2019 Tax Reporting for Your Self-Directed IRA

self directed ira taxSelf-Directed IRA investors must be aware of their self-directed IRA tax reporting responsibilities.  Some of these items are completed by your IRA custodian and others are the IRA owner’s sole responsibility. Here’s a quick summary of what should be reported to the IRS each year for your self-directed IRA. Make sure you know how these items are coordinated on your account as the ultimate authority and responsible tax person on the account is, you, the account owner.

IRA Custodian Files

Your IRA Custodian will file the following forms to the IRS annually. As a custodian of IRAs, Directed IRA & Directed Trust Company, we electronically file these with the IRS on every account. Different versions of these forms are completed for HSA and Coverdell/ESA accounts.

IRS FORM PURPOSE WHAT DOES IT REPORT
Form 5498 Filed to the IRS by your custodian. No taxes are due or paid as a result of Form 5498.  

IRA contributions, Roth conversions, the account’s fair market value as of 12/31/19, and required minimum distributions taken.

 

Form 1099-R Filed to the IRS by your custodian to report any distributions or Roth conversions. The amounts distributed or converted are generally subject to tax and are claimed on your personal tax return. IRA distributions for the year, Roth IRA conversions, and also rollovers that are not direct IRA trustee-to-IRA trustee.

IRA Owner’s Responsibility

Depending on your self-directed IRA investments, you may be required to file the following tax return(s) with the IRS for your IRA’s investments/income:

IRS FORM DOES MY IRA NEED TO FILE THIS? DUE DATE
1065 Partnership Tax Return If your IRA is an owner in an LLC, LP, or other partnership, then the partnership should file a 1065 tax return for the company to the IRS, and should issue a K-1 to your IRA for its share of income or loss. Make sure the accountant preparing the company return knows to use your custodian’s tax ID for your IRA’s K-1s, and not your personal SSN (or your IRA’s tax ID if it has one for UBIT 990-T tax return purposes). If your IRA owns an LLC 100%, then it is disregarded for tax purposes (a single-member LLC), and the LLC does not need to file a tax return to the IRS. March 15th, 6-month extension available
990-T IRA Tax Return (UBIT) If your IRA incurs Unrelated Business Income Tax (UBIT), then it is required to file a tax return. The IRA files a tax return and any taxes due are paid from the IRA. Most self-directed IRAs don’t need to file a 990-T for their IRA, but you may be required to file for your IRA if your IRA obtained a non-recourse loan to buy a property (UDFI tax), or if your IRA participates in non-passive real estate investments such as: Construction, development, or on-going short-term flips. You may also have UBIT if your IRA has received income from an active trade or business, such as a being a partner in an LLC that sells goods and services (C-Corp dividends exempt). Rental real estate income (no debt leverage), interest income, capital gain income, and dividend income are exempt from UBIT tax. April 15th, 6 -month extension available

Most Frequently Asked Questions

Below are my most frequently asked questions related to your IRA’s tax reporting responsibilities:

Q: My IRA is a member in an LLC with other investors. What should I tell the accountant preparing the tax return about reporting profit/loss for my IRA?

A: Let your accountant know that the IRA should receive the K-1 (e.g. ABC Trust Company FBO John Doe IRA) and that they should use the tax ID/EIN of your custodian and not your personal SSN. Contact your custodian to obtain their tax ID/EIN. Most custodians are familiar with this process, so it should be readily available. We are providing that number regularly to clients this time of year at Directed IRA & Directed Trust Company. If your IRA has a tax ID/EIN because you file a 990-T for Unrelated Business Income Tax then you can provide that tax ID/EIN.

Q: Why do I need to provide an annual valuation to my custodian for the LLC (or other company) my IRA owns?

A: Your IRA custodian must report your IRA’s fair market value as of the end of the year (as of 12/31/19) to the IRS on Form 5498, and in order to do this they must have an accurate record of the value of your IRA’s investments. If your IRA owns an LLC, they need to know the value of that LLC. For example, let’s say you have an IRA that owns an LLC 100% and that this LLC owns a rental property, and that it also has a bank account with some cash. If the value of the rental property at the end of the year was $150,000, and if the cash in the LLC bank account is $15,000, then the value of the LLC at the end of the year is $165,000.

Q: I have a property owned by my IRA and I obtained a non-recourse loan to purchase the property. Does my IRA need to file a 990-T tax return?

A: Probably. A 990-T tax return is required if your IRA has income subject to UBIT tax. There is a tax called UDFI tax (Unrelated Debt Financed Income) that is triggered when your IRA uses debt to acquire an asset. Essentially, what the IRS does in this situation is they make you apportion the percent of your investment that is the IRA’s cash (tax favorable treatment) and the portion that is debt (subject to UDFI/UBIT tax) and your IRA ends up paying taxes on the profits that are generated from the debt as this is non-retirement plan money. If you have rental income for the year, then you can use expenses to offset this income. However, if you have $1,000 or more of gross income subject to UBIT, then you should file a 990-T tax return. In addition, if you have losses for the year, you may want to file 990-T to claim those losses as they can carry-forward to be used to offset future gains (e.g. sale of the property).

Q: How do I file a 990-T tax return for my IRA?

A: This is filed by your IRA and is not part of your personal tax return. If tax is due, you will need to send the completed tax form to your IRA Custodian along with an instruction to pay the tax due and your custodian will pay the taxes owed from the IRA to the IRS. Your IRA must obtain its own Tax ID to file Form 990-T. Your IRA custodian does not file this form or report UBIT tax to the IRS for your IRA. This is the IRA owner’s responsibility. Our law firm prepares and files 990-T tax returns for our self-directed IRA and 401(k) clients. Contact us at the law firm if you need assistance.

Sadly, not many professionals are familiar with the rules and tax procedures for self-directed IRAs, so it is important to seek out those attorneys, accountants, and CPAs who can help you understand your self-directed IRA tax reporting obligations. Our law firm routinely advises clients and their accountants on the rules and procedures that I have summarized in this article and we can also prepare and file your 990-T tax return.

New Solo 401(k) Contribution Deadlines: Rules, Steps, and Strategies

As 2019 comes to an end, it is critical that Solo 401(k) owners understand when and how to make their 2019 contributions. There are three important deadlines you must know if you have a Solo 401(k) or if you plan to set one up still in 2019. A Solo 401(k) is a retirement plan for small business owners or self-employed persons who have no other full-time employees other than owners and spouses. It’s a great plan that can be self-directed into real estate, LLCs, or other alternative investments, and allows the owner/participants to contribute up to $56,000 per year (far more and faster than any IRA).

New Solo 401(k) Set-Up Deadline is 12/31/19

First, in order to make 2019 contributions, the Solo 401(k) must be adopted by your business by December 31st, 2019. If you haven’t already adopted a Solo 401(k) plan, you should start now so that documents can be completed and filed in time. If the 401(k) is established on January 1st, 2020 or later, you cannot make 2019 contributions.

2019 Contributions Can Be Made in 2020

Both employee and employer contributions can be made up until the company’s tax return deadline including extensions. If you have a sole proprietorship (e.g. single member LLC or schedule C income) or C-Corporation, then the company tax return deadline is April 15th, 2020. If you have an S-Corporation or partnership LLC, the deadline for 2019 contributions is March 15th, 2020. Both of these deadlines (March 15th and April 15th) to make 2019 contributions may be extended another six months by filing an extension. This a huge benefit for those that want to make 2019 contributions, but won’t have funds until later in the year to do so.

W-2’s Force You to Plan Now

While employee and employer contributions may be extended until the company tax return deadline, you will typically need to file a W-2 for your wages (e.g. an S-Corporation) by January 31st, 2020. The W-2 will include your wage income and any deduction for employee retirement plan contributions will be reduced on the W-2 in box 12. As a result, you should make your employee contributions (up to $19,000 for 2019) by January 31st, 2020 or you should at least determine the amount you plan to contribute so that you can file an accurate W-2 by January 31st, 2020. If you don’t have all or a portion of the funds you plan to contribute available by the time your W-2 is due, you can set the amount you plan to contribute to the 401(k) as an employee contribution, and will then need to make said contribution by the tax return deadline (including extensions).

Example

Now let’s bring this all together and take an example to outline how this may work. Sally is 44 years old and has an S-Corporation for her online business. She is the only owner and only employee, and had a new Solo 401(k) established in 2019. She has $120,000 in net income for the year and will have taken $50,000 of that in wage income that will go on her W-2 for the year. That will leave $70,000 of profit that is taxable to her and that will come through to her personally via a K-1 from the business. Sally has not yet made any 2019 401(k) contributions, but plans to do so in order to reduce her taxable income for the year and to build a nest egg for retirement. If she decided to max-out her 2019 Solo 401(k) contributions, it would look like this:

  1. Employee Contributions – The 2019 maximum employee contribution is $19,000. This is dollar for dollar on wages so you can contribute $19,000 as long as you have made $19,000. Since Sally has $50,000 in wages from her S-Corp, she can easily make an $19,000 employee contribution. Let’s say that Sally doesn’t have the $19,000 to contribute, but will have it available by the tax return deadline (including extensions). What Sally will need to do is let her accountant or payroll company know what she plans to contribute as an employee contribution so that they can properly report the contributions on her payroll and W-2 reporting. By making an $19,000 employee contribution, Sally has reduced her taxable income on her W-2 from $50,000 to $31,000. At even a 20% tax bracket for federal taxes and a 5% tax bracket for state taxes that comes to a tax savings of $4,750.
  1. Employer Contributions – The 2019 maximum employer contribution is 25% of wage compensation not to exceed $56,000 total. Since Sally has taken a W-2 wage of $50,000, the company may make an employer contribution of $12,500 (25% of $50,000). This contribution is an expense to the company and is included as an employee benefit expense on the S-Corporation’s tax return (form 1120S). In the stated example, Sally would’ve had $70,000 in net profit/income from the company before making the Solo 401(k) contribution. After making the employer matching contribution of $12,500 in this example, Sally would then only receive a K-1 and net income/profit from the S-Corporation of $57,500. Again, if she were in a 20% federal and a 5% state tax bracket, that would create a tax savings of $3,125. This employer contribution would need to be made by March 15th, 2019 (the company return deadline) or by September 15th, 2019 if the company were to file an extension.

In the end, Sally would have contributed and saved $31,000 for retirement ($18,500 employee contribution, $12,500 employer contribution). And she would have saved approximately $7,750 in federal and state taxes. That’s a win-win.

Keep in mind, you need to start making plans now and you want to begin coordinating with your accountant or payroll company as your yearly wage information on your W-2 (self-employment income for sole props) is critical in determining what you can contribute to your Solo 401(k). Also, make certain you have the plan set-up in 2019 if you plan to make 2019 contributions. While IRAs can be established until April 15th, 2020 for 2019 contributions, a Solo K must be established by December 31st, 2019 if you want to make 2019 contributions. Don’t get the two confused, and make sure you’ve got a plan for your specific business.

Note: If you’ve got a single member LLC taxed as a sole proprietorship, or just an old-fashioned sole prop, or even or an LLC taxed as a partnership (where you don’t have a W-2), then please refer to our prior article here on how to calculate your Solo K contributions as they differ slightly from the s-corp example above.

We can help in establishing your solo(k) at KKOS Lawyers using our IRS pre-approved solo(k) plan documents where you can self-direct the solo(k) and have checkbook control right out of the plan. We also assist with the plan quarterly statements and IRS required plan document updates at Directed Trust Company.

 

Self-Directed IRA Versus Solo 401(k)

Many self-directed investors have the option of choosing between a self-directed IRA or a self-directed solo 401k. Both accounts can be self-directed so that you can invest into any investment allowed by law such as real estate, LLCs, precious metals, or private company stock. However, depending on your situation, you may choose one account type over the other. What are the differences? When should you choose one over the other?

We’ve been advising clients for over a decade on self-directed IRAs and solo 401(k)s and what we’ve learned is that there is no universal answer to the question. Instead, you need to learn what is best based on your personal situation and investment objectives. Do you even qualify for a solo(k)? What investments do you plan to make and does one account type make a difference for your investments? The good news is that either way you go, we can help with a self-directed IRA at Directed IRA, where we are a licensed trust company and can serve as custodian of your IRA. Or, we can set-up a solo(k) at KKOS Lawyers using our pre-approved plan documents.

 IRA Solo 401K
Qualification Must be an individual with earned income or funds in a retirement account to rollover. Must be self-employed with no other employees besides the business owner and family/partners.
Contribution Max $6,000 max annual contribution. Additional $1,000 if over 50. $56,000 max annual contribution (it takes $140K of wage/se income to max out). Contributions are employee and employer.
Traditional & Roth You can have a Roth IRA and/or a Traditional IRA. The amount you contribute to each is added together in determining total contributions. A solo 401(k) can have a traditional account and a roth account within the same plan. You can convert traditional sums over to Roth as well.
Cost and Set-Up You will work with a self-directed IRA custodian who will receive the IRA contributions in a SDIRA account. Most of the custodians we work with have an annual fee of $300-$350 a year for a self-directed IRA. You must use an IRS pre-approved document when establishing a solo 401k. This adds additional cost over an IRA. Our fee for a self-directed and self-trusteed solo 401(k) is $995 with atty consultation or $495 for the plan only.
Custodian Requirement An IRA must have a third party custodian involved on the account (e.g. bank. Credit union, trust company) who is the trustee of the IRA. Of course we recommend our company, www.directedira.com. A 401(k) can be self trustee’d, meaning the business owner can be the trustee of the 401(k). This provides for greater control but also greater responsibility.
Investment Details A self-directed IRA is invested through the self directed IRA custodian. A self-directed IRA can be subject to a tax called UDFI/UBIT on income from debt leveraged real estate. A Solo 401(k) is invested by the trustee of the 401(k) which could be the business owner. A solo 401(k) is exempt from UDFI/UBIT on income from debt leveraged real estate.

Keep in mind that the solo 401(k) is only available to self-employed persons while the self-directed IRA is available to everyone who has earned income or who has funds in an existing retirement account that can be rolled over to an IRA.

Conclusion

Based on the differences outlined above, a solo 401(k) is generally a better option for someone who is self-employed and is still trying to maximize contributions as the solo 401(k) has much higher contribution amounts. On the other hand, a self-directed IRA is a better option for someone who has already saved for retirement and who has enough funds in their retirement accounts that can be rolled over and invested via a self-directed IRA as the self-directed IRA is easier to and cheaper to establish.

Another major consideration in deciding between a solo 401(k) and self-directed IRA is whether there will be debt on real estate investments. If there is debt and if the account owner is self-employed, they are much better off choosing a solo 401(k) over an IRA as solo 401(k)s are exempt from UDFI tax on leveraged real estate.

Choosing between a self-directed IRA and a solo 401(k) is a critical decision when you start self-directing your retirement. Make sure you consider all of the differences before you establish your new account.

Stuck With a 401K Loan and Leaving Your Job

Have you taken a loan from your employer 401(k) plan and plan on leaving? Unfortunately, most company plans will require you to repay the loan within 60 days, or they will distribute the amount outstanding on the loan from your 401(k) account. Its one of the ways they try to keep their employees from leaving. “Don’t leave or we’ll distribute your 401(k) loan that you took from your money in your 401(k) account.”

How to Buy Yourself More Time & Avoid the Distribution

The good news is that following the Tax Cuts and Jobs Act (TCJA) you now have the option to re-pay the loan to an IRA to avoid the distribution and you have until your personal tax return deadline of the following year (including extensions) to contribute that re-payment amount to an IRA. By re-paying the amount outstanding on the loan to an IRA, you will avoid taxes and penalties that would otherwise arise from distribution of a participant 401(k) loan.

How It Works In Practice

Let’s say you left employment from your employer in February 2019 and that you had a 401(k) loan that was distributed by your employer’s plan following your termination of employment. You will have until October 15th of 2020 (if you extend your personal return, 6 month extension from April 15th) to make re-payment of the amount that was outstanding on the loan to an IRA. These funds are then treated as a rollover to your IRA from the 401(k) plan and your distribution and 1099-R will be reported on your federal tax return as a rollover and will not be subject to tax and penalty. While it’s not perfect it’s far great time than was previously allowed. Traditionally, you had 30 or 60 days at most to try to make re-payment.

Limitations

The ability to rollover an outstanding 401(k) loan amount to an IRA is only available when you have left an employer (for any reason). It does not apply in instances where you are still employed and have simply failed to re-pay the loan or to make timely payments.