In the court case “Rollins v. Commissioner” the court ruled, based on the facts and circumstances that the taxpayer was engaging in prohibited transactions that were the result of his using plan assets for his personal benefit. Even though the entities dealing directly with the plan were not disqualified persons, the court ruled that Mr. Rollins directed that plan assets be used in way that provided him a personal benefit. This case thus creates uncertainty as to the outcome of any transaction that in any way involves an IRA that benefits, even indirectly, a disqualified person. A similar Department of Labor (DOL) ruling called 2006-1A also extends the potential for a negative finding on potentially prohibited activity where they determine that the purpose of the transaction is to benefit a disqualified person.
The specifics of “Rollins” case are as follows:
- Mr. Joseph Rollins (Rollins) was the 100% owner of his accounting corporation,
Rollins & Associates, P.C. (RA).
- RA sponsored a 401(k)-profit sharing plan (Plan).
- Rollins was its sole trustee.
- Mr. Rollins was also sole owner of Rollins Financial Counseling (RFC)
- Rollins’ professional credentials include CPA, RIA, CFP, ChFC, and Certified Employee Benefits Specialist.
As described in the court case, Mr. Rollins’ advisory firm (RFC) entered into an agreement with his accounting firm (IRA) for financial counseling service. The agreement provided that Rollins (as CEO of RFC) would make all investment decisions on behalf of RA. Mr. Rollins was also sole owner of Rollins Financial Counseling, which made all of the Plan’s investment decisions. The Plan lent funds to three businesses in which Rollins was, at the time, the largest (between 8.93% and 33.165%), but never a controlling, shareholder or partner. These three businesses had 28, more than 70, or more than 80 other shareholders or partners. Therefore, the entities that his plan lent to were not disqualified persons under 4975 (that is he did not own 50% or more interest in them), and, in isolation, there was no apparent transaction between a disqualified person and the Plan.
Mr. Rollins made the decisions to lend from his pension plan (for which he served as trustee) to the businesses involved. All the loans were demand loans, secured by all the borrowers’ machinery, property, and equipment. Interest rates on the loans were market or better and Mr. Rollins signed the loan checks on behalf of his Company’s (RA) Plan and he signed the notes on behalf of the borrowers (the companies in which he was invested).
In addition, Mr. Rollins would have to authorize actions by the Plan to collect on loans should borrowers default on repayment. Ultimately, all loans were paid back in full, although Rollins helped one firm by lending it funds to allow it to make its payments.
How and why did the Court rule against Mr. Rollins?
First, Rollins was a disqualified person (ownership of Plan and status as Plan fiduciary). There is no doubt about that. However, he was apparently only directing his plan to make the loans. So where is the prohibited transaction? The IRS contention was that there was a transfer of assets for the benefit of a disqualified person (4975 (d)), because the loans enabled businesses in which Rollins owned interests to operate without having to borrow funds at arm’s length from other sources. They also maintained that because Rollins was a fiduciary with conflicting interests and that brought him within the scope of 4975(e), ‘disqualified person who is a fiduciary dealing with plan income or assets for own interest or account’, and the Tax Court agreed that loans were a prohibited transaction pursuant to 4975(d).
Mr. Rollins’ argument was that the loans were good investments for Plan, and that the companies were not disqualified persons and that the loans were at market rates. The court felt otherwise and interpreted that he would not have been able to obtain the same loans from the private sector.
Read more about avoiding Prohibited Transactions on the Retirement Industry Trust Association’s website HERE.