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The taxpayer* in 2001 established traditional IRAs, formed a corporation (Corporation One), and directed the new IRAs to use rolled-over cash (from other tax-qualified plans of taxpayer) to purchase 100% of Corporation One’s newly issued stock.
*There is more than one taxpayer involved in this case, but is referred to in this report simply as one taxpayer.
Immediately after establishing the IRAs, Corporation One then acquired the assets of a second corporation, and the taxpayer personally guaranteed loans of Corporation One related to this asset purchase.
In 2003 and 2004, the taxpayer converted the traditional IRAs (holding Corporation One stock) to Roth IRAs, and included in income the value of the stock held in the IRAs in the years of conversion.
In 2006, after Corporation One had significantly appreciated in value, the taxpayer directed the Roth IRAs to sell all of the Corporation One stock. Payment of the related gains occurred in 2006 and 2007. The taxpayer’s personal guaranties on the asset purchase-related loans continued up to the stock sale in 2006.
The IRS audited the taxpayer’s individual income tax returns for 2006 and 2007 and determined a deficiency for the taxpayer’s failure to include in income the amount of capital gain from the sale of Corporation One stock. The IRS asserted that the personal guaranty for the asset-purchase loan was a prohibited transaction, and as a result, the gains realized in 2006 and 2007 from the 2006 sale of stock were to have been included by the taxpayer in income.
The Tax Court agreed with the IRS and held that:
- The personal guaranty was an indirect extension of credit to the IRAs, and as such constituted a prohibited transaction under section 4975(c)(1)(B). Thus, under section 408(e), the accounts that held the corporate stock were not IRAs from 2001 through 2006.
- The gains realized on the sale of the stock were to be included in the taxpayer’s income in 2006 and 2007.
- The taxpayer was liable for the accuracy-related penalty under section 6662.