Crowdfunding & Self-Directed IRAs: What Every Investor, Portal, and Offering Company Should Know

by Mat Sorensen | Apr 1, 2014 | Retirement & IRAs

Crowdfunding is the newest form of raising capital for small businesses and start-ups and it will eventually dominate as a primary method of raising capital in amounts under $1,000,000. In essence, Crowdfunding relaxes the current securities law restrictions, which make it nearly impossible for a small business or budding entrepreneur to raise capital from others. The basic premise of the Crowdfunding exemption to the securities laws is that the laws are loosened so long as the total amounts being raised are capped ($1M) and so long as each investor is only allowed to invest only a small portion of their income or net worth. For a breakdown on the details of the Crowdfunding rules, check out my prior article here. Keep in mind; the final rules still haven’t been put in effect so Crowdfunding hasn’t started yet. But we’re getting close.

Because the typical investor of a Crowdfunding company is likely to have more investible funds in their retirement account then in their personal account, it is my prediction, and this is shared by many, that self-directed IRAs will become a very popular investment vehicle and funding source for Crowdfunding deals. A self directed IRA is an IRA with a custodian or administrator whereby the IRA can invest into any investment allowed by law. The IRA is not restricted into only investing into publicly traded stocks, bonds, or mutual funds but can instead invest into real estate, private companies, or in a company via a Crowdfunding offering. The companies who offer these types of IRAs are referred to as self-directed custodians.

Before IRA money is invested in a Crowdfunding offering, the parties involved (investor, offering company, portal) should be aware of the following issues that are unique to Crowdfunding where an IRA is involved.

1. UBIT Tax. There is a tax that can apply to an IRA called unrelated business income tax (“UBIT”). IRC 512. This tax doesn’t apply to IRAs in passive investments like rental real estate, capital gains, or on dividend profits from a C-Corp (e.g. what you get from publicly traded stock owned by your IRA) as those types of income are specifically exempt from UBIT tax. However, one situation when an IRA is subject to UBIT tax is on profits from an LLC or LP where the profits are derived from ordinary income activities like the selling of goods or services. So, for example, if my IRA bought LLC units in a company that manufactured and sold a new yard tool then the profits that are returned to my IRA is ordinary income (where no corporate tax was paid) and will be subject to UBIT tax. The UBIT tax rate is 39.6% once you have $12,000 of annual net profits. Being subject to UBIT tax isn’t the end of the world and there are some structuring options to minimize the tax such as a c-corp blocker company which can cut the tax rate in half in many instances.
2. Avoid Perks. Many Crowdfunding offerings promise free products or special services to the shareholders/owners that invest through the Crowdfunding offering. Unfortunately, these perks to self-directed IRA owners will likely constitute a self-dealing prohibited transaction and will result in disqualification of the IRA. A self-dealing prohibited transaction occurs when and IRA owner receives personal compensation or otherwise personally benefits from an IRA’s investment. IRC 4975 (c)(1)(F). As a result, perks to self-directed IRA owners should be provided only when it has been determined that they would not result in a self-dealing prohibited transaction.
3. No S-Corporations. An IRA cannot become a shareholder in an s-corporation because IRAs do not qualify as an s-corporation shareholder under the tax laws. IRC 1361 (b)(1)(B).  Consequently, IRAs should not invest in companies that are s-corporations.
4. Watch Out for Companies Owned or Managed by Family. The tax laws restrict your IRA from investing into companies where you or a family member (e.g., spouse, children, parents) are owners or members of management. IRC 4975(c). As a result, if the Crowdfunding offering is offered by a family member or if a family member is involved in management, make sure you consult with an attorney prior to investing your IRA into the Crowdfunding offering as it could result in a prohibited transaction for your IRA.

The rules regarding self-directed IRAs can be a little tricky at first, but once learned they can be easily applied to common Crowdfunding scenarios. In summary, before investing your self-directed IRA into a Crowdfunding offering, make sure you add the above items to your due diligence check-list. Failure to properly understand these rules can result in taxes (e.g. UBIT tax) or disqualification of your IRA (e.g. prohibited transaction).

By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook.

2014 RETIREMENT PLAN & HSA CONTRIBUTION LIMITS

by Mat Sorensen | Dec 3, 2013 | Retirement & IRAs

The IRS recently announced the 2014 retirement plan contributions limits. The only significant changes in contributions amounts were for SEP IRAs Defined Benefit Plans. SEP IRA annual maximum contributions increase in 2014 from $51,000 to $52,000. Defined Benefit contributions increase in 2014 from $205,000 to $210,000.

Contributions limits for Roth and Traditional IRAs remain unchanged with annual contribution limits of $5,500 and an additional $1,000 for those 50 and older. Also unchanged are 401(k) employee contributions which remain at $17,500 annually with an additional $5,500 for those 50 and older.

On the HSA and FSA fronts there are two major changes for 2014. First, amounts placed into an FSA (flexible spending accounts) can now roll over from year to year. Previously, amounts placed in a FSA were subject to a use it or lose type system. HSA contribution limits increase in 2014 for individual accounts from $3,250 to $3,300 and for family accounts from $6,450 to $6,550.

All of 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 qualification and phase out rules that apply so make sure you are getting competent advice about which accounts should be set up in your specific situation.

By: Mat Sorensen

IRA’s & CREDITORS: WHAT EVERY SELF DIRECTED IRA OWNER SHOULD KNOW

by Mat Sorensen | Sep 10, 2013 | Retirement & IRAs

Many self directed IRA investors misunderstand or are unaware of the protections afforded to their IRA (Roth or traditional) as it relates to creditors and judgments. This article seeks to address the key areas of the law that every self directed IRA investor should know.

First, your IRA is not always exempt from creditors up to $1Million. Many IRA owners believe that federal law protects their IRA from creditors up to $1M. While Section 522(n) of the federal bankruptcy code protects an IRA owner’s IRA from creditors up to $1M, this protection is only provided to IRAs when an account owner is in bankruptcy. If the IRA owner is not in bankruptcy then the creditor protections are determined by state law and the laws of each state vary. For example, if you reside are a resident of Arizona then your IRA is still protected from creditors up to $1M even without filing bankruptcy. The approach Arizona takes is the most common, however, many states protections for IRAs outside of bankruptcy are extremely weak. For example, if you are a resident of California then your IRA is only protected in an amount necessary to provide for the debtor and their dependents. That’s a pretty subjective test in California and one that makes IRAs vulnerable to creditors.

Second, while your IRA can be exempt from your personal creditors, as explained above, it is not exempt from liabilities that occur in the IRAs investments. For example, if your IRA owns a rental property and something happens on that rental property then the IRA is responsible for that liability (and possibly the IRA owner). As a result, many self directed IRA owner’s who won real estate or other liability producing assets utilize IRA/LLC’s which protect the IRA and the IRA owner from the liability of the property.

Third, if the IRA engages in a prohibited transaction under IRC Section 4975 then the IRA is no longer an IRA and is no longer exempt from creditors. Despite the bankruptcy and state law protections outlined in my first point above, if a creditor successfully proves that a prohibited transaction occurred within an IRA then account no longer is considered a valid IRA and therefore the protections from creditors vanish. There seems to have been an increase in creditors who are pursuing IRAs, particularly self directed IRAs, and I have been representing more and more self directed IRA owners in bankruptcy and other creditor collection actions in defending against prohibited transaction inquiries.

In summary, the best way to protect your self directed IRA from creditors is to understand the rules that govern your self directed IRA and to seek counsel and guidance to ensure that your retirement is available for you and not just your creditors.