A Brief Review of Who is a Disqualified Person to Your IRA

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A Self-Directed IRA is a very powerful tool for your wealth accumulation, but there are rules you need to understand and comply with to avoid making mistakes that can destroy your IRA. In this post I provide a brief summary of the disqualified persons rules. A disqualified person is one who cannot directly or indirectly enter into or benefit from any transaction in your Self-Directed IRA. Not only must you understand who is on the list of disqualified persons to your IRA, but also who is not a disqualified person.

 

There are nine categories of disqualified persons. They are as follows:

Category 1—a fiduciary, including the Account Owner

Category 2—a service provider to the plan

Category 3—an employer any of whose employees are covered by the plan

Category 4—an employee organization any of whose members are covered by the plan

Category 5—an owner of 50% or more of an employer (Category 3) or employee organization (Category 4)

Category 6—Members of the family of any individual in Categories 1-5

Category 7—a disqualified entity owned 50% or more by a fiduciary (Category 1); a person providing services to the plan (Category 2); an employer (Category 3); an employee organization (Category 4); or an owner of 50% or more of an employer or employee organization (Category 5)

Category 8—certain officers, directors, shareholders, and employees of an employer (Category 3), an employee organization (Category 4), the owner of 50% or more of an employer or an employee organization (Category 5), or a disqualified entity (Category 7)

Category 9—a 10% or more partner of a person who is an employer (Category 3), an employee organization (Category 4), an owner of 50% or more of an employer or employee organization (Category 5), or a disqualified entity (Category 7)

Now let’s analyze a fact pattern to see how these rules apply.

Assume James owns more than 50% of Happy Pappy Investments, Inc., Jane owns more than 10%, and Judy owns less than 10%. James is CEO, Jane is president, Alice is executive vice president, and Krystal is the department head for the acquisitions team of Happy Pappy. Krystal has been with Happy Pappy for several years and makes more than 10% of the total wages of the company. James’s daughter Rhonda works for Happy Pappy as a customer service agent but does not make 10% or more of the wages of Happy Pappy. All the individuals listed wisely have their IRAs with Goode Trust Company, which is owned more than 50% by its President Betty Adamson, who is married to Barney Adamson. James also has an HSA at Goode Trust Company, which is funded by contributions from Happy Pappy.

Who is a disqualified person to James’s HSA in this fact pattern?

James is a disqualified person to his HSA under Category 1, since he is a fiduciary to his own HSA, and a fiduciary is a disqualified person.

Happy Pappy Investments, Inc. is a disqualified person under Category 7 because James, a fiduciary to his HSA, is a disqualified person and he owns more than 50% of Happy Pappy. Happy Pappy Investments, Inc. is also a disqualified person under Category 3 because Happy Pappy is an employer, any of whose employees are covered by the HSA plan.

James is also disqualified under Category 5 because he is the owner of 50% or more of Happy Pappy Investments, Inc., an employer any of whose employees are covered by the HSA plan.

Finally, since James is the CEO of Happy Pappy Investments, Inc., and Happy Pappy is a disqualified entity under Categories 3 and 7, he is a disqualified person under Category 8 as well.

Jane is a disqualified person under Category 8 because she owns more than 10% of Happy Pappy Investments, Inc. and is an officer of Happy Pappy, which is a disqualified person under Categories 3 and 7.

Alice is a disqualified person under Category 8 since she is an officer of Happy Pappy, which is a disqualified person under Categories 3 and 7.

Judy makes less than 10% of the wages of Happy Pappy and is not a 10% or more shareholder or an officer, so she isn’t disqualified.

Krystal is a disqualified person under Category 8 since she is a person who makes 10% or more of the wages of Happy Pappy, which is a disqualified person under Categories 3 and 7.

Rhonda is a disqualified person under Category 6 since she is a family member of James, who is a disqualified person under Categories 1 and 5.

Goode Trust Company is a service provider to James’s HSA, so it is a disqualified person or entity under Category 2.

Betty is not a disqualified person, even though she is a more than 50% owner and officer of Goode Trust Company. Goode Trust Company is a service provider to James’s HSA under Category 2 and therefore a disqualified person. However, the fact pattern does not indicate that Betty individually is a service provider. To fall under Category 8, Betty would have to be a manager, director, 10% or more shareholder, or an employee earning 10% or more of the wages of one of the following:

  • an employer any of whose employees are covered by the plan (Category 3)
  • an employee organization any of whose members are covered by the plan (Category 4)
  • the owner of 50% or more of an employer or employee organization (Category 5)
  • a disqualified entity under Category 7, which is defined as being an entity owned 50% or more by—
  • a fiduciary (Category 1)
  • a person providing services to the plan (Category 2)
  • an employer (Category 3)
  • an employee organization (Category 4)
  • an owner of 50% or more of an employer or employee organization (Category 5)

Since Betty is not individually a service provider under Category 2, the fact that she owns more than 50% of Goode Trust Company is not relevant.

Barney, Betty’s husband, is not a disqualified person under Category 6 because he is not a family member of a fiduciary, a service provider, an employer, an employee organization, or the 50% or more owner of an employer or employee organization.

Were you able to identify all of the disqualified persons in the scenario and identify why they were disqualified? If not, I recommend that you buy my book Self-Directed IRA Secrets Revealed. Appendix A provides a detailed description of the disqualified persons rules. You can purchase a copy by clicking here: [link to purchase page].

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