (IRC 4973). In 2004, Congress mandated a $100,000 penalty for abusive transactions. A corporation, including one used in an individual s tax shelter, faces a mandatory $200,000 penalty for not disclosing a listed transaction. 12

13 e. Required reporting process for listed transactions A listed transaction (IRC (b)(2), (b)(2) and (b)(2)) is any transaction that is substantially similar that transfers value to the Roth IRA corporation comparable to a contribution to the Roth IRA, even if it is perceived to be at fair market value or not between otherwise disqualified persons (for example, between a business owned by a sibling to a Roth owned business owned by another sibling). These are also subject to disclosure, list keeping and registration requirements. In addition, the IRS may take the position that the transaction gives rise to one or more prohibited transactions between the Roth IRA and a disqualified person as described in 4975 (e) (2). You are, therefore, strongly advised to consult with a qualified attorney or other professional when considering the transfer of an asset you have an interest in through an entity and your Roth controlled entity. III. Office of Chief Counsel, Internal Revenue Service, Memorandum Number: (Release Date: 4/24/2009) 13

14 a. Issues This was an issue to determine if the facts in this case were substantially similar to those outlined in IRS Notice , and, if so, was the proper disclosure procedure followed by the taxpayers. In this case, it is conceivable that had the transaction been properly listed, that the IRS would not have ruled against the taxpayers for a violation of b. IRS Conclusions Based on the facts submitted, and representations made, under T(b)(2), as in effect when the taxpayers entered into the transactions, the IRS found that the transactions at issue were the same as, or substantially similar to, the listed transactions described in Notice , making the transactions listed transactions. Participation in a listed transaction creates a duty for a taxpayer to disclose the transaction (pursuant to I.R.C. 6011). This duty of disclosure was satisfied by the Roth IRA Corporation through its filing of Form Unlike the Roth IRA Corporation, Taxpayers A and B (collectively, Taxpayers ) failed to disclose their involvement in the transaction as required by I.R.C For these reasons, section 6501(c)(10) applies to the assessment of tax with regard to the Taxpayers but is not extended for the Roth IRA Corporation. 14

15 c. Facts on which the IRS ruled In December, Taxpayers A and B, husband and wife (collectively, Taxpayers ) set up a corporation, ( Roth IRA Corporation ), into which they would direct payments for consulting, accounting, and bookkeeping services they provided to other individuals and businesses. Also in December, the Taxpayers each opened a Roth IRA account at Bank C. After contributing to their respective Roth IRA accounts, Taxpayer A and Taxpayer B each directed their Roth IRA account to purchase 50% of the stock of the Roth IRA Corporation. Consequently, following the transactions, the couple s two Roth IRA accounts were the sole shareholders of the Roth IRA Corporation. Before the formation of the Roth IRA Corporation, Taxpayer A worked as general manager for and received consulting fees from Company X and possibly other clients and Taxpayer B received income for bookkeeping services she provided to unrelated clients. After the formation of the Roth IRA Corporation, the Taxpayers provided services to various clients, including Company X, through the Roth IRA Corporation as employees of the Roth IRA Corporation. In each of its first two fiscal years, the Roth IRA Corporation made dividend distributions to each of the Roth IRA accounts. 15

16 Under Internal Revenue law certain transactions or substantially similar transactions which are deemed to be prohibited tax-shelter related are required to be reported or listed by the party engaging in them. Form 8886 is use to disclose information for each reported transaction. In addition, if you are a tax-exempt entity and you are a party to a prohibited tax shelter transaction, you may be required to file Form 8886-T, Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction, in addition to filing Form The fact that a transaction must be reported on these forms does not mean the tax benefits from the transaction will be disallowed. Definitions (by the IRS) Transaction A transaction includes all of the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement and it includes any series of steps carried out as part of a plan. Substantially Similar A transaction is substantially similar to another transaction if it is expected to obtain the same or similar types of tax consequences and is either factually similar or based on the same or similar tax strategy. Receipt of an opinion regarding the tax consequences of the transaction is not relevant to the determination of whether the transaction is the same as or substantially similar to another transaction. Further, the term substantially similar must 16

17 be broadly construed in favor of disclosure. See Regulations section (c)(4) for examples. Transactions identified as listed transactions in Notice include arrangements in which an individual, related persons, or a business controlled by such individual or related persons, engage in one or more transactions with a corporation, including contributions of property to such corporation, substantially all the shares of which are owned by one or more Roth IRAs maintained for the benefit of the individual, related persons, or both. The transactions are listed transactions with respect to the individuals for whom the Roth IRAs are maintained, the business (if not a sole proprietorship) that is a party to the transaction, and the corporation substantially all the shares of which are owned by the Roth IRAs. Transactions described in Notice are designed to illegally avoid the statutory limits on contributions to a Roth IRA contained in 408A and, in general, these transactions involve the following parties: (1) an individual who owns a pre-existing business such as a corporation or a sole proprietorship (the Business), (2) a Roth IRA within that is maintained for such individual, and (3) a corporation, substantially all the shares of which are owned by the Roth IRA (the Roth IRA Corporation). At the direction of the individual, the Business and the Roth IRA Corporation enter into transactions designed to shift value into the Roth IRA Corporation. Because the individual owns the Business and is the beneficial owner of substantially 17

18 all of the Roth IRA Corporation, such individual controls both entities and bears little or no economic disadvantage if transactions shift value between the two entities. Other examples include arrangements between the Roth IRA Corporation and the individual that have the effect of transferring value to the Roth IRA Corporation comparable to a contribution to the Roth IRA. Section (a) of the Income Tax Regulations provides that, in general, every taxpayer who has participated in a reportable transaction and who is required to file a tax return must attach a disclosure statement (these are called listed transactions ) to its return for the taxable year. Again, to satisfy this disclosure obligation the taxpayer is required to attach to its tax return Form 8886 as prescribed by Treas. Reg (d) (2003) (see T.D. 9000). d. Discussion Congress enacted the IRA provisions (including the Roth IRA provisions) to provide an individual with retirement plan options that provide income tax deferral (income tax exemption in the case of a Roth IRA) to enable the individual to maintain his/her accustomed standard of living during retirement. However, Congress also placed limits on the amount that an individual is permitted to contribute to these tax-favored retirement accounts. 18

19 Generally, a Roth IRA is permitted to invest in stock of a corporation, and the Roth IRA will not be subject to tax on any appreciation in value of that stock. However, pursuant to Notice , certain value-shifting transactions that are designed to avoid the statutory limits on contributions to a Roth IRA have been identified as listed. In determining whether a transaction is the same as or substantially similar to the transaction described in Notice , the IRS will consider whether a transaction is expected to obtain the same or similar types of tax benefits and is either factually similar or based on the same or similar tax strategy as the Notice transaction. The IRS will construe the term substantially similar broadly in favor of disclosure. In this case ( ), like the transaction described in Notice , the structure of the transaction at issue purportedly allows a taxpayer or multiple related taxpayers to create a Roth IRA investment that avoids the contribution limits by transferring value to the Roth IRA Corporation comparable to a contribution to the Roth IRA, thereby yielding tax benefits that are not contemplated by a reasonable interpretation of the language and purpose of 408A. Specifically, the value of the services provided was shifted from the Taxpayers or their business to the Roth IRA Corporation 19

20 when the Taxpayers provided services through the Roth IRA Corporation as employees of the Roth IRA Corporation. [Please note that even if this scenario was not considered within the guidance of , there is a high probability that another prohibited transaction would occur as the entity itself is disqualified person under IRC 4975 (100% owned by the Roth IRAs of disqualified persons (man and wife)), and as employees and disqualified persons themselves, they are providing services to their Roth-owned corporation, which is a violation of IRC 4975]. Furthermore, the total value of services provided by the Taxpayers to clients of the Roth IRA Corporation was not received by the Taxpayers in the form of salary or other compensation from the Roth IRA Corporation. As in the Notice transaction, the Taxpayers shifted the value of income or property from the Taxpayers or a business of the Taxpayers to the Roth IRA Corporation, thereby purportedly avoiding the contribution limitations applicable to Roth IRAs. As set forth in Notice , the Business can be a sole proprietorship or other type of business and need not be a corporation. A taxpayer is required to disclose its participation in a listed transaction pursuant to section (a) of the income tax regulations. For the year in question, the regulations provided that the disclosure of the taxpayer 20

21 was to be made on Form 8886 and include all the information required by the form. (Treas. Reg (d) (2003)). In conjunction with its tax return for its tax year, the Roth IRA Corporation filed Form In this form the Roth IRA Corporation disclosed its participation in the listed transaction. This disclosure met the requirement section (a) of the income tax regulations and thus limited the time in which the corporation could be assessed deficiencies related to the return to the general period of three years provided in section 6501(a). However, unlike the Roth IRA Corporation, Taxpayers A and B did not include Form 8886 with their tax return. The Taxpayers did file Forms 5329 disclosing their excess contributions into their Roth IRAs along with their subsequent withdrawal of the same. The form did not identify a listed transaction in any manner nor did it provide the pertinent facts of the transactions or the tax benefits derived from engaging in the transactions as would be found on a properly completed Form The regulations provide that adequate disclosure can only be made on Form 8886 (Treas. Reg (d) (2003)). The taxpayers did not file this form and thus did not adequately disclose their participation in a listed transaction leaving the statute of limitations open until one year from the date they provided the information required under section

22 IV. Rollovers to Start Businesses (ROBS) For example, the IRS and the Department of Labor have expressed concern over Rollovers as Business Startups (ROBS), where an individual rolls his corporate 401(k) over to an individual 401(k), and then has the 401(k) buy stock in the company (generally franchises) that employs the 401(k) participant. Although they issued a notice on this approach on October 1, 2008, they fell short of declaring them in general in violation of the rules, but indicated that they would be examining instances of this approach through an audit process going forward. According to the IRS, while ROBS would otherwise serve legitimate tax and business planning needs, they are questionable in that they may serve solely to enable one individual s exchange of tax-deferred assets for currently available funds, by using a qualified plan and its investment in employer stock as a medium. This may avoid distribution taxes otherwise assessable on this exchange. Note: such lump sum distributions would generally be taxed at the individual s ordinary income tax rates. In addition, if the individual was not yet 59.5, there would be a 10% early distribution penalty unless such distributions were periodic and substantially equal pursuant to IRC

23 In general, the ROBS transaction entails having an individual initially establish a shell corporation that then sponsors an associated and purportedly qualified retirement plan. At this point, the corporation (by plan) has no employees, assets or business operations, and may not even have a contribution to capital to create shareholder equity. The retirement plan document (e.g., 401(k)) typically provides that all participants may invest the entirety of their account balances in employer stock. Note: that there is a Department of Labor exemption permitting plan participants to purchase the stock of the company sponsoring their plan. The individual then becomes the only employee of the shell corporation and the only participant in the plan. Generally, at this point, there is still no ownership or shareholder equity interest. The individual then executes a rollover or direct trustee-to-trustee transfer of available funds from a prior qualified plan or personal IRA into the newly created qualified plan. These available funds might be any assets previously accumulated under the individual's prior employer's qualified plan, or under an IRA which served as a conduit for these amounts. Also, because assets were transferred from one tax-exempt accumulation vehicle to another, all taxes/penalties applicable to the distribution would have been avoided. 23

24 Under the ROBs approach, the sole participant in the plan then directs investment of his or her account balance into a purchase of employer stock. The employer stock is valued to reflect the amount of plan assets that the taxpayer wishes to access. The individual then uses the transferred funds to purchase a franchise or to start a new company. Usually, the plan is then amended so that future employees and plan participants will not be entitled to invest in employer stock. This raises one of the two primary issues that the IRS has with ROBS transactions; that they create a violation of the nondiscrimination requirements of Treas. Reg (a)(4)-4. Because ROBS transactions generally benefit only the principal involved with setting up a business, and do not enable rank-and-file employees to acquire employer stock, we believe that some of these (ROBS) plans violate the anti-discrimination provisions of the Code and Regulations. The second issue raised by the IRS concerning ROBS transactions has to do with deficient valuations for the stock being purchased. In all of the ROBS scenarios examined by the IRS prior to their notice, capital stock was exhanged for the value of available assets at the value of available assets. The IRS has questioned the legitimacy of appraisals for the stock as not being reflective of the true enterprise value-an otherwise prohibited 24

25 transaction. For example, they point to the fact that in many cases the Start-up entity might record cash as its only asset and that at the outset, in most cases, there is no real attempt to secure a franchise license or other plant and equipment necessary to support a legitimate business. A tertiary issue also raised by the IRS is that there may also be a violation of IRC 4975(c) (1) (E), as the promoter of these transactions (who could be construed as the fiduciary having discretionary control and rendering investment advice), generally is paid a fee immediately out of the proceeds. This may be either a direct payment from plan to promoter, or an indirect payment, where gross proceeds are transferred to the individual and some amount of his gross wealth is then returned to promoter. Under the rule, a fiduciary is prohibited from dealing with the assets of the plan in his own interest or for his own account. To summarize, the IRS at the time (2008) had identified 9 promoters of these programs. Having examined the plans of these promoters, the IRS had the following concerns: 1) Employees in some arrangements had not been notified of the existence of the plan, and/or they did not enter the plan or receive contributions or allocable shares of employer stock; 2) Plan assets were either not valued or are valued with threadbare appraisals; 25

26 3) Required annual reports for some plans had not been filed; 4) In several situations, they also found that the business entity created from the ROBS exchange either did not survive, or used the resultant assets on personal, non-business purchases. Many promoters will claim that they have IRS approval for their program, when in fact the IRS has only approved the form of the Plan document. The Memorandum notes that the violations that occur are typically operational and not document failures. However, it is also important to note that the IRS did not take a general position against the ROBS approach as they did with , but rather suggested areas of concern and potential violations that might be applicable to a specific ROBS program. The result is that it is clear that the ROBS approach is clearly a concern to the IRS, and promoters and customers of such programs can assume they will be examined at some time in the future. As discussed in Section I above, RITA has adopted certain policies regarding ROBS- like scenarios. In addition, RITA agrees with the IRS concerns as outlined in this section. V. Other areas of potential abuse a. Roth Conversions 26

27 Because the IRS has only published and , one might assume that these are the only Roth IRA abuses with which they may be concerned. Value shifting while avoiding tax is obviously high on the IRS lists of priority abuses, but no doubt there is any number of scenarios that would concern them. It is also safe to assume that there is a great deal of overlap between a Roth IRA abuse and a traditional IRA abusive transaction, as well as prohibited transactions in general. For example, the process of converting a traditional IRA to a Roth IRA involves the transference of value from the traditional IRA (generally taxdeferred) to the ROTH IRA (tax-free). The execution of the conversion results in a one-time taxable event as the amount converted must be claimed on the individual s tax return. Thus, there is the potential to create another abusive transaction if the values are not determined to be at fair market value. RITA members are aware of the potential for abuse associated with Roth IRA conversions and thus follow a best practices approach to obtaining fair market values for all traditional IRA assets converted. b. Checkbook Control Another approach that has received concern from RITA members is commonly referred to as checkbook control, a strategy which in some 27

28 ways is similar to the ROBS approach. There are numerous promoters of this approach that can be found on the Internet, who are compensated for setting up a single-member (e.g., IRA or Roth IRA) or family-only owned entity (multiple IRAs) for the purported purpose of obtaining more flexibility than they might if transactions within their retirement account(s) were handled through a custodian. Many of the claims of the promoters of checkbook control are exaggerated, and the potential pitfalls either ignored or de-emphasized. Therefore, investors exploring this approach are advised to perform their own research so as to prevent inadvertent prohibited transactions. The general claims are that checkbook control puts the IRA or other plan owner in the driver s seat with control of the checkbook; that is, with the direct ability to write checks against funds in a corporate account that were originally supplied by the investment made in that corporation by an IRA or other retirement plan. The claims will also generally imply that because of this direct control, transactions can be accomplished more efficiently and with less cost (purportedly avoiding custodial transaction fees that would apply if the transactions were processed directly from the IRA or plan custodied at a financial institution). Generally, many self-directed custodial firms do not charge transaction fees for investments and, therefore, the claim of cost savings is overstated. Secondly, while it is true that transactions generally can be accomplished more efficiently, that is not 28

29 always the case, as custodians are very familiar with the processing aspects of self-directed investing. Moreover, the apparent danger (according to some custodians and their regulators), of the IRA or plan owner creating a prohibited transaction is heightened. The main concern is that the IRA owners of these entities (generally LLCs) will either directly violate the prohibited transactions rules or do so inadvertently due to a lack of knowledge. As a result, RITA members will either not permit these arrangements, or those that do, generally require that the IRA investor employ a qualified professional to review transactions in advance for the purpose of avoiding the creation of a prohibited transaction. Investors and their advisers should be aware that the checkbook control approach can expose the client s retirement account to significant adverse consequences if a prohibited transaction occurs. Therefore, the cost of creating and maintaining a checkbook control LLC and the exposure to risk should be considered carefully, before pursuing this approach. VI. Summary RITA recognizes and respects the concerns of various regulatory bodies, particularly those that inappropriately increase the value of Roth IRAs without the commensurate tax consequence. Investors and their advisors should be 29

30 aware of and avoid these types of scenarios ( and ) that result in very adverse consequences to clients retirement accounts due to taxes and penalties imposed. RITA seeks to provide investors and their advisers with educational support through the content of this website and the efforts of its members, and to promote best practices for its members to identify, disclose and report potential abusive Roth transactions in an effort to comply with all IRS and Department of Treasury rules and regulations. Investors interested in pursuing any of the aforementioned potentially abusive strategies are strongly advised to obtain the counsel of a qualified and independently objective adviser such as a CPA or attorney familiar with the regulations. 30