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Lane
Lane, JD, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 11819
Experience:  Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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When applying SMLLC that will be owned or held in a SDIRA

Customer Question

When applying for FEIN for a SMLLC that will be owned or held in a SDIRA with a custodian not the taxpayer and not a related party, and with an individual manager for the manager-run LLC (the manager also being unrelated to the IRA owner), whose SS or EIN number and name should be indicated as the "responsible party"? Are there options in which to use? What makes the most streamlined means of handling this in terms of not needing to make tax filings for what is the combo of an IRA and a disregarded entity?
Submitted: 1 year ago.
Category: Tax
Expert:  Lane replied 1 year ago.

Hi,

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Swanson vs. the Commissioner is the court case that most people reference when discussing the legality of this arrangement.

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It is the IRA holder's responsibility to effect the creation of the LLC or other entity. It's not the obtaining of the EIN that's at issue. It's the language in the Operating agreement for the LLC that you create.

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You, as the manager of the member managed LLC, will be the "responsible party," for the, again, less important part of the process (getting an EIN) but also for adhering to laws that apply to entities in the state in which the LLC is created (usually found in your state's corporate code) ... not adhering to this code is one of the many "holes" that IRS will use to disallow, and make a case for the self-dealing or other prohibited transactions that you seem to be familiar with.

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Also important: The entity document must not contain language that disallows ownership of shares by an IRA. (which you will many times find in the template Operating Agreements out there.

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As your IRA's LLC manager, you'll have to file tax returns for the entity, annual reports, and pay reporting fees to the Secretary of State. Filing 1099s or other IRS reports may also be necessary. Remember, the requirements for an LLC owned by your IRA are the same as any other business entity.

Expert:  Lane replied 1 year ago.

One very important step if using an IRA custodian that really understands and has experience here (rather that some of those big advertisers, that have left many hanging but continue to charge hefty fees).

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Dealing with a tax attorney is a best practice here,

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Let me know what questions you have from here

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lane

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Customer: replied 1 year ago.
Some aspects of my Q that seem to be overlooked in your response: 1) SMLLC. i.e. disregarded entity. No income tax returns (unless UBIT or UDFI are triggered) (reporting may be due for payers to the SMLLC, e.g. 1099s). Correct? 2) "individual manager for the manager-run LLC (the manager also being unrelated to the IRA owner)" therefor not "You, as the manager of the member managed LLC, will be the "responsible party," and also much of the self-dealing prohibited transaction risk is gone I believe. Of course the arm's length manager also cannot self deal as that may create issues.You mention "state's corporate code) ... not adhering to this code is one of the many "holes" that IRS will use to disallow, and make a case for the self-dealing or other prohibited transactions" and I wonder if you can cite any such cases, i.e. where failure of an unrelated party manager of a SMLLC with the SM-interest held in IRA form by an independent custodian was found (or even attacked) by the IRS for violating state LLC code provisions with the result that the tax deferral of the IRA was defeated. Thanks
Expert:  Lane replied 1 year ago.

Will go to WestLaw and see what I can find .... But again this is not the only issue .... If you've any research at all you've undoubtedly see the cases.

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Give me a little time so I can get you all of the "holes." with proper citation

Expert:  Lane replied 1 year ago.

Yes, as long as S-corp (2553) or C-Corp (8332) is not elected - which SOME tout as a better vehicle ( the C-Corp) that would be correct, No 1120 or 1120-S but just information returns 1099, W-2's if company has employees, and yes , 990-T for the IRA and liability for tax on certain types of income that may be considered unrelated business income or unrelated debt-financed income.

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On the second question, I'm not sure exactly what you're asking ... but I don't think that having a second "unrelated" individual manage the LLC necessarily provide more "protection" here, for exactly the reason you point out - they can have their OWN self-dealing/PT issues AND you cannot control "watch" others as well as yourself.

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As an aside It's important to point out (may be stating the obvious) that the reason that the overwhelming majority of custodians don't allow "self-directed" IRAs is the fact that using investments for which there are established markets runs interference for the kinds of problems that do come up with self-directed IRS and owners almost necessarily becoming more involved.

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One example of that is In Peek v. Commissioner (May 9, 2013), where the U.S. Tax Court ruled that two taxpayers had engaged in an indirect “prohibited transaction” with their individual retirement accounts (IRAs) when they provided personal guarantees for promissory notes issued by a company owned by the IRAs.

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Seems obvious, but in the real world when a guarantee of some sort allows for a profitable sale they seem to find their way in. (Not necessary in a market where buying and selling is easy, almost effortless)

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The Court reasoned that since § 4975 prohibits both “direct and indirect . . . lending of money or extensions of credit” between an IRA and its owner, it did not matter that the loan guarantee by the taxpayers was to the company and not the IRAs directly. ...The Court reasoned that a prohibition only on loans directly between the IRA and the disqualified person could be “easily and abusively avoided” by creating shell companies, which would be an “obvious evasion” of the intent of Congress.

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and NOT UNrelated, U.S. Department of Labor provided guidance suggesting that an “arrangement” between the plan and the disqualified person to do through an intermediary that which they were prohibited from doing directly – for example, for the plan to invest in a mutual fund with the understanding that the mutual fund would purchase securities from a disqualified person – was generally the hallmark of an indirect prohibited transaction. (29 C.F.R. § 2509.75-2 (2012))

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IT's the whole Alter-ego issue (piercing the corporate veil) that I was talking about with the following of our Op Agreement AND DESIGNING the Op Agreement in a way that doesn't take away that layer of separateness.

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Many tout Swanson (I'm sure you've heard) as the basis for the "checkbook IRA." But I find it a HUGE oversight that the court in Swanson v. Commissioner ignored completely that Swanson’s non-IRA owned corporation, Swansons’ Tools, paid commissions to Worldwide, hence reducing Swansons’ Tools’ taxable income and indirectly benefiting Swanson.

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It's these indirect transactions that will begin to get folks going forward ... the case of Rollins v. Commissioner shows that the law is evolving here. Using THAT as precedent, Swanson would have come out differently.

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Another case, LLC’s payment of compensation to the taxpayer for his services to the LLC was a prohibited transaction resulting in disqualification of the IRA and a deemed distribution of its assets. Ellis, et ux. v. Comm., (CA 6/5/2015) 115 AFTR 2d ¶ 2015-805

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Section 4975(e)(2)(A) as you likely know, provides that the term “disqualified person” includes a “fiduciary”, which is defined by Section 4975(e)(3)(A) as any person who “exercises any discretionary authority or control respecting management…or disposition of [the plan] assets”. The owners of self-directed IRA’s are held to be “fiduciaries” of an IRA, and as such are “disqualified persons”.

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I do NOT see a case where IRS has specifically used the alter-ego theory (used to attach assets of corporations and LLC's for the tax debts of their responsible parties - and of course used by lawsuits and debtors to do the same thing), but given the trend we see here, and the fact that growing awareness IS there they will get there. This one's ripe for the picking

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I love Warren baker's analogy in a fairly recent 2013 Journal of Accountancy article ... He call;s self directed IRA's a tax compliance black hole

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I think that's largely because there is little reporting for IRS to rely upon to find issues. But I'd submit to you that the reliance on this by custodians touting this ... and who get the deal done and then leave the client hanging ... is causing this to be the next "offshore account," or "S-Corp salary" kind of thing ... where IRS really does start paying attention.

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One person's opinion ... time will tell

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