Take-Away: Using self-directed IRA is often asking for trouble. Trouble not only in the form of prohibited transaction penalties but also in disqualifying the IRA, thus causing the entire IRA balance to be subject to immediate taxation. A recent Tax Court decision demonstrates the risks associated using a self-directed IRA, or perhaps more importantly, relying upon the advertisements of the promoter of the self-directed IRA.

Decision: Andrew and Donna McNulty v. Commissioner, U.S. Tax Court, No. 1377-19, 157 T.C. No. 10 (November 18, 2021)

Facts: The spouses opened self-directed IRAs in 2015 and funded them that year and the next. Andy [a plant manager] used his IRA funds ($295,554 and $21,862) to invest in an condominium and American Eagle coins (herein coins) using an LLC structure to hold title. Donna [a registered nurse] opened her self-directed IRA and formed a single-member LLC (named Green Hill) to which she transferred her IRA funds those years. Donna then purchased coins through her LLC. Donna was appointed manager of her LLC. Donna transferred $378,487 from a MetLife annuity to the LLC and $48,375 from her employer’s 401(k) plan to the LLC owned by her self-directed IRA. Most of Donna’s funds were used to purchase coins. [Also transferred to Donna’s single member LLC was the spouses’ personal residence which was listed as the LLC’s principal place of business.] Of note, there was no record of certificates of ownership for the coins or any other documentation documenting title to the coins.

Notice of Deficiency: The IRS issued Notices of Deficiency for 2015 and 2016. In the Notice the IRS claimed that each spouse received taxable distributions from their IRAs and retirement assets which they failed to report on their income tax returns for the years in question. They were also assigned accuracy related penalties under IRC 6662(a) and (b)(1) and (2) for substantial understatements of their income tax and for their negligence. The claim was that each received a taxable distribution with respect to the coins equal to the cost of the coins. With respect to Donna, who is the primary focus of the decision [Andy threw in the towel early on], the taxable distributions were for $374,000 and $37,380 for years 2015 and 2016.

Law: While collectibles are an impermissible asset to be held in a self-directed IRA, a statutory exception exists for ‘”any coin which is a gold coin described in section 5112(a) or a silver coin described in section 5112(b) of title 31, or any gold, silver platinum or palladium bullion” of a specified quality of fineness, ….”if such bullion is in the physical possession of the IRA trustee.” [IRC 408(m)(3).]

Tax Court: Deficiencies were affirmed against Andy and Donna for $250,558 for 2015 and $18,094 for 2016.

  • Physical Possession: The IRS argued that Donna should be treated as having possession of the coins, despite her use of the LLC as the nominal titleholder, due to her status as the LLC’s manager. Donna claimed that the coins were assets of the LLC and her physical receipt of the coins did not constitute a taxable distribution to her of the

“The parties arguments reveal numerous disagreements including whether Mrs. McNulty or her IRA was Green Hill’s [the LLC] sole member, who owned the AE coins, who held legal title to the AE coins, whether AE coins are bullion, whether the AE coins were commingled with non-IRA assets, and who can have physical possession of the AE coins purchased with IRA funds. We resolve this case on the answer to the last question and hold that Mrs. McNulty had taxable distributions from her IRA when she received physical custody of the AE coins irrespective of her status as Green Hill’s manager.”  A self-directed IRA is permitted to invest in a single-member LLC…..However, IRA owners cannot have unfettered command over the IRA assets without tax consequences. It is on the basis of Mrs. McNulty’s control over the AE coins that she had taxable IRA distributions.”

  • Bullion: When coins or bullion are in the physical possession of the IRA owner, in whatever capacity the owner may be acting, there is no independent oversight that could prevent the owner from invading her own retirement funds. That lack of oversight is inconsistent with the statute that authorizes self-directed IRAs.

“Personal control over the IRA assets by the IRA owner is against the very nature of an IRA….  Mrs. McNulty had complete, unfettered control over the AE coins and was free to use them in any way she chose. This is true irrespective of Green Hill’s purported ownership of the AE coins and her status as Green Hill’s manager. Once she received the AE coins there were no limitations or restrictions on her use of the coins even though she asserts on brief that she did not use them. While an IRA owner may act as a conduit or agent of the IRA custodian, she made do so only as long as she is not in constructive or actual receipt of the IRA assets….An owner of a self-directed IRA may not take actual and unfettered possession of the RIA assets. It is a basic axiom of tax law that taxpayers have income when they exercise complete dominion over it.”

  • Commingling: In addition, Donna stored the coins in a safe in her home, along with other non-IRA assets. The IRS argued that Donna commingled the IRA assets with non-IRA assets, contrary to the requirements of the Tax Code. [IRC 408(a)(5).] The judge ducked this question of whether storage of the coins in the home safe was sufficient to constitute wrongful commingling in light of his ultimate conclusion that Donna was in physical possession of the

Promoter: So how did Andy and Donna initially get into this predicament? Well, they purchased services from Check Book IRA, LLC, through its website. That website provided claimed that it would assistance to investors to establish self-directed IRAs and form LLCs. The website advertised that an ‘IRA could invest in American Eagle coins and the IRA owners could hold the coins at their homes without tax consequences or penalties as long as the coins were ‘titled’ to an LLC.’ The claimed trustee for the self-directed IRAs was a company called Kingdom Trust which apparently held the LLC membership unit certificates, and did nothing else other than annually demand a certification of the value of the LLC assets. While Andy and Donna argued that they relied upon Check Book IRA’s website such that they relied upon ‘professional advice’ which would not then expose them to the expensive accuracy related penalties, the judge disagreed:

  • “We question whether Check Book’s website and/or services could constitute professional advice upon which a reasonable person could rely for purposes of sections 6664(c)(1.) Check Book’s website is an advertisement of its products and services and a reasonable person would recognize it as such and would understand the difference between professional advice and marketing materials for the sale of products or services. Petitioners have not provided any evidence that sets forth Check Book’s qualifications to provide professional tax advice. Nor was Check Book disinterested. It benefited financially from petitioner’s purchase of its services.”

Conclusion: Apparently Check Book IRA, LLC was wrong in its legal conclusions, which cost the McNultys thousands of dollars in income taxes and excise penalties, both for the 10% penalty premature IRA distributions prior to age 59 ½ but also the 10% penalty for the understatement in their income tax liabilities for the two years. Anyone who uses a self-directed IRA does so at his or her peril!