In recent years, individuals have used self-directed IRAs and 401Ks to invest in their startup business. There are numerous companies that will help setup and maintain the complicate arrangements needed to stay in compliance with the IRS. With the territory comes a long list of regulations and prohibited transactions. Prohibited transactions trigger a set of events that would cause the IRS to deem that a taxpyaer took an early distribution from the retirement account used to fund the business. With that would come additional tax and penalties.
In 2013, there have been several court cases involving prohibited transactions and self-directed IRAs. In one case, the IRS deemed a guarantee of a loan to be deemed a prohibited transaction. In the other scenario the IRS deemed payroll received from the company funded by the IRA to be a prohibited transaction. In both cases, the IRS hit the taxpayer with substantial tax and penalties.
Our take is that self-directed IRAs and 401Ks are risky scenarios with an unknown court and enforcement environment. The downside (in the case of a prohibited transaction) could potentially have a large negative impact from the taxpayers. Given these new 2013 court cases, our recommendations to taxpayers are to stay away from them.