SDIRAs Under Attack: What To Know & What To Do

Posted on by ReSure Financial

What you can do to stop this unreasonable attack on Self-Directed IRA

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How proposed legislation will impact SDIRA investing

There are many dimensions to the sophisticated use of retirement accounts for tax and financial strategy, and all of those are targeted in the proposed legislation. For purposes of this post, we’ll be focusing strictly on the investment aspect of SDIRAs.

Summary of The Proposed Attack on SDIRAs

The proposed legislation would prohibit IRAs from holding privately-placed equity and debt securities and other investments that require the IRA owner to meet certain minimum financial, educational or licensing requirements. For example, the legislation would prohibit IRAs from holding unregistered investments that are offered to accredited investors, like equity or debt investments in small businesses or investments in private funds. You may very well hold investments in your IRA today that would be prohibited by the proposed legislation.

The bill would also prohibit IRA owners from investing in (1) non-publicly traded entities in which the IRA owner and related entities (including the IRA itself) own a 10% interest or (2) any entity in which the IRA owner is an officer or director, regardless of ownership percentage. So called “Checkbook IRAs” (Single Member IRA-LLC & IRA-Owned Trusts), or any investment in an entity in which the IRA-owner is a manager or trustee could no longer be held in an IRA.

If the proposed legislation becomes law, you will no longer be able to purchase any of the above investment types in your IRA. Furthermore, you will be required to dispose of any such investments that you currently hold in your IRA by no later than December 31, 2023, which could result in significant and previously unforeseen financial and tax consequences, including taxes and penalties associated with any assets that could not be sold and must be distributed from the IRA.

Details of the Proposed Legislative Attack on SDIRAs

Sec. 138302. Increase in Minimum Required Distributions for High-Income Taxpayers with Large Retirement Account Balances: If an individual’s combined traditional IRA, Roth IRA and defined contribution retirement account balances generally exceed $10 million at the end of a taxable year, a minimum distribution would be required for the following year. This minimum distribution is only required if the taxpayer’s taxable income is above the thresholds described in the section above (e.g., $450,000 for a joint return). The minimum distribution generally is 50 percent of the amount by which the individual’s prior year aggregate traditional IRA, Roth IRA and defined contribution account balance exceeds the $10 million limit.

In addition, to the extent that the combined balance amount in traditional IRAs, Roth IRAs and defined contribution plans exceeds $20 million, that excess is required to be distributed from
Roth IRAs and Roth designated accounts in defined contribution plans up to the lesser of (1) the amount needed to bring the total balance in all accounts down to $20 million or (2) the aggregate
balance in the Roth IRAs and designated Roth accounts in defined contribution plans. Once the individual distributes the amount of any excess required under this 100 percent distribution rule,
then the individual is allowed to determine the accounts from which to distribute to satisfy the 50 percent distribution rule above.

This provision is effective tax years beginning after December 31, 2021.

Comments:

  • This is NOT inherently unreasonable. Tax advantaged IRAs were created to incentivize long-term saving & investing to fund… retirement! They were intended to supplement Social Security, not to facilitate unlimited tax free wealth accumulation.
  • Legislation of this nature should have been drafted into the original IRA legislation.
  • This section of the proposed legislation, itself, achieves Congress’ goal of limiting tax-advantaged retirement accounts to reasonable retirement savings. The following Sections (138312 & 138314) inflict extraordinary harm on Main Street Americans and achieve nothing.

Sec. 138312 – Prohibition of IRA Investments Conditioned on Account Holder’s Status: The bill prohibits an IRA from holding any security if the issuer of the security requires the IRA owner to have certain minimum level of assets or income, or have completed a minimum level of education or obtained a specific license or credential. For example, the legislation prohibits IRAs from holding investments which are offered to accredited investors because those investments are securities that have not been registered under federal securities laws. IRAs holding such investments would lose their IRA status. This section generally takes effect for tax years beginning after December 31, 2021, but there is a 2-year transition period for IRAs already holding these investments.

Comments:

  • In this case, the summary provided is accurate enough. No need to quote the actual proposed legislation.
  • No more syndicated deals of any type!
  • Investor protection is the role of the SEC, not the IRS. Deals that require “accredited” status are not inherently more risky!
  • The 2 year transitionary period is punitive!

Sec. 138314. Prohibition of Investment of IRA Assets in Entities in Which the Owner Has a Substantial Interest: To prevent self-dealing, under current law prohibited transaction rules, an IRA owner cannot invest his or her IRA assets in a corporation, partnership, trust, or estate in which he or she has a 50 percent or greater interest. However, an IRA owner can invest IRA assets in a business in which he or she owns, for example, one-third of the business while also acting as the CEO. The bill adjusts the 50 percent threshold to 10 percent for investments that are not tradable on an established securities market, regardless of whether the IRA owner has a direct or indirect interest. The bill also prevents investing in an entity in which the IRA owner is an officer. Further, the bill modifies the rule to be an IRA requirement, rather than a prohibited transaction rule (i.e., in order to be an IRA, it must meet this requirement). This section generally takes effect for tax years beginning after December 31, 2021, but there is a 2-year transition period for IRAs already holding these investments. 

Actual Legislative Text of Sec. 138314:

  • No part of the trust funds will be invested in a corporation, partnership or other unincorporated enterprise, or trust or estate if—
    • ‘‘(A) in the case of an entity with respect to which interests described in clause (i), (ii), or (iii) are not readily tradable on an securities market, 10 percent or more of—
      • ‘‘(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,
      • ‘‘(ii) the capital interest or profits interest of such partnership or enterprise, or
      • ‘‘(iii) the beneficial interest of such  trust or estate,
    • is owned (directly or indirectly) or held by the  individual on whose behalf the trust is maintained, or
    • ‘‘(B) the individual on whose behalf the trust is maintained is an officer or director (or  an individual having powers or responsibilities  similar to officers or directors) of such corporation, partnership, or other unincorporated enterprise.
  • For purposes of subparagraph (A), the constructive  ownership rules of paragraphs (4) and (5) of section 4975(e) shall apply, and any asset or interest held by the trust shall be treated as held by the individual described in such subparagraph.’’

Comments:

  • No more “Checkbook IRAs,” whether using a trust or LLC.
  • No more asset protection or anonymity.
  • Does it help to use another entity manager? With near certainty, can say that NOT.

How did Peter Thiel create a $6,000,000,000 IRA + Did the IRS drop the ball on Peter Thiel’s Roth IRA?

  • Peter Thiel’s Roth IRA Transactions (as reported in ProPublica): Lord of the Roths: How Tech Mogul Peter Thiel Turned a Retirement Account for the Middle Class Into a $5 Billion Tax-Free Piggy Bank (ProPublica)
  • Bought PayPal startup shares in a Roth IRA, as advised by the founder of Pensco
    • Prohibited Transactions: Ownership, Goods and Services, Compensation, Self-Dealing (The company needed capital, as evidenced by loans from Thiel’s own hedge fund.)
    • Valuation – Roth IRA Stuffing = Excess Contributions & Listed Transactions; Thiel paid $0.001 per share!
  • Thiel used the millions in proceeds from his PayPal windfall to invest in other Silicon Valley startups as well as his own hedge fund
    • Prohibited Transactions: Ownership, Goods and Services, Compensation, Self-Dealing
    • Valuation – Roth IRA Stuffing = Excess Contributions & Listed Transactions
  • Thiel invested $500,000, Facebook’s first large outside infusion of cash
    • Prohibited Transactions: Ownership, Goods and Services, Compensation, Self-Dealing (There is an exemption for publicly traded companies, so more info is needed.)
  • In 2005, he sought residency in New Zealand… Thiel applied as an investor. His application, prepared by his then-financial assistant, Jason Portnoy, touted the size of his Roth. Thiel transferred $749,967 to a bank in New Zealand, keeping it under the umbrella of the Roth.
    • Prohibited Transactions: Self-Dealing
  • Thiel, a fan of J.R.R. Tolkien, by then had brought his Roth under the auspices of a family trust company called Rivendell Trust.
    • Prohibited Transactions: Ownership, Goods and Services, Compensation, Self-Dealing
  • There’s more… but this is enough for now! (Google Matt Nippert – New Zealand Journalist)
  • None of the foregoing commentary regarding Thiel’s IRA is any way definitive or conclusive. It is all speculative, based on limited info provided by ProPublica – as provided by ProPublica, not through review of original source documents.

Key Concepts

  • Tax law is supposed to be economically neutral, unless there’s a specific outcome congress wants to incentivize.
  • People should not be punished for being savvy investors.
  • There’s a serious lack of due process and tyranny of the – very slim – majority, considering the extreme punitive impact on SDIRA investors that have used existing law – compliantly – to invest in non-public assets with their SDIRA.
  • Members of congress likely do not understand the impact & context of the proposed legislation, as currently drafted.
  • The impetus for the legislation is the activity and achievement of the likes of Peter Thiel, a handful of of multi-billionaire’s who have used – and possibly abused – retirement savings’ tax incentives to accumulate extraordinary wealth. However, the unintended consequences of the legislation are decimation and harm to the retirement savings’ of 100,000s of Main Street Americans who use these accounts compliantly and in accordance with their intended purpose.
  • The rules governing self-directed IRAs – the prohibited transaction rules – ensure that SDIRAs are used for long-term saving & investing, not for current benefit. Within that framework, Congress has recognized that it should be left to individual investors to choose what assets to invest in.
  • Understand what “prohibited transactions” are about – and what they aren’t about!
  • What makes a risky investment and why do some investments require “accredited” status. Investments that require accredited status are NOT inherently riskier or more speculative.
  • Securities law and the SEC handle investor protection, NOT the tax code and the IRS.
  • Sec. 138302 of the proposal, which places caps on the size of tax sheltered retirement account, achieves the reasonable goal of limiting tax sheltered retirement accounts to retirement investing and in-line with the initial intent of these accounts.
  • Sections 138312 & 138314 – which disallow investment in syndications, private placements, and IRA-LLC/Trust – do little, if anything, towards bringing IRAs into alignment with their intended purpose. On the contrary, they are counter-productive and undermine the intended goals of IRA legislation.
  • Sections 138312 & 138314 inflict incredible hurt on all real estate investors, but disproportionately affects those the government claims they want to help – Main Street Americans leveraging the combination of real estate and retirement accounts to enhance their financial futures – with no offsetting gain to show for it.
  • At the very least, a “Grandfather Clause” is needed to allow assets already held in SDIRAs to remain there, unaffected. Forced asset sales of private investments currently held inside IRAs, along with a simultaneous flight to public securities, may inflict devastating financial harm on regular Americans forced to sell low and buy; they will find themselves in a “squeeze.”
  • This is “collective punishment,” with the masses of Main Street Americans being punished due to the actions of fewer than a handful of individuals that have huge IRAs.
  • It seems highly likely that from both the perspective of IRA legislation and IRS regulation and enforcement, the “ball was dropped” on the Peter Thiel IRA.
    • Legislatively: Something akin to proposed Sec. 138302 should have been on the books from inception of the IRA.
    • Regulation/Enforcement: Existing rules – Prohibited Transactions & Excess Contributions – would likely have stood in the way of Peter Thiel’s Tax Free Roth IRA growth.

For a 60-minute video on this topic, click here to head over to the ReSure Financial member space and select Events.

I prefer to believe that the incredible harm of the legislation to 100,000s of law-abiding Main Street Americans is unintended, so all we have to do is educate our representatives in Congress. We need to demonstrate that:

  • Self-Directed IRAs are NOT the province of billionaires. SDIRAs are retirement savings tools of Main Street America!
  • Self-Directed IRAs are NOT just used by a handful of investors, aided and abetted by highly-paid tax avoidance advisors. SDIRAs are used by 100,000s of Main Street Americans!
  • Self-Directed IRAs do NOT just benefit Silicon Valley tech startups founded and founded by billionaires. SDIRAs primarily fund small-to-medium sized operators in communities throughout the USA! 
  • The proposed legislation is NOT very harmful to billionaires. It is, however, devastating to 1,000,000s of Mainstreet Americans that SDIRA investors or are are funded by SDIRAs!