Swanson v. Commissioner remains a landmark Tax Court decision confirming that Individual Retirement Accounts (IRAs) may form and invest in entities under certain conditions. While the case continues to be widely cited in Self-Directed IRA planning, it is important to understand both its holdings and its limitations in light of current IRS regulations and enforcement trends.
Below is an overview of the case and its ongoing relevance.
Background
Mr. Swanson, the central figure in this case, structured an investment strategy involving his IRAs and newly formed corporations. He established two corporations, with his IRAs serving as the sole shareholders. Importantly, Mr. Swanson did not personally own any stock in the corporations, although he did serve as a director.
The corporations were formed at inception with IRA ownership, and no pre-existing ownership interests were transferred to the IRAs.
Key Legal Points
Initial Formation and Stock Purchase
The Tax Court ruled that the initial formation and capitalization of the corporations by the IRAs did not constitute a prohibited transaction under Internal Revenue Code Section 4975.
Why?
The court found that the purchase of newly issued stock by the IRAs did not qualify as a sale or exchange of property between a plan and a disqualified person under Section 4975(c)(1)(A). At the time of formation, the corporations were not yet disqualified persons, making the initial transaction permissible.
This distinction applies specifically to the initial capitalization of a newly formed entity.
Dividends and IRA Assets
The court also clarified that the receipt of dividends by the IRA from the corporation was not a prohibited transaction.
Why?
Dividends did not become IRA assets until they were actually declared and paid to the IRA. As such, the payment of dividends alone did not trigger a prohibited transaction, provided the distributions were made on standard, non-preferential terms.
Management Functions
Mr. Swanson’s service as a director of the corporations did not constitute a prohibited transaction.
In other words, the Tax Court held that the performance of typical management or oversight functions, by itself, did not violate the prohibited transaction rules governing IRAs. However, the ruling did not address extensive operational involvement or the provision of personal services beyond normal corporate governance roles.
Entity Status After Formation
The Tax Court did acknowledge that after formation, the corporations became disqualified persons with respect to the IRAs.
This distinction is critical. Once the entity exists and is owned by the IRA, most transactions between the IRA, the entity, and the IRA owner are subject to strict prohibited transaction limitations. Ongoing compliance is essential to preserve the IRA’s tax-advantaged status.
Takeaway
The Swanson case affirmed that IRAs have the legal capacity to form and invest in entities without automatically triggering a prohibited transaction, provided the structure is implemented correctly at inception.
At the same time, the ruling underscores the importance of continued adherence to IRS rules after formation. While Swanson provides valuable guidance, it does not grant unlimited authority for IRA owners to control or transact with IRA-owned entities. Operational conduct, ongoing transactions, and indirect benefits remain key areas of IRS scrutiny.
Careful structuring and ongoing compliance are essential to maintaining the tax-advantaged status of IRA investments.
About the Author
Adam Bergman is a tax attorney and the founder of IRA Financial, one of the largest Self-Directed IRA platforms in the United States. He has helped more than 27,000 clients take control of their retirement savings, overseeing over $5 billion in retirement assets. Adam is also the author of nine books focused on helping investors understand and confidently manage their retirement strategies.
