Updated. Originally posted May 13, 2022
Can I Use a Self-Directed Roth IRA to Fund My Start-Up?
I was asked this question by three different clients yesterday. Ever since it was revealed that Peter Thiel reportedly accumulated billions of dollars inside his Roth IRA, more entrepreneurs have been asking whether they can use a self-directed Roth IRA to invest in their own businesses.
The short answer is: probably not. While there are circumstances in which a self-directed Roth IRA can invest in a start-up, the prohibited transaction rules make it difficult for founders to use these structures without running afoul of the tax laws.
Background
An IRA is an “individual retirement account.” There are two basic types: traditional IRAs and Roth IRAs.
With a traditional IRA, contributions are generally made with pre-tax dollars and distributions are taxed when withdrawn. With a Roth IRA, contributions are made with after-tax dollars, but qualified distributions are tax-free.
For 2026, the contribution limit is $7,500 ($8,600 for individuals age 50 or older). Contribution limits and income restrictions are adjusted periodically.
A self-directed IRA is simply an IRA that allows the account holder to direct investments into a broader range of assets than are typically available through conventional brokerage IRAs. These investments may include real estate, private companies, and other alternative assets.
The Prohibited Transaction Problem
The primary obstacle is the prohibited transaction rules.
If an IRA engages in a prohibited transaction, the consequences can be severe. The IRA is generally treated as having distributed all of its assets as of the first day of the year in which the prohibited transaction occurred, potentially resulting in substantial taxes and penalties.
A prohibited transaction generally involves a transaction between the IRA and a “disqualified person.”
Disqualified persons include:
- the IRA owner;
- certain family members, including spouses, ancestors, descendants, and spouses of descendants;
- entities owned 50% or more by the IRA owner and other disqualified persons;
- officers, directors, partners, and certain highly compensated employees of such entities; and
- certain fiduciaries, custodians, and service providers to the IRA.
Can the IRA Invest in Your Start-Up?
If you or other disqualified persons already own 50% or more of the company, an investment by your IRA will generally constitute a prohibited transaction.
There is, however, some authority suggesting that an IRA may be able to form and initially capitalize a corporation before the IRA owner becomes a disqualified person with respect to that entity. In Swanson v. Commissioner, the Tax Court approved an arrangement in which an IRA purchased stock of a newly formed corporation.[1]
That case has led some practitioners to conclude that an IRA may be able to serve as the initial investor in a start-up under limited circumstances.
The Bigger Issue: Operating the Business
Even if the initial investment is permissible, the greater challenge is operating the business afterward.
The prohibited transaction rules do not merely prohibit certain ownership arrangements. They also prohibit many forms of self-dealing and indirect benefits involving IRA assets.
For example, problems can arise if the founder:
- receives compensation from an IRA-owned business;
- personally guarantees company debt;
- contributes substantial personal services that enhance the value of the IRA’s investment; or
- otherwise uses IRA assets for personal benefit.
In Ellis v. Commissioner, the Tax Court held that a prohibited transaction occurred when the owner of an IRA-owned business received compensation from the business.
As a practical matter, this means that many founders will find it difficult to actively operate an IRA-owned company without creating prohibited transaction concerns.
What About Peter Thiel?
The lesson from Peter Thiel’s reported Roth IRA success is often misunderstood.
The reported growth in Thiel’s Roth IRA was not simply the result of using a Roth IRA to fund a start-up. Rather, it appears that his Roth IRA acquired founder-stage shares in highly successful companies at very low valuations. Those shares then appreciated dramatically inside the Roth IRA, where future gains could potentially be realized tax-free.
Most entrepreneurs do not have access to similar opportunities, and the prohibited transaction rules make it difficult for founders to replicate that strategy using their own operating businesses.
Takeaway
A self-directed Roth IRA can invest in private companies, but using your own Roth IRA to fund and operate your own start-up is often problematic.
While there may be limited circumstances in which an IRA can be the initial investor in a new company, the prohibited transaction rules create substantial risk once the founder begins actively operating the business.
Anyone considering this strategy should obtain specialized tax advice before proceeding. A prohibited transaction can cause the entire IRA to lose its tax-favored status, making an expensive mistake even more expensive.
Mike Baker frequently advises with respect to matters affecting start-ups. He possesses a breadth and depth of experience in tax and employee benefits & compensation law that spans multiple decades. For additional information, please contact mike@mbakertaxlaw.com.
[1] Swanson v. Commissioner, 106 T.C. 76 (1996). See also Ellis v. Commissioner, T.C. Memo 2013-245.