Checkbook LLC’s Just Took a Major Hit in Tax Court

Please share this far & wide, it has massive implications for SDIRA investing with “Checkbook LLC’s”. This is not a proposed law. This is a Tax Court ruling and is, therefore, the law today.

Here are the basics:

The taxpayer had an LLC 100% owned by her IRA. She was the manager. The LLC bought gold coins and stored them in her home. The Tax Court ruled that possession of the coins by her, in her home, was a distribution of the coins based on the tax concept of “constructive receipt”. They also penalized her at 20% of the distribution tax. Here’s some key language:

“Independent oversight by a third-party fiduciary to track and monitor investment activities is one of the key aspects of the statutory scheme. When coins or bullion are in the physical possession of the IRA owner (in whatever capacity the owner may be acting), there is no independent oversight that could prevent the owner from invading her retirement funds. This lack of oversight is clearly inconsistent with the statutory scheme. Personal control over the IRA assets by the IRA owner is against the very nature of an IRA.

Mrs. McNulty had complete, unfettered control over the AE coins and was free to use them in any way she chose. This is true irrespective of Green Hill’s purported ownership of the AE coins and her status as Green Hill’s manager. Once she received the AE coins there were no limitations or restrictions on her use of the coins even though she asserts on brief that she did not use them. While an IRA owner may act as a conduit or agent of the IRA custodian, she may do so only as long as she is not in constructive or actual receipt of the IRA assets.”

This was pretty cut & dried. I and others have long been against the “hold IRA gold in your home with an LLC” schemes. But this case has broader implications for other asset classes. First, one wants to make sure one does not have “unfettered control” or “constructive receipt” of IRA assets.

Here’s more key language, with the case law citations omitted for simplicity of reading:

“An owner of a self-directed IRA may not take actual and unfettered possession of the IRA assets. It is a basic axiom of tax law that taxpayers have income when they exercise complete dominion over it. Constructive receipt occurs where funds are subject to the taxpayer’s unfettered command and she is free to enjoy them as she sees fit. Mrs. McNulty’s possession of the AE coins is a taxable distribution. Accordingly, the value of the coins is includible in her gross income. Petitioners’ arguments to the contrary would make permissible a situation that is ripe for abuse and that would undermine the fiduciary requirements of section 408. Mrs. McNulty took possession of the AE coins and had complete control over them. Accordingly, she had taxable distributions from her IRA.”

Note: Whether a taxpayer abuses their complete control over assets is not the distribution trigger. The above language states that when assets are subject to a taxpayer’s “unfettered command” and “is free to enjoy them as she sees fit”, we have a problem whether or not that command & power to enjoy the assets was actually exercised or abused. It’s the potential for abuse via constructive receipt of the assets that triggers a distribution.

That describes a lot of checkbook LLCs. In other words, “I can do whatever I want as manager”.

I smell A LOT of checkbook LLC agreement redrafting to include a separate manager who actually has control over assets with the SDIRA owner’s control being limited. That or the dissolution of said LLCs (and the trusts that mimic them). One must weigh the benefits of a properly structured CBLLC (with limits on one’s control, such as having a separate manager, including limits on one’s own ability to utterly dominate that manager) versus the risks (having a truly empowered manager is annoying and potentially costly, etc.).

I’ll add: I do think Solo 401k’s have far less vulnerability to this ruling. Because with Solo 401k’s, there is no requirement to have a custodian. The owner of the 401k can be the trustee (think “custodian”) of the 401k. This is just one more reason for my oft-expressed preference for 401k’s over IRA’s.
The link to the case is in the first comment.

PS: I will go to the Tax Court to pull case details. Briefs from both sides, settlement details to the extent they are available, etc. That is not cheap. Those who share in the costs can have a copy of what I pull with my notes included. The more who chip in, the less it costs each participant.

John Hyre