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Small Businesses Can Use IRA Funds — but Only for a Limited Time

Aug. 27, 2014
Small Business
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Written by NerdWallet’s small business expert on small business structure, Craig W. Smalley, E.A., C.E.P.®, C.T.R.S.® 

I used to suffer from insomnia, and as a result, I’ve seen my share of infomercials.

The infomercial always ends with a limited time offer, and you must act now.

But a particular limited time offer comes from the United States government.  This offer seems too good to be true, but you can only use this little trick before January 2015.

Have you been thinking of starting a small business?  Perhaps you are in business for yourself, and like all small businesses, you are experiencing short-term cash flow problems. Whatever your reason for needing short-term cash, you need only look to your retirement account.

Let’s say that you have decided that you are going to go into business for yourself, and you have money in your retirement account.  You have always been told that if you take a distribution from that account, you would have to pay income tax and a 10% penalty if you are under age 59½.  All of that is true.

However, you have a couple of ways to use your retirement plan assets 100% tax-free to fund a business, buy real estate or anything else.

Do I have your attention now?

One of those options will end in January 2015.

You’re likely familiar with IRA funds and changing jobs: You leave your job, and your former company forces you to either take a distribution or roll over your plan assets to another qualified plan.  Typically rollovers are done trustee to trustee, meaning your old company will send a check with your retirement funds directly to your new company.  You never see the cash, but the money ends up in the new account.  This is technically not a rollover.  This is known as a trustee-to-trustee transfer.

In a rollover, you cash out your plan, receive the money and place the funds into the new retirement account.

What you may not realize is that you don’t have to put the money into the new retirement account for 60 days.  If you have more than one retirement account, you can take the cash out of each account and hold onto it for 60 days. As long as you put it back into the same account or another qualified account within 60 days, it is considered a rollover of your assets and is not subject to income tax.

You can do several of these rollovers before January 2015.  In the 60 days that you have possession of the money, you could infuse it into a small business, buy real estate that you are going to flip within 60 days, or anything else you want. You can do this several times throughout the year.

I would love to say I thought of this strategy, but I did not. A recent United States Tax Court Case involving a tax attorney in Texas addresses this exact strategy.  The attorney had several IRA accounts.  He would take money out of his IRA several times a year and put it back within the 60-day time frame.

Did he follow the law?  Absolutely!  However, the attorney was audited by the IRS, and the IRS argued that he was abusing this law.  The case went all the way to the United States Tax Court.  The Tax Court issued a memo that basically sided with the IRS and stated that the Texas attorney was taking advantage of this tax law.

The court said that while taxpayers could indeed take money out of their IRAs and roll it over into another IRA or simply put it back into the original IRA, they could only do it once a year.  Since that case, the IRS has issued guidance stating that it will allow the rest of 2014 to be a grace period and will begin enforcing this new rule in January 2015.

If you run out of time on using the 60-day rule, don’t worry.

Another way to use your retirement account tax-free is through a Self-Directed IRA.  Your financial planner would like you to think that the only thing that you can invest your retirement plan assets into are stocks, bond, or mutual funds.  Remember your financial adviser has a vested interest in you keeping your plan assets in securities.

But in 1975, as part of the Employee Retirement Income Security Act of 1974 (ERISA) and the creation of IRAs, self-directed IRAs were also permitted. At that time, qualified plans, such as Defined Benefit, Profit Sharing and Money Purchase Pension Plans, were self-directed.

What you can do is actually kind of neat.  You can start a Self-Directed IRA (SDIRA) that invests in real estate, small businesses, gold bullion and other assets.  You could form a limited liability company (LLC), find an IRA custodian, write an operating agreement that is special to a SDIRA, and roll over your current IRA into the SDIRA.  Typically SDIRAs are used to buy real estate.  The real estate you buy can either be flipped (bought, fixed up, held for a short period and sold), or rented out.  Because these investments are done within an IRA, the profits that you make are completely tax free.

But there are certain rules that you have to follow.  SDIRA’s have a clause in them that deal with something called self-dealing.  Basically, under the self-dealing rules, you cannot personally benefit from your SDIRA.  For instance, if you were to buy real estate and it needed repairs, you could not do the repairs yourself, or have anyone in you maternal or paternal family (including cousins) do the work for you for payment.

Another quirky thing is that you can only pay a small salary to yourself or others.  You don’t have to buy real estate; you could buy the stock of a small C-Corporation.  For instance, if you wanted to start a small business, you could form a C-Corporation, and your SDIRA could purchase the stock of that corporation.  If you happen to do something deemed self-dealing or if you take money out of the SDIRA, it is treated as a distribution from the IRA, subject to taxes and a 10% early withdrawal penalty if you are under age 59 ½.

Even though you are not watching an infomercial, you need to act now or you could lose one of these powerful tax provisions.

Craig Smalley is the managing partner of CWSEAPA®, LLP, which is an accounting and financial firm located in Delaware, Florida, and Nevada.  Craig has been Admitted to Practice Before the Internal Revenue Service, is a Certified Estate Planner™, and is a Certified Tax Resolution Specialist™.  Craig specializes in taxation and IRS representation all the way through the United States Tax Court.  For more information visit, call 1-844-CWSEAPA, or email him at [email protected]

Small business illustration via Shutterstock.