Many self-directed IRA investors use an IRA/LLC to make and hold their self-directed IRA investments. In essence, an IRA/LLC (aka “checkbook-controlled IRA”) is an LLC owned 100% by an IRA. For a summary and description of an IRA/LLC, please refer to my video here. While most self-directed investors are using the IRA/LLC to invest in real estate or other non-publicly traded assets, there are many instances where an IRA/LLC owner would like to invest the cash from their IRA/LLC checking account into stocks or other publicly-traded investments. This may arise with portions of cash that are not yet large enough to make a desired self-directed investment, or when the IRA/LLC is between investments, such as after the sale of an asset or investment and before a new self-directed investment may be found. Or, it could simply arise because the account owner finds a publicly traded opportunity that they would like to pursue using the IRA/LLC account funds and structure.
I. Can My IRA/LLC Establish a Brokerage Account to Buy Stocks?
Yes, an IRA/LLC may have a brokerage account to buy stocks or other publicly traded assets. This account must be established in the name of the LLC. The brokerage account cannot have a margin account whereby account trades on credit. A margin account typically requires the personal guarantee of the underlying IRA/LLC owner, and this would amount to an extension of credit prohibited transaction. Additionally, any profits due from the trading on credit, even if you could get around a personal guarantee, would be subject to unrelated business income tax (UBIT).
II. What Are the Pros and Cons of Having a Brokerage Account with an IRA/LLC That I Should Know About?
Uninvested or accumulating cash from an income producing asset often times sit without earning any income in an IRA/LLC. By having a brokerage account with an IRA/LLC, the cash could be invested into stocks or other publicly traded investments, but could still be somewhat liquid in the event that funds are needed for a self-directed investment.
Most brokerage firms do not have a specific account option for IRA/LLCs. As a result, most brokerage firms will simply treat the brokerage account as an LLC brokerage account. The problem with this is that they will send the IRS and your LLC tax reporting via IRS From 1099-B for trading income. While I’ve had many clients receive and ignore this, because the LLC is owned by their IRA, it does raise concern of an IRS audit for failure to report the 1099-B.
3. Potential Solution
TD Ameritrade has a specialty account for LLCs where you can identify that the account is owned by an IRA. This is optimal as it’s the only LLC brokerage account I’ve come across where the IRA can be identified as the owner of the LLC. Refer to TD Ameritrade’s Specialty Account Page and their account form here.
III. What are the Options?
A second option to establishing a brokerage account with your IRA/LLC is to simply return funds from the LLC back to the self-directed IRA. This is not taxable. It is a return of investment funds or profits to the IRA. Then transfer funds from the self-directed IRA to a brokerage IRA as a trustee-to-trustee transfer. This is also not taxable. Now, you can buy stocks with the IRA funds in the brokerage account. When you would like the funds back in the IRA/LLC for a self-directed investment, you would send funds from the brokerage IRA back to the self-directed IRA as a trustee-to-trustee transfer, and would then invest the funds from the self-directed IRA to the IRA/LLC. While this involves more steps, its cleaner in the end as the brokerage IRA will be set-up with no tax reporting to the IRS on trading income. In the end, both options are viable, but self-directed investors should understand the differences and requirements for each option before proceeding with a brokerage account with their IRA/LLC funds.
Business owners and investors doing business in multiple states often ask the question of whether their company, that is set up in one state needs to be registered into the other state(s) where they are doing business. This registration from your state of incorporation/organization into another state where you also do business is called a foreign registration. For example, let’s say I’m a real estate investor in Arizona and end up buying a rental property in Florida. Do I need to register my Arizona LLC that I use to hold my real estate investments into Florida to take ownership of this property? The answer is generally yes, but after reviewing a few states laws on the subject I decided to outline the details of when you need to register your LLC or Corporation into another state where you are not incorporated/organized. (Please note that the issue of whether state taxes are owed outside of your home state when doing business in multiple states is a different analysis).
In analyzing whether you need to register your out of state company into a state where you do business or own property it is helpful to understand two things: First, what does the state I’m looking to do business in require of out of state companies; and Second, what is the penalty for failure to comply.
When Do I Need to Register Foreign?
First, a survey of a few state statutes on foreign registration of out of state companies shows that the typical requirement for when an out of state company must register foreign into another state is when the out of state company is deemed to be “transacting business” into the other state. So, the next question is what constitutes “transacting business”? The state laws vary on this but here are some examples of what constitutes “transacting business” for purposes of foreign registration filings.
- Employees or storefront located in the foreign registration state.
- Ownership of real property that is leased in the foreign registration state. Note that some states (e.g. Florida) state that ownership of property by an out of state LLC does not by itself require a foreign registration (e.g. a second home or maybe land) but if that property was rented then foreign registration is required.
Here is an example of what does not typically constitute “transacting business” for foreign registration requirements.
- Maintaining a bank account in the state in question.
- Holding a meeting of the owners or management in the state in question.
So, in summary, the general rule is that transacting business for foreign registration requirements occurs when you make a physical presence in the state that results in commerce. Ask, do I have employees or real property in the state in question that generates income for my company? If so, you probably need to register. If not, you probably don’t need to register foreign. Note that there are some nuances between states and I’ve tried to generalize what constitutes transacting business so check with your attorney or particular state laws when in question.
What is the Penalty if I Don’t Register Foreign?
Second, what is the penalty and consequence for failing to file a foreign registration when one was required? This issue had a few common characteristics among the states surveyed. Many company owners fear that they could lose the liability protection of the LLC or corporation for failing to file a foreign registration when they should have but most states have a provision in their laws that states something like the following, “A member [owner] of a foreign limited liability company is not liable for the debts and obligations of the foreign limited liability company solely by reason of its having transacted business in this state without registration.” A similar provision to this language was found in Arizona, California and Florida, but this provision is not found in all states that I surveyed. This language is good for business owners since it keeps the principal asset protection benefits of the company in tact in the event that you fail to register foreign. On the other hand, many states have some other negative consequences to companies that fail to register foreign. Here is a summary of some of those consequences.
- The out of state company won’t be recognized in courts to sue or bring legal action in the state where the business should be registered as a foreign company.
- Penalty of $20 per day that the company was “transacting business” in the state when it should have been registered foreign into the state but wasn’t. This penalty maxes out at $10,000 in California. Florida’s penalty is a minimum of $500 and a maximum of $1,000 per year of violation. Some states such as Arizona and Texas do not charge a penalty fee for failure to file.
- The State where you should have registered as a foreign company becomes the registered agent for your company and receives legal notices on behalf of your company. This is really problematic because it means you don’t get notice to legal actions or proceedings affecting your company and it allows Plaintiff’s to sue your company and to send notice to the state without being required to send notice to your company. Now, presumably, the state will try to get notice to your company but what steps the states actually takes and how much time that takes is something I couldn’t find. With twenty to thirty day deadlines to respond in most legal actions I wouldn’t put much trust in a state government agency to get me legal notice in a timely manner nor am I even certain that they would even try.
- In addition to the statutory issues written into law there are some practical issues you will face if your out of state company is not registered into a state where you transact business. For example, some county recorders in certain states won’t allow title to transfer into your out of state company unless the LLC or corporation is registered foreign into the state where the property is located. It is also common to run into insurance and banking issues for your company until you register foreign into the state where the income generating property, employee, or storefront is located.
In summary, you should register your company as a foreign company in every state where you are “transacting business”. Generally speaking, transacting business occurs when you have a storefront in the foreign state, employees in the foreign state, or property that produces income in the foreign state. Failure to file varies among the states but can result in penalties from $1,000 to $10,000 a year and failure to receive legal notices and/or be recognized in court proceedings. Bottom line, if you are transacting business outside of your state of incorporation/organization you should register as a foreign entity in the other state(s) to ensure proper legal protections in court and to avoid costly penalties for non-compliance.
I’m routinely asked questions about what taxes and rules apply when a distribution occurs from a retirement account. Here are the top ten rules you should know about distributions from retirement accounts.
The First 5 Facts Apply to Traditional IRA and 401(k) Accounts.
1. Early Withdrawal Penalty. A distribution from a traditional IRA or 401(k) before the account owner reaches 59 1/2 causes a 10% early withdrawal penalty on the amount distributed. This is in addition to taxes owed on the amount distributed. So, for example, if you take a $10,000 distribution from your traditional IRA at age 45 then you will be subject to a $1,000 penalty and you will also receive a 1099-R from your IRA custodian and will need to report $10,000 of income on your tax returns. Once you reach age 59 1/2, the 10% early withdrawal penalty does not apply.
2. Required Minimum Distributions. Whether you need the money or not, at age 70 1/2, the IRS requires a traditional IRA or 401(k) owner (unless still employed by employer 401(k)) to begin taking distributions from their retirement account. These distributions are subject to tax and the account owner will receive a 1099-R of the amount distributed that will be included on their tax return. The amount of the distribution is based on the person’s age and the account’s value. For example, someone with a $100K IRA who has turned 70 1/2 and is taking their first RMD would take $3,639 (3.79%).
3. Avoid Taking Large Distributions In One-Year. Because distributions from traditional retirement accounts are subject to tax at the time of distribution, it is wise to avoid taking too much in one year as a large distribution can push your distribution income and your other income into a higher tax bracket. For example, if you have employment and or rental/investment income of $50,000 annually then you are in a joint income tax bracket of 15% on additional income. However, if you take $100,000 as a lump-sum that year this will push your annual income to $150K and you will be in a 28% income tax bracket. If you could instead break up that $100K over two tax years then you could stay in 15% to 25% tax bracket and could reduce your overall tax liability. In short, only pull out what you need when you need it to lesson the immediate year’s tax liability.
4. Distribution Withholding. Most distributions from an employer 401(k) or pension plan (including solo K), before the age of 59 1/2, will be subject to a 20% withholding that will be sent to the IRS in anticipation of tax and penalty that will be owed. In the case of an early distribution from an IRA, a 10% withholding for the penalty amount can be made but you can also elect out of this automatic withholding provided you make an estimated tax payment or that you will otherwise be current on your tax liability.
5. If You Have Tax Losses, Consider Converting to a Roth IRA or Roth 401(k). When you have tax losses on your tax return you may want to consider using those losses to offset income that would arise when you convert a traditional IRA or 401(k) to a Roth account. Whenever you convert a traditional account to a Roth account, you must pay tax on the amount of the conversion. In the end though, you’ll have a Roth account that grows entirely tax-free and that you don’t pay taxes on when you distribute the money. Using the losses when they are available is a good way to get your Traditional retirement funds over to Roth.
The Final 5 Rules are For Roth IRAs and Roth 401(k)s.
1. Roth IRAs Are Exempt from RMD. While traditional IRA owners must take required minimum distributions (“RMD”) when the account owner reaches age 70 1/2, Roth IRAs are exempt from RMD rules. That’s a great perk and allows you to keep your money invested as long as possible.
2. Roth 401(k)s Must Take RMD. Roth 401(k) designated accounts are subject to RMD. This is a confusing rule since Roth IRAs are NOT subject to RMD. Such is the tax code. How can you avoid this? Simply roll your Roth 401(k) funds over to a Roth IRA when you reach 70 1/2.
3. Distributions of Contributions Are Always Tax-Free. Distributions of contributions to a Roth IRA are always tax-free. Regardless of age, you can always take a distribution of your Roth IRA contributions without penalty or tax.
4. Distributions of Roth IRA Earnings. In order to take a tax-free distribution from a Roth IRA, you must be age 59 1/2 or older and you must have had a Roth IRA for five years or longer. As long as those two criteria are met, all amounts (contributions and earnings) may be distributed from a Roth IRA tax free. If your funds in the Roth IRA are from a conversion, then you must have converted the funds at least 5 years ago and must be 59 1/2 or older in order to take a tax-free distribution.
5. Delay Roth Distributions. Roth retirement accounts are the most tax efficient way to earn income in the U.S. As a result, it is best to distribute and use other funds and assets that are at your disposal before using the funds built up in your Roth account as those funds aren’t as tax efficient while invested.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook
Self-Directed IRA investors should be aware of the following IRA tax reporting responsibilities. Some of these items are completed by your 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.
IRA Custodian Files
Your IRA Custodian will file the following forms to the IRS annually:
|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 12/31/17, 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-1’s and not your personal SSN (or your IRAs 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 (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. 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 12/31/17) 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.
For most American workers and business owners, the first vehicle to save and invest in is your 401(k). The tax benefits and the typical company matching that offers free company money make a 401(k) a great place to save and invest for the long-haul. But what if you’ve maxed out your 401(k) contributions? What else can you do?
Here are the three options you should consider that provide significant tax and financial benefits:
1. Back-Door Roth IRA
This is a really cool option that many clients utilize every year. (I do too.) First, you may be thinking that you can’t do a Roth IRA because your income is too high or because you already maxed out your 401(k). WRONG: It is still possible to do a Roth IRA, but you just have to know the back-door route. The reason it’s called a back-door Roth IRA is because you make a non-deductible traditional IRA contribution (up to $5,500 annual limit, $6,500 if 50 or older). Then, after the non-deductible traditional IRA contribution is made, you then convert the funds to Roth. There is no income limit on Roth conversions, and since you didn’t take a deduction on the non-deductible traditional IRA contribution, there is no tax due on the conversion to Roth. And now, voila, you have $5,500 in your Roth IRA. That’s the back-door route.
There is a road block though for some who already have funds already in traditional IRAs. The Roth conversion ordering rules state that you must first convert your pre-tax traditional IRA funds, which you got a deduction for and now pay tax when you convert, before you are able to convert the non-deductible traditional IRA funds. So, if you have pre-tax traditional IRA funds and you want to do the back-door Roth IRA, you have two options:
- First, convert those pre-tax traditional IRA dollars to Roth and pay the taxes on the conversion.
- Second, if your 401(k) allows, you can roll those pre-tax traditional IRA dollars into your 401(k). If you don’t have a traditional IRA, you’re on easy street and only need to do the two-step process of making the non-deductible traditional IRA contribution and then convert it to Roth.
You have until April 15th of each year to do this for the prior tax year. Additionally, while the GOP tax-reform restricted Roth re-characterizations, Roth conversions and the back-door Roth IRA route were unaffected. For more detail on the back-door Roth IRA, check out my prior article here.
2. Health Savings Account (HSA)
If you have a high-deductible health insurance plan, you can make contributions to your HSA up until April 15th of each year for the prior tax year. Why make an HSA contribution? Because you get a tax deduction for doing it, and because that money comes out of your HSA tax-free for your medical, dental, or drug costs. You can contribute and get a deduction, above the line, of up to $3,400 if you’re single or for up to $6,750 for family. We all have these out-of-pockets costs, and this is the most efficient way to spend those dollars (from an account you got a tax deduction for putting money into). If you didn’t have a high deductible HSA-qualifying plan by December 1st of the prior year, then the HSA won’t work.
Any amounts you don’t spend on medical can be invested in the account and grow tax-free for your future medical or long-term care. Health savings accounts can also be invested and self-directed into real estate, LLCs, private companies, crypto-currency or other alternative assets. We’ve helped many clients invest these tax-favored funds using a self-directed HSA.
For more details on health savings accounts, check out my partner Mark’s article here.
3. Cash Balance Plan or Defined Benefit Plan
If you’re self-employed you may consider establishing a cash balance plan or a defined benefit plan (aka “pension”), where you can possibly contribute hundreds of thousands of dollars each year. The amount of your contribution depends on your income, age, and the age and number of employees you may have. A cash balance plan or defined benefit plan/pension will cost you ten thousand dollars or more in fees to establish, and is far more expensive to maintain and administer. But, if you have the income, it’s a valuable option to consider. For more details on cash balance plans, check out Randy Luebke’s article here.