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Comment by nrmitchi | Hacker News Reader

What I don't understand about this whole maneuver is that Roth transactions must be made at arms length; ie, "Transactions must be made at arm’s length and not involve the IRA owner or a member of his or her family."

An example of this is that if you use a Roth to invest in property, you are not allowed to use it personally, not allowed to manage it or do maintenance yourself, etc.

Prohibited transactions risk tainting (and thus exposing) the entire account.

How is Thiel investing in his own company not considered a prohibited investment?

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>"How is Thiel investing in his own company not considered a prohibited investment?"

It should be, but the IRS doesn't catch every cheat, and as with most other white collar crime, the responsibility can be laundered through a number of accountants and other professional staff, resulting in fines rather than jail time.

So a lot of rich people make a lot of questionable calls regarding how their assets are categorized and if they get caught out they generally just pay what they're supposed to have paid, or sometimes slightly less (some countries have legislation prohibition tax authorities from accepting settlement offer at under-assessed amounts, but there are ways around that too). If they're particularly risk-averse and ballsy, they'll ask for an advance ruling certificate or another pre-emptive ruling on their filings to confirm they're correct beforehand. You can bake those too, if needed.

1. Thiel was not rich when he did this. He was 32 with $2K tucked away in a Roth, maybe more in a standard IRA.

2. What he did was in no way illegal. He did not cheat the system. The IRS would have come down on him with a hammer already, and they haven't managed to figure out how to do it for the last decade.

1. Thiel was not Mega rich, but he had money, he had worked as a lawer for a few years and managed his own venture capital firm. Either way, this is irrelevant as he met the income requirements to contribute to an IRA.

2. It very well may have been illegal, as mentioned in the top level post. The purchase price was the legal value, but using an IRA as a vehicle to invest in your own company appears be prohibited by IRA regulations. At the time, it was a purchase <$2000, and may not have been reviewed. If paypal was someone else's company, there would be no legal issue.

essentially it seems that his venture capital firm IS his Roth IRA - and it was making the investments - definitely not hands off

>The IRS would have come down on him with a hammer already

Part of my work is in financial investigations. The finances of large, multi-entity organizations are expensive to create, difficult to parse, and require extensive periods of time of trained, expensive staff to understand.

Assuming that 'things would have been caught' flies in the face of the fact that they almost never are. Accounting rules change frequently, software systems for logging information is changed, and records are lost. Emails have to be read in tandem with entries to understand the intentions.

Even in cases where we have confessions that someone has embezzled money, we often need to spend multiple weeks tracking down records to isolate when/where/how it occurred.

Even during audits, requests for records can be baked. 'Random' samples of given entries can just exclude the questionable ones.

I've appeared in front of federal tax courts in my practice, the game isn't fair - don't base your reasoning on the idea that it must be.

Sorry, what does "bake a request for records" mean?

IRAs can be shareholders in anything. They can be 100% shareholders as well. They can even form their own companies from the beginning.

Being a minor shareholder in a corporation isn't a prohibited transaction or run afoul of self dealing regulations.

Even in circumstances that they would, you having less than X% of voting shares mitigates that, the X depending on what type of tax deferred or exempt entity is in question. SOME tax deferred/exempt entities have stricter self dealing regulations and even they wouldnt have had an issue here as Peter Thiel was one of several co-founders.

But if you work for a company owned mostly by your Roth IRA, that's easily abused.

Suppose you're a consultant and your one-person consulting company is owned by your Roth IRA. You could deliberately draw a very small taxable salary, so that most of your work goes towards increasing the company's untaxed value in your IRA.

You're basically making your earnings tax free.

Obviously, your Roth IRA's company employing you at below market rate isn't a fair, arms length transaction.

Okay. Don't mess it up.

The problem would be buying the company with the roth, not the wages afterwards.

It is completely legal to own a company and pay yourself below market rate, or even not at all. In fact, it is how many small business work.

In your example, the company still has to pay corporate tax, even though it is owned by the IRA.

The only tax advantage to your consulting scheme would come at the time you sold it to someone else, or liquidated it.

It is not legal to own an USA S-Corp and pay yourself a below market rate.

That is a good point. S-Corps are an exception, because the corporations do not handle income tax the way a C-corp would.

>But if you work for a company <i>owned mostly by your Roth IRA</i>, that's easily abused.

As I understand it, you can't own a company that you(or a relative) own a controlling interest in with your IRA. I can see the sense in this because if own 20% the person(people) who own the other 80% have an incentive to make sure I'm not playing any kind of games with the finances.

In the case of Thiel, it seems like he took $2000 and made a moonshot investment in Paypal. At that point his investment could have just as easily went to $0 as it was to hit $5 billion. He took the risk, why shouldn't he have gotten the reward?

> He took the risk, why shouldn't he have gotten the reward?

And he should get the reward, minus capital gains tax.

This country provided an environment for that investment to turn into five billion. He couldn't have done the same thing in Somalia, or Vietnam, or Greece. Why shouldn't it reap its share?

Nearly everyone else pays their fair share of taxes.

He invested a tax advantaged $2000. If he had invested that $2000 in the S&P 500 in 1995 he would have a tax advantaged $25,000. He would have been out that tax advantaged $25,000 if paypal didn't take off. Instead he decided to make a much longer shot bet and for him it paid off.

I can understand adding legislation that would tax distributions on Roth IRA's for billionaires. Thiel would be fine if he had to pay taxes on that windfall.

I just think that it is a mischaracterization that he isn't paying his fair share of taxes. To me, it doesn't seem like he did anything wrong. He took advantage of a system that is accessible to everyone.

The issue is as far as people can tell he illegally invested 2000$ from an IRA. You’re not allowed to invest in a company with an IRA if:

an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G) https://uscode.house.gov/view.xhtml?hl=false&edition=1994&re...

Being the CEO clearly qualifies. That said, the statute of limitations means you can often get away with things if they go unreported for long enough. It may be he’s currently in the clear.

The article says he was audited.

> In 2011, Thiel caught the attention of the IRS. The agency launched an audit, tax records show. The records don’t spell out what the IRS was looking at or if it involved Thiel’s Roth. Whatever the case, the audit was closed years later and Thiel didn’t owe any more taxes, tax records show.

He was CEO of PayPal until 2002, which means in 2011 this would presumably be past the statute of limitations for many things. It’s unclear if this falls under Tax Fraud or not.

> That said, the statute of limitations means you can often get away with things if they go unreported for long enough.

What I find most interesting in regards to this is that by the time there was any reportable gain (2002 sale), and thus any reason it would even be looked at, the 3 year statute of limitations would be up on the initial prohibited transaction. Which is... interesting.

> Nearly everyone else pays their fair share of taxes.

It seems the whole point of these Roth IRA is so people don't have to pay their fair share of taxes. I'd blame the government for creating that.

I think the problem is these IRAs were not designed to shield the super rich from taxes. It's meant to help the average person. Implemented properly it should have an upper limit, probably under a million dollars. Letting it grow to five billion tax free is a loophole that shouldn't exist and does not benefit society at large.

> IRAs can be shareholders in anything. They can be 100% shareholders as well. They can even form their own companies from the beginning. > Being a minor shareholder in a corporation isn't a prohibited transaction or run afoul of self dealing regulations.

Yes, obviously, and is exactly how the real estate example I provided works. The IRA opened a company. Obviously it is a company in order to financially benefit the owner of the IRA. That's literally the whole point of investing, and is not what I am debating here.

It is different when you are then taking an active role in the day-to-day management and/or operation of that business, which is obviously what Thiel did at PayPal.

Oh by property that to you meant real estate, I didnt catch that

Peter Theil did not have 100% voting shares of Paypal, and if he did that went away very soon after with the other co founders and investors diluting him fast enough for it to satisfy IRS regulations.

That would work now as well, but it is also possible that it worked better 22 years ago as the IRS may have lacked clarity back then.

> Peter Theil did not have 100% voting shares of Paypal,

First, that's not the requirement.

> and if he did that went away very soon after with the other co founders and investors diluting him fast enough for it to satisfy IRS regulations.

Your argument here is "even if he made illegal investments into a tax-advantaged account that has set him up to not pay taxes on 50000000000 dollars, we should ignore it because if he made the investment later it wouldn't have been illegal".

By that logic let's just throw out insider trading laws. "Well if he made the investment after the information was public, it would have been fine"

> the IRS may have lacked clarity back then.

They didn't. It was still explicitly not allowed for a officer/director of a company, someone with a similar role, > 10% share-holder, etc to make investments like this with a Roth IRA.

Peter Theil was a 3.5% shareholder in 2002 when it was sold to Ebay

He likely was within the thresholds back in 1999 or very quickly after

its director && >= 10%

not or

but feel free to split hairs about that nuance, this isnt an area the IRS is splitting hairs, they go with the percent ownership

Owning 3.5% after a acquisition by/merger with x.com, and raising $200M in funding is not anywhere near the same thing as owning 3.5% at the time of the Confinity founding (which is apparently why $0.001/share is valid?).

It doesn't matter if the ownership percentage changed quickly throughout the year of 1999

These kinds of sanctions are based on the result by time of reporting or audit, not by their mere action

and as we’ve already gone over, he very well may have chosen to pay a self reported penalty if his accountant’s tax software just spit out that additional number of $2000

I can think of two reasons: (1) It was not his own company when the IRA made the investment. That is, the IRA invests alongside other investors at the founding. Anyone who wants to buy shares at 0.01 is able to do so. He is not dictating some special price that only he gets. (2) If some investors create an SPV to invest in PayPal (e.g. to limit liability), then his IRA becomes an investor in that SPV. He loses management control over that portion of the investment, but when the SPV sells its PayPal shares, it distributes the cash to all investors, including to the IRA.

Easy. He doesn't own the company, shareholders do, and he happens to be a shareholder. If you work for Microsoft, can you buy Microsoft shares in your IRA? Yes. This is why the IRS can't do squat about this. It's completely legal. If he owned a controlling interest (>50%) things would have been different.

If you bought the property as part of an incorporated entity, it would be entirely legal for you to do work or be contracted by that entity.

It appears this transaction would invalidate the IRA under today's law because he was an officer of the company.

(Unclear whether the original law was written that way or whether this loophole was closed sometime after.)

It's still completely legal. These disqualifications only kick in when you own a controlling interest (more than 50%) of an entity.

[0]: https://www.irafinancialgroup.com/learn-more/self-directed-i...

Keep reading the disqualified persons section:

https://news.ycombinator.com/item?id=27621342

It specifically sweeps in classes of people with responsibilities that are held by typical active co-founders: "(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G)"

Very difficult to a) be a cofounder with meaningful equity b) not do any work so this provision doesn't trigger c) keep your equity and d) have it be worth anything.

Oh that is interesting. This must get very complicated for officers or directors of companies in the S&P 500. Could you not buy index funds that hold shares of the company you work for?

They probably just have to buy the shares in taxable accounts.

Edit: misread this. I would be surprised if index/mutual funds are subject to the same rules because holders of an index fund don't own shares in any of the underlying securities.

But then what do they hold in their tax advantaged accounts? Can they not invest in index funds there?

I have to assume you're just feigning naivete here.

First, officers or directors of S&P500 companies are almost definitely above the income level to open a new Roth IRA.

Second, you're really grasping at straws here trying to trace a relatively minuscule investment through mutual fund in order to defend Thiel here.

Someone is saying "Bank robbers are bad because they steal other people's money" and you're sitting over here saying "Well technically when I pick up a penny on the ground, it's not mine. So it's basically the same thing. We have to find a solution that solves both problems at the same time".

> First, officers or directors of S&P500 companies are almost definitely above the income level to open a new Roth IRA.

Backdoor Roth method allows people of any income level to put money in a Roth IRA. I don’t think there’s any income limit to open the account.

I think you are reading into my post too much.

I am trying to wrap my head around these rules regarding IRA transactions. I’m certainly not trying to defend Thiel here. Would you mind pointing me to what in my comment lead you to that conclusion?

Also I would be shocked if there aren’t directors at publicly traded companies making under 208,000 and are filing jointly in a single income household.

He put the shares in when it was still a private company.

So what? You can use your Roth IRA to invest in private companies, buy gold, houses, whatever too.

My guess is he used a self-directed IRA that he converted into a Roth.

did he place the shares into IRA before any outside round though? because otherwise, he would have violated contribution limits?

I would assume he did, unless there is any proof otherwise.

ProPublica specifically omitted this information, so assuming that it was all kosher seems reasonable.

He would have deposited them at company formation when they were essentially worthless.

Right, so this is an example of journalism that reduces people’s trust. Or at least it did mine with regards to ProPublica, which I had previously held in higher regard.

right, but then how did he convert them to roth? roth has contribution limits, right? Ah, there are no limits for backdoor conversion.

You're also not allowed to put ISOs or anything "earned" into a Roth IRA (or buy it from yourself).

The problem here is that this was clearly a prohibited transaction, but the IRS state of limitations is effectively 3 years for stuff like this (unless you have really pissed someone off). It's likely that by the time the stock was worth enough (in terms of 409A guesstimate) to look in to, or there was any kind of reportable transaction showing a gain, the time frame on investigating the initial transaction was long past.

> IRS records show that in 1999 Thiel purchased 1.7 million shares of his startup, which would soon become PayPal, for just $1,700 — a tenth of a penny per share

> Even though Thiel's startup received millions in funding within months, Pensco still told the IRS these founders' shares were worth less than $1,700 at the end of 1999.

Under certain circumstances, there is no statute of limitations. If Pensco did knowingly misrepresent the value of the shares, and if the funding round did imply a wildly different valuation, IRS could still pursue the case.

Yes, that is true.

But I cannot fathom the cries of "IRS Pursuing Investigation against a single Tax Transaction from 20 years ago against vocal Trump supporter" would go over well.

That's not the IRS's problem.

> The problem here is that this was clearly a prohibited transaction

I have been unable to find any source for this claim. Even ProPublica, the people with the original documents and the most incentivized to break the news, do not claim this.

ProPublica making a public claim of a tax crime is much more likely to be considered libel than an insignificant person on HN doing the same.

So people claiming that he committed fraud are just making up stuff.

OR they read the basic rules, regulations, and restrictions about contributing to a Roth IRA and came to a logical conclusion.

>> What I don't understand about this whole maneuver is that Roth transactions must be made at arms length; ie, "Transactions must be made at arm’s length and not involve the IRA owner or a member of his or her family."

Wouldnt this be as simple has investing in another company (managed by external managers) that then invests in your company? I'm sure the wealthy have all sorts of ways to get around this.

All is OK, until they take a closer look (and IRS, I assume will now)

It is IMO but who is going to actually enforce that?

Thats not the issue here

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