Terry L. Ellis; Sheila K. Ellis, Petitioners - Appellants
Commissioner of Internal Revenue, Respondent - Appellee
Submitted April 14, 2015.
Appeal from the United States Tax Court.
For Terry L. Ellis, Sheila K. Ellis, Petitioners - Appellants: Troy D. Renkemeyer, Renkemeyer Law Firm, Overland Park, KS.
For Commissioner of Internal Revenue, Respondent - Appellee: Richard Farber, John A. Nolet, Gilbert Steven Rothenberg, Senior Attorney, U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC; William Wilkins, Internal Revenue Service, Washington, DC.
Before WOLLMAN and GRUENDER, Circuit Judges, and DOTY, District Judge.
DOTY, District Judge
Terry and Sheila Ellis appeal from the decision of the tax court finding a deficiency in their 2005 income tax and imposing related penalties. Because we conclude that Mr. Ellis engaged in a prohibited transaction with respect to his individual retirement account (IRA), we affirm.
On May 25, 2005, an attorney for Mr. Ellis formed CST Investments, LLC (CST), to engage in the business of used automobile sales in Harrisonville, Missouri. The operating agreement for CST listed two members: (1) a self-directed IRA belonging to Mr. Ellis, and (2) Richard Brown, an unrelated person who worked full-time for CST. The operating agreement contemplated that Mr. Ellis's IRA would provide an initial capital contribution of $319,500 in exchange for a 98 percent ownership in CST, and that Brown would purchase the remaining 2 percent interest for $20. Mr. Ellis was designated as the general manager for CST and given " full authority to act on behalf of" the company. The operating agreement also stated that " the General Manager shall be entitled to such Guaranteed Payment as is Approved by the Members."
Mr. Ellis's IRA did not exist at the time CST was formed. Rather, he established the IRA with First Trust Company of Onaga (First Trust) in June 2005. On June 22, 2005, he received $254,206.44 from a 401(k) that he had established with his previous employer, and he deposited the amount in his IRA. He then directed First Trust as the custodian of the IRA to acquire 779,141 shares of CST at a cost of
$254,000. On August 19, 2005, Mr. Ellis received an additional $67,138.81 from his 401(k), which he again deposited into the IRA. He directed First Trust to acquire an additional 200,859 shares of CST at a cost of $65,500. Mr. Ellis reported the transfers from his 401(k) to the IRA as non-taxable rollover contributions. By the end of 2005, the IRA had a fair market value of $321,253, consisting of its membership interest in CST and $1,773 in cash.
To compensate him for his services as general manager, CST paid Mr. Ellis a salary of $9,754 in 2005 and $29,263 in 2006. The wages were drawn from CST's corporate checking account and were reported as income on the Ellises' joint tax returns for both years. It is unclear whether CST paid the salary pursuant to the guaranteed payment provision in its operating agreement or under Mr. Ellis's authority as general ...