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.
The IRS announced new contribution amounts for retirement accounts in 2018, and there are some winners and losers in the bunch.
The biggest win goes to 401(k) owners, including Solo K owners, who saw employee contribution amounts go from $18,000 to $18,500. Health savings account (HSA) owners won a small victory with individual contribution maximums increasing $50 to $3,450 and family contribution amounts increasing by $150 to $6,900.
However, IRA owners lost with no increase in the maximum contribution amount for Traditional or Roth IRAs. The IRA maximum contribution amount remains at $5,500 and hasn’t increased since 2013.
Here’s a quick breakdown on the changes:
- 401(k) contributions also increased for employees and employers: Employee contribution limitations increased from $18,000 to $18,500 for 2018. The additional catch-up contribution for those 50 and older stays the same at $6,000. The annual maximum 401(k) (defined contribution) total contribution amount increased from $54,000 to $55,000 ($61,000 for those 50 and older).
- HSA contribution limits increased from $3,400 for individuals and $6,750 for families to $3,450 for individuals and $6,900 for families.
- IRA contribution limitations (Roth and Traditional) stayed at $5,500, as did the $1,000 catch-up amount for those 50 and older.
There were additional modest increases to defined benefit plans and to certain income phase-out rules. Please refer to the IRS announcement for more details here.
These accounts provide tax advantageous ways for an individual to either save for retirement or to pay for their medical expenses. If you’re looking for tax deductions, you should determine which of these accounts is best for you. Keep in mind there are qualifications and phase out rules that apply, so make sure you’re getting competent advice about which accounts should be set up in your specific situation.
There has been a significant increase in the amount of marketing directed towards IRA owners for non-publicly traded investments. Many of these investment sponsors and promoters are using marketing slogans like “IRS Approved” or “IRA Approved”. Don’t be fooled though, as the IRS does not review or approve investments, nor do they comment or issue statements on investments in an IRA. In fact, the IRS recently revised and updated IRS Publication 3125 titled, “The IRS Does Not Approve IRA Investments,” in an effort to inform IRA investors.
IRAs Can Invest into Non-Publicly Traded Investments (Real Estate, LLCs and Precious Metals)
Yes, it’s true that a self-directed IRA can invest into real estate, LLCs, LPs, private stock, venture or hedge funds, start-ups and qualifying precious metals, among other things. However, just because you can invest in all of these assets doesn’t mean that you should. Make sure you’re investing your IRA into assets you are familiar with, and with persons and companies with whom you have thoroughly vetted. Non-publicly traded investments can be easier to understand and vet than a mutual fund prospectus, but you need to be careful when investing your funds with another person or when buying investments from third-parties who regularly sell to IRA owners using comforting, yet totally false, representations like “IRA Approved” or “IRS Approved.”
“IRA Approved” or “IRS Approved” Representations are False
In Publication 3125, “The IRS Does Not Approve IRA Investments,” the IRS provided some guidelines for IRA owners to evaluate and protect their account from “IRA Approved Schemes.”
- Avoid any investment touted as “IRA Approved” or otherwise endorsed by the IRS.
- Don’t buy an investment on the basis of a television “infomercial” or radio advertisement.
- Beware of promises or no-risk, sky-high returns on exotic investments from your retirement account.
- Never transfer or rollover your IRA or other retirement funds directly to an investment promoter.
- Proceed with caution when you are encouraged to invest in a “general partnership” or “limited liability company”.
- Don’t be swayed by the fact that a bank or trust department is serving as an IRA custodian.
- Always check out an investment and promoter before you turn over your money.
- Educate yourself about IRAs and retirement planning.
- Exercise extra caution during tax season when it comes to making IRA investments.
As a self-directed IRA investor, you are solely responsible for investment decisions, and as a result you must make certain that you understand the investments you are selecting and the associated risks. Beware of slogans and terms like “IRA Approved” or “IRS Approved,” as such slogans are just false. In addition to the consideration from the IRS above, I’ve previously written my own “Self Directed IRA Investment Due Diligence Top Ten List” which includes additional tips and questions to ask when investing your hard-earned retirement plan dollars with others.
Take the IRS guidelines and my Top Ten List into consideration when investing your IRA, but in the end, don’t be scared about investing into non-publicly traded investments. Rather, keep the risk and opportunities in perspective, and realize that you may need to get out of your comfort zone by asking pointed questions, demanding additional documentation, or simply saying “no.” Remember: You are the best person to protect your retirement.
If you’ve inherited an IRA from a parent or other loved one, it is likely that you have a beneficiary IRA. These can be powerful accounts, but you need to understand the required minimum distribution (“RMD”) rules for your beneficiary IRA to properly utilize it. The inherited IRA may be a traditional or Roth IRA and there are three different distribution options you may elect when you inherit the IRA.
You will have three distribution options upon the death of your loved one to receive the funds from their IRA. In general, the best option is the “Life Expectancy Method” as it allows you to delay the withdrawal of funds from the IRA, and allows the money invested to grow tax-deferred (traditional) or tax-free (Roth). The three options are outlined fully below:
1. Lump Sum
The first option is to simply take a lump-sum and be taxed on the full distribution. There is no 10% early withdrawal penalty (regardless of your age or their deceased owner), but you are taxed on the amount distributed if it is a traditional IRA. You’re also giving up the tax-deferred (traditional) or tax-free (Roth) benefits of the account. Don’t take this option. It’s the worst tax and financial option you have.
2. Life Expectancy Method
The Life Expectancy Method is the best option. Under this option, you take distributions from the inherited IRA over your life-time based on the value of the account. These distributions are required for traditional IRAs and even for inherited Roth IRAs. For example, if you inherited a $100,000 IRA at age 50, you would have to take about $3,000 a year as a required minimum distribution each year. The RMD amount changes each year as you age and as the account value grows or decreases. There is no 10% early withdrawal penalty. Traditional beneficiary IRA distributions are taxable to the beneficiary, and Roth IRA distributions are tax-free. And yes, beneficiary Roth IRAs are subject to RMD even though there is no RMD for regular Roth IRAs.
3. 5-Year Method
This option is available to all inherited Roth accounts, but is only available to inherited traditional IRAs where the deceased account owner was under age 70 1/2 at the date of their death. Under this option, the beneficiary IRA is not subject to RMD. However, it must be fully distributed by December 31st of the fifth year following the year of the account owner’s death. There is no 10% early withdrawal penalty, and distributions are subject to tax. Again, this option is only available to traditional accounts.
Investing with a Self-Directed Beneficiary IRA
Yes, you can self-direct your beneficiary IRA. Before you do, make sure you understand the amount of funds you’ll need to take as an RMD, and that you will have available cash in the account to cover the those RMDs. As I described above, assume you are 50 and inherited a beneficiary IRA for $100,000. You will need to take annual distributions of around $3,000. So, if you invest all of the $100,000 into an illiquid asset, then you will be unable to take RMDs and force the IRA account to pay stiff penalties. Consequently, when making a self-directed investment from a beneficiary IRA, you must take into account the amount of the investment, the total value of the account, and the time-line of the investment (when will it generate cash back to the IRA). If you inherited the $100,000 account above, you may decide to only invest $70,000 of the beneficiary IRA into an illiquid investment (e.g. real estate or private company), while leaving the other $30,000 to be invested into liquid investments like publicly-traded stocks, CDs, cash or mutual funds. This will leave funds available for RMD until such time as the illiquid investment generates income or is sold for profit.
Stretching out the benefits of an inherited IRA can be powerful, but make sure you plan for RMDs before you make any self-directed investment from your beneficiary IRA.
Do you have tuition or other college expenses due for yourself, your spouse, or your child? Would you like to use your IRA to pay for these expenses? Would you like to avoid the 10% early withdrawal penalty for accessing your IRA funds before you are age 59 ½? This article outlines how you can avoid the 10% early withdrawal penalty when using your IRA to pay for higher education expenses.
Whether you should actually take a distribution from your IRA to pay for the higher education expenses of your child is another topic. Sadly, too many parents have raided their own retirement savings to pay for their children’s college education expenses. They then reach retirement age with a sliver of what savings or retirement accounts they could’ve otherwise relied on. Everyone’s situation and goals are unique but if you have decided to use IRA funds to help pay for educational expenses here’s how you can avoid the 10% penalty for accessing your own money.
10% Penalty Exception Rules for Higher Education Expenses
Here’s a quick breakdown on how the 10% withdrawal penalty can be avoided when you use IRA funds to pay for qualifying higher education expenses.
1. Who can the IRA money be used for?
Your IRA funds may be used for qualifying higher education expenses of the IRA owner, their spouse, children, and their descendants.
2. What schools qualify?
Any school eligible to participate in federal student aid programs qualifies. This would include public and private colleges as well as vocational schools. Any school where you, your spouse, or your child completed a FAFSA application will qualify.
3. What expenses qualify?
There is a broad list of qualifying expenses. These include tuition, fees, books, supplies, and equipment. Also, room and board is included if the student is enrolled at least halftime.
4. How much is exempt?
The amount of your distribution that is exempt from tax is computed in three steps. First, determine the total qualifying expenses (tuition, fees, books, room and board, etc.) Second, reduce the qualifying expenses by any tax-free education expenses. These include Coverdell IRA distributions, federal grants (e.g. Pell grants), and any veterans or employer assistance received. Third, subtract and tax-free education assistance from the total qualifying expenses incurred and this gives you the total qualifying amount that you may take an early withdrawal from your IRA and avoid the 10% penalty.
Here’s a quick example to illustrate theses rules: You’re age 53 and have an IRA you’d like to access to help cover your daughter’s education expenses. Your daughter Jane is attending Harrison University, a private college that participates in federal student aid programs.
Her expenses for the year are as follows:
- Tuition: $22,000
- Room and Board: $13,000
- Books: $1,000
- Supplies: $500
- Equipment: $500
- Total Qualifying Expenses: $37,000
Jane received the following aid:
- Federal Grant: $2,400
- Coverdell IRA Payment: $5,000
- Federal Student Loan: $10,500 (loans do not reduce the qualifying expenses)
- Total Tax-Free Assistance: $7,400
- Total Amount Eligible for a Penalty-Free 10% Early Withdrawal: $29,600
You decide to take a $10,000 withdrawal from your IRA. Since the total amount eligible is $29,600, the entire distribution will be penalty-free. Keep in mind that while the $10,000 distribution is penalty-free it is still included into the taxable income of the IRA owner.
For more details on the 10% early withdrawal exception for higher education expenses, refer to IRS Publication 970. Also, the above example presumes the IRA owner has a traditional IRA. If the IRA owner has a Roth IRA, there are different considerations and distribution rules.