Rocket dollar gets many FAQs about reducing or eliminating tax liabilities for startup shares an employee already owns through an IRA.
You cannot eliminate tax liabilities for startup shares you already own OR startup shares earned through work at your company, whether that is a share or an option. There is no way around paying tax for these shares already personally owned or earned through work at your company. There are strict rules related to Self-Dealing, and breaking them will cause a distribution of your entire IRA.
You cannot WORK for shares and then put them into your IRA. It does not matter the nature of your work or how you are related to the company. You must BUY the shares. If shares get added to your IRA as a condition of your employment, it is a prohibited transaction. You must approach the company separately and purchase the shares.
I've heard a lot about startup shares in an IRA, so how are people getting tax-free investments in Traditional and Roth IRAs?
Investors are buying shares at market rates, receiving no employee advantages connected to their own contract of employment. You can buy from another employee as long as that employee is not a prohibited person. You could also take advantage of a private market or another a non-employee investor. Your IRA can also approach the company as an investor in a current or upcoming raise or investment opportunity.
What if I no longer work at the company I want to invest in?
Whether you were granted shares or options it is prohibited to use your IRA to invest in shares or options that were previously granted to you. In this case, it would result in a self-dealing situation.
You can own new shares of a private company, through fair market price, a venture fund, or private placement that you do not currently own. To learn more about how to invest in other private companies please review our previous article here.
How does my company ownership levels affect my ability to invest with my IRA?
You must always add personal share ownership levels with your IRA and potentially your family if your family also owns shares of the startup and is a prohibited person.
Red Light: Over 50%
Yellow Light: 49% - 10%
Green Light: <10% *
*If you have a key position of control, you should still be careful investing. If you have complete control, such as a CEO position, you should likely never invest. It is almost impossible to properly divorce yourself from a conflict of interest between you and your IRA.
What rules should I keep in mind?
Self-Dealing - You cannot buy or sell any assets between yourself and your IRA (or startup options you have not officially bought). You cannot use your work or "sweat equity" to get the beneficial monetary value of free shares into your IRA. Breaking this rule would allow you to avoid valid tax liabilities and receive undo benefits to your IRA, where shares were bought at "employee prices" rather than fair market prices, and investors coming in blind to the company might expect.
Disqualified Persons - Usually, people think of family members, such as spouse, parent, child, or grandparent, but startup employees must be most mindful of "key employees" and how they can become disqualified persons. A transaction with disqualified persons, such as a CEO buying share from their co-founder and CFO, could lead to a prohibited transaction and IRA distribution. An officer, director, or 10% or more shareholder, or highly compensated employee (earns 10% or more of the company's wages) of a company owned by an IRA owner or other disqualified persons. IRC § 4975 (e)(2)(H)(G).
What is an example of someone acquiring shares in an IRA?
So a non-officer (Employee A) of a startup owns 5% of a company as a taxable asset. They want to add some shares of the company stock to their IRA, which would push their total ownership levels to 7% overall. When considering the 10% and then 50% rules, Employee A remembers to add their IRA ownership and personal ownership together.
The IRA investor needs to buy shares from someone else at the company or the company itself. Employee A talks to an Employee B that is leaving the company and agrees to buy 2% more of the company by sending dollars from their IRA LLC.
Employee A had plenty of startup shares and options at their disposal, but would not be able to buy them without a prohibited transaction. Employee A decides to purchase the shares at the market rate, equal to a recent valuation, from Employee B.