A court case (James E. Thiessen et ux. v. Commissioner; 146 T.C. No. 7; No. 11965-10) from March of 2016 serves to remind us that it is prohibited for the solo 401k owner to personally guarantee a loan to his solo 401k or IRA.
In this court case the IRA owners (Mr. and Mrs. Thiessen) invested their IRAs in a corporation and then guaranteed a loan made to the IRA funded corporation. When the IRS discovered the prohibited transaction during an audit, the IRS ruled that the Thiessens’ guaranties were prohibited transactions. The Tax Court concluded the same and the Thiessen’s were both on the hook for $180,129 in taxes. On top of this amount, their IRAs were also subject to a 10% early distribution penalty because they were under age 59 ½.
The Thiessens’ participation in the prohibited transactions caused their IRAs to close as of the first day of the year in which the prohibited transactions occurred. They were deemed to have received distributions of amounts equaling the fair market values of all assets in their IRAs on that day.
On a side note, the Thiessens also became employees of the IRA funded corporation which is also prohibited. Essentially, it appears that the Thiessens were under the impression that they can fund their own business directly with an IRA which is obviously not the case. They may have gotten confused with the rules that allow one to use their 401k to fund their own business. This type of 401k is known as a rollover as business startup 401k/PSP, which does allow the individual to transfer his IRA or former employer retirement plans to a ROBS 401k/PSP which can then be invested in your own C-corporation and the ROBS 401k/PSP owner can also guarantee a loan to the corporation.