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Author: Bob78164 Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121599  
Subject: The Pennsylvania two-step Date: 7/14/1999 12:35 PM
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I'd like to try this variant on an Education IRA strategy that NaggingFool (I think) quite rightly punctured. Here's the background: My brother (who is my youngest sibling) will turn 30 next February. I also have three sisters, two of whom have daughters. No one is contributing to Education IRAs on their behalf. I've got a son due in October.

My idea is to fund a contribution to my nieces' Education IRAs in 1999 and early 2000. As soon as the 2000 contribution shows up in the brokerage statements, they will transfer their accounts to my brother -- their uncle -- as beneficiary, who in turn will transfer the accounts to my son -- his nephew. This strategy lets us fund an Education IRA with $2000 more than we could otherwise manage. If my brother would only marry a younger woman, we could do even better. ;-)

Assuming that my family will cooperate, does this strategy seem viable? The two-step seems necessary to me because I don't believe that cousins are qualifying relatives. But if there's a simpler way to accomplish my goal, I'd love to hear it. --Bob
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Author: WilliamLipp Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17304 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/14/1999 12:56 PM
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Bob78164 Date: 7/14/99 12:35 PM Number: 17302
My idea is to fund a contribution to my nieces' Education IRAs in 1999 and early 2000. As soon as the 2000 contribution shows up in the brokerage statements, they will transfer their accounts to my brother -- their uncle -- as beneficiary, who in turn will transfer the accounts to my son -- his nephew.

If you were an IRA auditor trying to decide if this was real or a sham, would you believe that your neices, of their own free will, chose to give their uncle $2000? If I were conducting the audit, I'd claim it's a no-brainer that this is a sham.

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Author: Bob78164 Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17308 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/14/1999 2:19 PM
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WilliamLipp writes (in part):

If I were conducting the audit, I'd claim it's a no-brainer that this is a sham.

I reply:

Are you sure that sham transaction rules apply in this setting? Let's take a look at a similar issue in a different setting. Suppose I want to transfer money from a former employer's 401(k) plan to a Roth IRA. Now most people know this can't be done directly; rather, the money must first make a brief stopover in a traditional IRA; there to be converted to a Roth IRA. Everyone knows that the substance of the transaction is to effect the forbidden transfer of funds from a 401(k) to a Roth IRA. But no one cares because it's a permitted transaction.

Of COURSE anyone who looks at this for a second will see the presence of a tax planning technique that was intended from the get-go. (And in any event, I have no interest in violating the law, even if I were confident that I would not be caught.) That begs the question. The question is whether the technique is permitted. --Bob

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Author: WilliamLipp Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17311 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/14/1999 3:09 PM
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Bob78164 Date: 7/14/99 2:19 PM Number: 17308
Are you sure that sham transaction rules apply in this setting? Let's take a look at a similar issue in a different setting. Suppose I want to transfer money from a former employer's 401(k) plan to a Roth IRA.

I'm not a tax professional, so I'm never sure about any tax question. The insurmountable difference between these two examples, in my opinion, is the issue of whether be really gave the money to his neices. If he did, then they were free to do anything they wanted with it. I think it stinks of sham that what they wanted to do with it was to give it away, especially since they chose to give it in a way that benefitted him. In your example, there isn't any point in the chain where someone seems to be acting against their own interests, so I don't smell sham there.

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Author: zorloc Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17312 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/14/1999 3:14 PM
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Bob,

I won't say if the technique is technically legal, but it will probably get an immediate audit. When the SSN of your son shows that he has 4 accounts that were funded with $500 contributions (or one account with deposits of ~$2000). The computer will immediately spit your SSN to the auditors for a review. Then, when this technique is reviewed, even if legal, the rest of your return/life will probably be examined to see if there are more boarderline activities, which they might challange.

Low visibility is good. High visibility is bad.

jbw

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Author: Bob78164 Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17313 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/14/1999 6:00 PM
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WilliamLipp writes (in part):

The insurmountable difference between these two examples, in my opinion, is the issue of whether be really gave the money to his neices. If he did, then they were free to do anything they wanted with it.

I reply:

A fair comment. Let me try the following example, which is routinely endorsed on this board and (as far as I know) has not been criticized by anyone. Assume that my income is too high to make an Education IRA contribution for the benefit of my son, and I don't want to deal with the hassle of having him fund his own Education IRA. So I find a willing and eligible relative (say, my sister), to whom I give $500 with the expectation that she will, in turn, fund my son's Education IRA to the tune of $500 (but not the legal obligation to do so). Is the "sham" aspect of this transaction any different from my proposal? --Bob

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Author: Bob78164 Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17314 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/14/1999 6:05 PM
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zorloc writes (in part):

I won't say if the technique is technically legal, but it will probably get an immediate audit.

I reply:

Is your basis for this conclusion simply the technical analysis you present in the rest of your post, or do you have practical experience to back it up? I don't intend criticism; rather, absent an authoritative analysis demonstrating that it violates the I.R.C., I may implement this option notwithstanding the doubts expressed on this board. Knowing the basis for your conclusion will help me evaluate the weight I accord it when I make my decision. --Bob

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Author: zorloc Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17316 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/14/1999 7:20 PM
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Not personal experience, but an partnership down the hall from my previous job attracted an audit from the IRS through some shifty dealings (which were eventually ruled legal), and resulted in a multi-year audit (in both time audited and time the audit took). They lost about 4 times the money (if not more) they made from the shifty actions in dealing with the IRS.

jbw

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Author: WilliamLipp Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17332 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/14/1999 10:32 PM
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Bob78164 Date: 7/14/99 6:00 PM Number: 17313
Assume that my income is too high to make an Education IRA contribution for the benefit of my son, and I don't want to deal with the hassle of having him fund his own Education IRA. So I find a willing and eligible relative (say, my sister), to whom I give $500 with the expectation that she will, in turn, fund my son's Education IRA to the tune of $500 (but not the legal obligation to do so). Is the "sham" aspect of this transaction any different from my proposal?

I'm not sure where this is going. Is the purpose to find a sequence of grays so close to the same shade as to be indistiguishible in adjacent pairs, so we can prove by trasitivity that black is white? I've already made my views known; no one is required to share them, and there very little chance that consideration of these cases will change them.

As my final contribution to this thread - yes this is an intermediate case. Less likely to be caught because there need be no record of the gift to the sister, and unlikely to be audited because the funding total has not been circumvented, and furthermore equivalent to the suggested legal approach of giving the money directly to the child to fund her own EIRA.


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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 17365 of 121599
Subject: Re: The Pennsylvania two-step Date: 7/15/1999 8:13 PM
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[[My idea is to fund a contribution to my nieces' Education IRAs in 1999 and
early 2000. As soon as the 2000 contribution shows up in the brokerage
statements, they will transfer their accounts to my brother -- their uncle -- as
beneficiary, who in turn will transfer the accounts to my son -- his nephew. This
strategy lets us fund an Education IRA with $2000 more than we could
otherwise manage. If my brother would only marry a younger woman, we could
do even better. ;-)

Assuming that my family will cooperate, does this strategy seem viable? The
two-step seems necessary to me because I don't believe that cousins are
qualifying relatives. But if there's a simpler way to accomplish my goal, I'd love
to hear it.]]

My personal opinion is that it has a decent chance of flying. A good point is made about the "substance vs. form" issues. If the IRS could show that the contributions that you are making to your various "older" relatives were never intended to be used by them for educational purposes, and simply as a vehicle to by-pass the law, then the IRS would have a pretty good claim against this "step" transaction.

But if it could be reasonably expected that your "older" relatives would use the funds themselves for qualified educational expenses, then you have a leg up on Uncle Sammy. If they ACTUALLY use the funds or not is not really the point. IRS would be looking at intentions.

Getting caught is not the issue. Being able to support your position is the key. So I believe that if it is well thought out, and your intentions are reasonable and valid (as to your "older" relatives using the funds for education purposes...at least initially), then you've certainly got a fighting chance.

But it is clear that you would not violate the letter of the law. This section of the law was written in such a sloppy fashion that I'm not sure that even the courts would be able to determine what the intent of the Congress was when it was written.

Just my $.02
TMF Taxes
Roy





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