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SDIRA investment in family companies would shrink under BBB Act, part 2

On Behalf of | Jan 3, 2022 | Private Placements, Regulatory Work, Securities Fraud, Securities Law And Litigation |

In part 1 of this post, we described self-directed individual retirement accounts (SDIRAs) and how they differ from traditional individual retirement accounts (IRAs), including ROTH IRAs. Broadly, traditional IRAs invest in conventional products like stocks, mutual funds or bonds, while those that are self-directed purchase more risky, often unregulated investments, including into private, closely held and often family businesses.

The U.S. House of Representatives recently passed the Biden Administration’s social safety net legislation called the Build Back Better Act, now pending in the U.S. Senate. If enacted as currently written, it would place more stringent control over an SDIRA’s investment options.

Proposal to restrict SDIRA investment in closely held or family businesses

The controversial provision of the Act (Sec. 138314), if passed, would significantly lower the number of SDIRA owners eligible to invest for their IRAs in private companies in which they have direct or indirect financial interests.

Currently, to invest SDIRA assets in a company that is not publicly traded, the account owner may not own 50% or more of that private business. These investments tend to be in relatively small, private, closely held (often within a family) businesses.

Perhaps to reduce the chance of self-dealing – a prohibited transaction – in a closely held, privately owned company in which the SDIRA owner has a “substantial interest,” the Act would lower the proportion of ownership the account owner could have to 10% percent from the current 50% cap.

Owning half of a business makes you a major player, while a 10% owner is more likely a minor participant, so the change would put more space between the owner’s personal investment and career and their choices as an SDIRA owner. The law would also prohibit investment when an SDIRA owner is a company officer.

Existing IRAs already holding interests that would violate this rule would have two years to become compliant. Still, critics may object to this unexpected interruption in owners’ long-term planning and fear potential losses as a result of owners having to sell off SDIRA assets or pull back from ownership or management of a family business to become compliant, for example.

Reactions to the proposal

Some speculate this is a response to media reports of wealthy individuals abusing SDIRAs to shield taxation of income from massive investment into private companies at their early (and less valuable) stages. But some critics note that many SDIRA owners who invest in private family businesses are not wealthy.

Some use SDIRAs because they do not want to purchase mainstream, highly regulated investments and would rather invest into their local communities or make choices in support of particular social causes. These kinds of owners may object if they feel forced to support Wall Street when they want to support Main Street, so to speak.

On the other hand, without the regulatory oversight of traditional investments, the assets in SDIRAs tend to be riskier, especially for people without investment experience. Tightening investment into business startups arguably could make SDIRAs more stable and better able to grow into solid retirement assets.

Investing for retirement into a family business seems like a win-win, both for the business and for the growth of the SDIRA. But if the owner is an officer or major owner, supporters of the proposal may argue that the owner with both hats may be tempted to make business decisions better for their SDIRA than for the business. It may be harder to maintain the distance needed not to engage in prohibited self-dealing. Violating IRA rules could bring major regulatory penalties, even potentially the loss of the tax advantages of the SDIRA.

We will monitor this proposal and keep our readers apprised.



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