Prime example of a Roth IRA “stuffing transaction” – don’t try this at home!

In the course of representing self-directed IRA investors, I run into many situations where the proposed IRA investment appears to create a danger of an “excess contribution” – sometimes called a “stuffing transaction”.  The United States Tax Court recently examined one of these situations – a rather blatant one I might add.  Repetto, TC Memo. 2012-168 (June 14, 2002) describes a situation where a couple owned a construction business and established two new corporations, each 98% owned by their Roth IRAs.  The new corporations entered into contracts to provide services to the construction company, which resulted in each Roth IRA receiving $50,000 in “dividends” each year.  However, because the couple did all of the work that resulted in income to the construction company, the Tax Court concluded that the structure was a sham and was used only to put amounts above the normal Roth contribution limits ($5k – or $6 if over 50 years old) in each Roth.  As a result, the couple was forced to remove the funds from the Roth IRAs and owed a 6% excess contribution penalty (among other penalties).

Frankly, the whole structure sounds like a prohibited transaction (due to corporations owned by Roth IRAs entered into a financial transaction with a disqualified person – i.e. the construction company), so I am frankly surprised that the Roth IRAs were allowed to remain in existence at all!

Here is a link to the complete Tax Court opinion: http://www.ustaxcourt.gov/InOpHistoric/RepettoMemo.TCM.WPD.pdf