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 Topics
 
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions