Lessons from McNulty Case (hint: precious metals within IRA-owned LLC = trouble!)

Recent News, Self Directed IRA, Tax,

Yesterday, the US Tax Court released their ruling in the case of McNulty vs. Commissioner of IRS (157 T.C. No. 10, November 18, 2021).  In short, it wasn’t pretty for a husband and wife who had two self-directed IRAs and IRA-owned LLCs and used those IRA/LLCs to hold precious metals (e.g., American Eagle coins) in a safe at their personal residence.  The entire value of the coins was deemed received by them in a taxable distribution from their IRAs, regardless of the fact that the coins were “titled” in the name of the IRA-owned LLC.  Many lessons can be learned from this case, many of which are a continuing sad story of unwitting individuals relying on companies pedaling misleading self-directed IRA advice.  Below are several key points that all self-directed IRA investors should take from the case.

(1) Reliance on “IRA LLC facilitators” is dangerous (and always has been!).  First, some quick background.  Self-directed IRAs must be held by an independent qualified custodian under the Investment Advisors Act of 1940.  In addition, there are also many third-party companies (not custodians) that serve the sole purpose of coordinating the formation of self-directed IRAs and IRA-owned LLCs.  These “facilitators” often have a close relationship with a particular IRA custodian, but the facilitator is not the custodian itself (although clients have trouble telling the difference).  In the McNulty case, Mrs. McNulty hired a facilitator called “Check Book IRA” to form both her self-directed IRA and IRA-owned LLC (called Green Hill Holdings LLC – hereafter, “Green Hill”).  Technically, the custodian was Kingdom Trust Co., but Check Book IRA facilitated the process – which involved $425,000 being moved into the IRA and then into Green Hill (side note: the IRA-owned LLC setup itself is perfectly legal – it’s what happens when the LLC starts to invest the money that raises legal concerns).  Mrs. McNulty relied on statements from Check Book IRA’s website, which said that she could have Green Hill purchase precious metals (e.g., American Eagle coins) and then store them at her own house, which is exactly what she did.  From Kingdom Trust’s perspective, the only asset within Mrs. McNulty’s IRA was 100% ownership of Green Hill, and thus, Kingdom Trust was uninvolved in the purchasing and/or storage of the coins.

The appeal of an IRA/LLC facilitator is that they charge a very minimal amount to help setup the new self-directed IRA and IRA-owned LLC.  To people in Mrs. McNulty’s position, these low costs are undoubtedly appealing [side note: potential clients contact me on a daily basis “shopping” for IRA-owned LLC formation help; when the potential client learns the difference in cost between an experienced attorney (e.g., me) and a facilitator (e.g., Check Book IRA), they often pick the facilitator – but with what consequences??].  The websites of these facilitators are filled with information that appears to be solid guidance – but, in reality, the information is either overly generalized and/or blatantly incorrect.  To make matters worse, the “fine print” of both facilitators and custodians is that they do not provide legal or tax advice, and thus, the individual person using their service cannot rely on anything they say (whether online material and/or communication over the phone or email).  However, when Check Book IRA’s website told Mrs. McNulty that she didn’t need to store the IRA/LLC’s precious metals at a third-party depository, but instead could store the metal at her own house, she understandably trusted that information.  Big mistake!  As of the writing of this article, Check Book IRA’s website still has a page that says: “The Check Book IRA staff showed me how to buy physical precious metals, LEGALLY”, and “Protection by NOT having your IRA Gold or Silver 1,000 miles away”, and “Protection by having your metals held locally”.  All of these statements are promoting the exact course of action that Mrs. McNulty pursued, which in turn destroyed her IRA.

(2) If your IRA-owned LLC holds precious metals that are in your possession (or within an IRA-owned LLC’s safe-deposit box), you have a major problem!  The Tax Court in McNulty vs. Commissioner ultimately ruled that although an IRA can purchase certain types of precious metals, those metals must always be in the physical possession of a trustee or custodian.  Thus, when Mrs. McNulty, as the “Manager” of Green Hill (her IRA-owned LLC) took physical possession of the American Eagle coins, she was deemed to take a taxable distribution of the value of the coins.  In addition, because Mrs. McNulty did not acknowledge this taxable distribution on her personal tax return [of course she didn’t, because she was relying on Check Book IRA that Green Hill could legally hold the coins!], she was subject additional IRS penalties.  Mrs. McNulty attempted to argue that she should not be subject to the penalties because she had “reasonable cause” to assume that no tax was due.  However, because Check Book IRA’s advice did not constitute “professional advice”, she lost this argument.  [Double ouch!]

The facts in the McNulty case are not an isolated event.  Many individuals have been “sold” on the concept of IRA-owned LLCs to take physical possession of precious metals.  Perhaps ironically, these individuals are often afraid of government intervention and/or economic collapse (and thus, precious metals are “safe”), but also distrust precious metals depositories (i.e., third-party companies used to hold precious metals) – and thus, an IRA-owned LLC storing the metals in their basement (or within the IRA-owned LLC’s safe deposit box) is the answer!  Various companies that benefit from these IRA/LLCs and the metal sales (e.g., facilitators, precious metal dealers, etc.) have convinced countless Americans to pursue this path.  Of course, the problem now is that the McNulty case makes it abundantly clear that these individuals have been duped – and their reward(?) … a very large IRA distribution tax bill!

This very issue was examined in an article by Laura Saunders of the Wall Street Journal in September of 2016, entitled, “Want to Keep Gold in Your IRA at Home?  It’s Not Exactly Legal”.  When researching the subject, Mrs. Saunders contacted me for a quote.  After discussing with her that there is an exception in the IRA rules that allows holding of certain precious metals (e.g., American Eagle coins) within IRAs, we discussed how that exception only applies if the assets are held by a “trustee” (e.g., an IRA custodian).  In her article, Mrs. Saunders discussed how advocates of IRAs containing precious metals stored at home or in bank safe-deposit boxes promote IRA-owned LLCs as a method that is valid.  I then stated, “if the bank is only aware of the LLC and not the IRA, then it can’t be acting as a trustee.”  In other words, a valid argument does not exact that the bank associated with the IRA-owned LLC is equivalent to an IRA custodian, because the LLC’s bank often has no clue that an IRA even owns the LLC.

In short, the federal tax laws have always allowed IRAs to hold certain types of precious metals. However, a careful reading of those rules reveals that these metals must be held by an IRA custodian directly. Unfortunately, the vast majority of Americans are not in a position to understand these intricate rules, and thus, they rely on information provided by companies like Check Book IRA, which can result in difficult lessons.