United States: The Gripes Of Roth: New Decisions Highlight The Boundaries Of Roth's Golden Country

The Migration...

A coming storm of increased tax rates is encouraging high net worth individuals and business owners to migrate to new lands and to take refuge in the Roth IRA's tax benefits. However, when viewing the lay of the land that makes up Roth's golden country, it is important to be aware of recent decisions that limit Roth's bounties.

Roth IRA Basics

The Roth IRA is a unique type of nondeductible IRA. Although contributions to Roth IRAs are not deductible, all of the qualifying distributions received from the Roth IRA are tax-free. Unlike the Roth IRA, in a regular or traditional IRA, withdrawals of contributions and earnings are taxable, but the money contributed to the IRA is deducted from income.

The maximum annual contribution an individual can make to his or her Roth IRA is subject to both a "dollar limitation" (which caps contributions by a dollar amount) and an "AGI limitation" (which stands for adjusted gross income, and caps contributions based on the participant's modified adjusted gross income).

Since the inception of the Roth IRA, individuals have sought to avoid the statutory limits on Roth IRA contributions. Often, transactions between different corporate entities are designed to indirectly contribute to a Roth IRA in an attempt to protect assets or evade taxes. The IRS has responded by challenging such avoidance transactions, and in such cases, it has denied deductions, required corporations involved to recognize the gain on the transfer, required inclusion of the payment in the taxpayer's income, and/or reallocated income to other involved entities in order to prevent tax evasion or to reflect the income clearly. In addition to these possible consequences, the amount treated as a contribution is subject to a 6 percent excise tax under Section 4973 of the Internal Revenue Code.

Recent Decisions

Two recent decisions highlight some of the problems that can arise when business owners seek to utilize the Roth IRA's beneficial tax structure without considering the legal limitations.

Repetto v. Commissioner

In a recent Tax Court decision, Repetto v. Commissioner (June 14, 2012), the court determined that two individuals who formed two subchapter C corporations in which their Roth IRAs held a 98% interest were subject to the excise tax on excess contributions.

The individuals involved, Steven and Gayle Repetto, owned all of the stock in a subchapter S Corporation, SGR Investments, Inc. (SGR). Relying on the advice of an attorney and a C.P.A., the Repettos formed two C Corporations: (1) Yolo, Inc. (Yolo), which was established to provide office and support services for SGR; and (2) WFR Investments, Inc. (WFR), which was established to provide marketing and business development services for SGR. Gayle Repetto's Roth IRA owned a 98 percent interest in Yolo, and Steven Repetto's Roth IRA owned a 98 percent interest in WFR. Gayle Repetto, acting in her capacity as Yolo's president, established a medical and dental expense reimbursement plan, which made distributions to the Repettos for healthcare expenses. The IRS, on audit, determined that the Repettos made excess contributions to their Roth IRAs and were liable for the excise tax under Code Section 4973. The IRS also disallowed WFR's and SGR's deductions for facility support payments, as well as Yolo's deduction for medical reimbursement expenses and officer compensation expenses. Further, the IRS recharacterized some payments from SGR to Steven Repetto as compensation, rather than as a distribution. The IRS also assessed filing penalties and penalties for reportable transaction understatements.

In court, the Repettos argued that their corporate structure had a legitimate business purpose of asset protection, that payments between the entities were legitimate because the entities that offered support and development services to SGR actually provided such support and development services, and that the IRS had recognized the support and development entities by continuing to retain over $112,000 in federal corporate income taxes. They also noted that a Roth IRA may own shares of a C Corporation.

The court held that the Repettos were liable for the Code Section 4973 excise taxes for excess contributions to their Roth IRAs, and concluded that the service agreements, and payments between the entities, were nothing more than a mechanism for transferring value to the Roth IRAs since the Repettos had continued to do the same work that they had done prior to the time the agreements were in place.

Taproot Administrative Services v. Commissioner of Internal Revenue

In Taproot Administrative Services v. Commissioner of Internal Revenue (Mar. 21, 2012), the Ninth Circuit Court of Appeals, affirming the Tax Court's decision, held that a corporation was not eligible for S corporation status because its sole shareholder, a Roth IRA, was not an eligible S corporation shareholder, and consequently, that the corporation was taxable as a C corporation.

The individual taxpayer involved, Paul Di Mundo (Mundo), incorporated his business and elected subchapter S status. The sole shareholder of the corporation in 2003 was a custodial Roth IRA for the benefit of Mundo. After the IRS issued a notice of deficiency, determining that the corporation was taxable as a C corporation for 2003, Mundo filed suit.

The Tax Court agreed with the IRS, and concluded that the Roth IRA did not qualify as an eligible shareholder of the S corporation. On appeal, the Ninth Circuit rejected Mundo's corporation's argument that the custodial Roth IRA qualifies as an eligible shareholder for purposes of assessing S corporation taxation. The Ninth Circuit and Tax Court relied on IRS Revenue Ruling 92-73 (the only IRS guidance on this issue), which prohibits IRAs as S Corporation shareholders. The Ninth Circuit court, in reaching its decision to affirm the Tax Court's determination, noted that unlike grantor trusts and qualified subchapter S trusts, which are both taxed currently on their income, IRAs and Roth IRAs are subject to deferred taxation on current income, and thus are incompatible with the S corporation taxation rules. The court further noted that the legislative history of the S corporation statute favors limited eligibility.

The Migration Continues...

Although these decisions highlight some of the pitfalls that can occur when seeking tax safety, they will not deter the larger migration to Roth's golden country, and to other such refuges. Plan accordingly, and discuss these issues with your attorneys and financial advisors.

Originally published on For Your Benefit, September 2012

www.foxrothschild.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.