Individual Retirement Accounts (IRAs) have long been used by Americans looking to save for retirement, and Limited Liability Companies (LLCs) provide flexible structures offering liability protection to members. By merging the two structures – having an IRA invest in an LLC–this has become an increasingly popular retirement saving strategy; often known as Checkbook IRAs due to direct control they give investors over investments similar to writing checks from an actual checkbook. But merging an IRA and LLC can be complicated with various tax implications, so this article details key tax considerations when merging.
- Unrelated Business Income Tax : An IRA typically benefits from tax deferral or even free growth when investing through it; however, when an IRA earns money through unrelated business activity that exceeds its original purpose of investing, however it could become subject to UBIT – for instance if your IRA-owned LLC operates a business and produces profits which fall outside its primary objective, any profits could become subject to UBIT and could mean you unexpectedly face tax liability after investing your savings with an IRA!
- Prohibited Transactions
Individual Retirement Arrangements (IRAs) are subject to specific IRS rules which prohibit certain transactions; violating them could incur severe tax penalties as well as disqualifying an IRA altogether. When investing an IRA into an LLC, additional care must be taken as it could include serious tax consequences:
Engaging in any form of self-dealing. Lending to or borrowing from an IRA. Selling assets between an IRA and disqualified persons.
- No Additional Tax Benefits
Operating within an LLC does not bring any additional tax advantages beyond what an IRA already possesses; rather, using such an entity often provides increased control and flexibility over investment decisions rather than extra tax savings.
- Complex Reporting Requirements
Converting to an LLC can create additional reporting complexities. Your LLC could need to file its tax returns separately, as well as report its assets annually to an IRA custodian, while meeting any state-specific rules regarding LLCs; all this could add extra administrative duties and costs for you and increase administrative burden.
- Potential Increase of State Taxes
Depending on where an LLC is established, its formation could incur state-level tax implications that must be carefully taken into account. Some states impose franchise or annual fees for LLCs operating within them – an impactful consideration when your IRA owns one of them!
- Distribution Rules Remain Unchanged
When taking distributions from an IRA invested in an LLC, traditional IRA distributions will generally be taxed as ordinary income while qualified Roth IRA distributions may be completely exempt of income taxes.
Establishing an LLC as part of your IRA strategy may give you greater control and flexibility, yet comes with its own set of complications and tax repercussions. Before embarking on this path, it’s vital that you consult with tax professionals and financial planners familiar with IRAs/LLCs to ensure informed decisions align with retirement goals while complying with tax laws.