Loans from IRAs Not Permitted

During this difficult economic period, taxpayers struggling financially should be wary of using IRA funds to supplement their income. In a recent real-life example, a taxpayer struggled to pay his business expenses, home mortgage, and family living expenses. To meet those needs, he withdrew funds from his Individual Retirement Account (IRA), which he intended to be a loan and not a distribution. He had previously borrowed money from his 401(k) plan to purchase a home.

However, in this particular case, the Tax Court determined that unlike a loan from a qualified employer plan, i.e., 401(k) plan (which is permitted), a loan from an IRA to its owner is always a prohibited transaction. (There is no exception for loans from an IRA to its beneficiary.) The court’s opinion added that, regrettably, there is no exception to the 10% early distribution tax for amounts used for business and living expenses. (This 10% penalty is in addition to the regular income tax due on the distribution.) Although the taxpayer’s financial circumstances were not unusual during this tumultuous period, the tax code is sometimes unforgiving in its attempts at standardization.

Note: It is permissible to withdraw funds from an IRA and redeposit the same amount back in to an IRA within 60 days to avoid taxation and the 10% penalty.