by Mat Sorensen | Mar 24, 2015 | Tax & Legal Updates and Policy Changes
I’m presently attending and speaking at the Retirement Industry Trust Association’s (RITA) conference in Washington, D.C. RITA is the national association that represents the self directed IRA industry and has most major companies in the industry as members. I have spoke today on Legal/Litigation Case Updates in the industry and will be speaking tomorrow on unrelated business income tax compliance (UBIT). However, I wanted to update those who follow my blog and our firm’s newsletter as to some interesting comments from the IRS relating to self directed IRAs. As RITA does every year, a representative from the IRS was present and spoke on new rules for IRAs. The representative was a high ranking lawyer at the IRS with supervision responsibilities over retirement plans. Her remarks were a good insight into the IRS and what they are interested in with respect to self directed IRAs. I have copied a few items from my notes below.
1. Government Accountability Office Report– The IRS representative referenced a Government Accountability Office (GOA) report on IRA’s issued on October of 2014. This report was called, IRS Could Bolster Enforcement of Multi-million Dollar Accounts, but more direction from Congress is Needed. In short summary, the report outlines that there are over 600,000 IRAs that have balances of over $1M. This is great news for retirees but the GAO believes that a small portion of these accounts may have obtained large values improperly. Specifically, the IRS representative referenced the report on two issues. First, on Roth conversions where the valuation is low at the time of conversion and then increases in value and is distributed tax free. The concern is that the proper valuation needs to be set at the time of the conversion to fairly report tax and GAO report believes that values are being underreported. Second, the IRS representative referenced IRAs that fund a business and then take a salary from that business. This was possibly in reference to what are called Rollover on Business Start-Ups (ROBS) or to IRA/LLCs where the IRA owner takes a salary for serving as manager as a salary is a prohibited transaction (see, Ellis v. Commissioner). As outlined more fully in my book and prior blog articles, it is a prohibited transaction to take a salary for managing your own IRA/LLC.
2. Update IRA Form 5498– The IRS updated from 5498 a couple of years ago and starting in 2015 is requiring IRA custodians to begin reporting the type of assets held in the IRA if those assets include “non market assets”. For example, real estate, LLC or LP, and notes would have specific codes for reporting the assets held by the IRA. I specifically asked the IRS representative what the IRS intends to use this data for and was told that the IRS doesn’t release that information and provide that guidance to the public. Fair enough. The GAO report does, however, offer some insight and it primarily discusses how the form can be used to zero in on potentially abusive transactions and un-fair value shifting transactions where closely held non-publicly traded assets are unfairly purchased or valued (in a roth conversion) in the IRA.
I will be writing more about the GAO report in later articles but these were the two items referenced by the IRS representative today that I though were insightful. The message from the IRS today was really focused on bad actors and that the IRS does have a desire, but admittedly not the resources, to audit and find those bad actors abusing the tax rules with their self directed IRA. And so they should, a self-directed IRA can be an excellent tool for building wealth but must be used properly in accordance with the law.
by Mat Sorensen | Aug 12, 2014 | Tax & Legal Updates and Policy Changes, Uncategorized
We’ve all heard the buzz words of crowdfunding, PPMs, and IPOs, but there are less complicated ways to raise money and start a business and one of the most reliable and most used methods is that of partnerships or joint ventures.
If you ‘re raising money from others in an LLC, partnership, or joint venture, you must take specific precautions in structuring your documents so that the investment of money from any member, partner, or joint venturer does not constitute a violation of federal or state securities laws. Failure to comply with the securities laws can result in civil and criminal penalties. Many real estate investments, real estate developments, and emerging companies rely on numerous strategies to raising capital that are outside of publicly traded stock and that do not require registration with a state securities division or the federal Securities and Exchange Commission. This article addresses those strategies and outlines some of the key issues to consider when raising funds through an LLC, partnership, or joint venture arrangement. This article addresses the legal considerations that should be analyzed when bringing in “cash partners” or “investors” into your LLC, partnership, or joint venture.
Is the LLC Member, Partner or Joint Venturer Contributing More Than Just Money?
The courts have widely held that an investment in an LLC, joint venture, or partnership is a security when the investor is investing solely cash and has no involvement, vote, or say in the investment. In these instances where the investor just puts in cash (sometimes called “silent cash partner” arrangements), the investment will likely be deemed a security. In a famous securities law case called Williamson, the Fifth Circuit Court of Appeals held that a joint venture contract investment is a security if the investor has little say or voting power, no involvement in the business or investment, and no experience that would provide any benefit to the business or investment. Williamson, 645 F.2d 424. As a result, to avoid triggering these factors and having your investment or business deemed a security we strongly recommend that all investors in Joint Venture agreements, LLCs, or partnerships have voting rights and that they participate in the key decision-making functions of the investment or business. Investors do not have to be part of the management team but they do need to have voting rights and need to have real opportunities to use those voting rights. For example, they could have voting rights on incurring additional debt, on management compensation, and/or on buying or selling property.
Don’t Give Yourself Unlimited Control as Manager
In most LLCs with cash partners, the person organizing the investment and running the operations is often the manager of the LLC, partnership, or joint venture and has the ability to bind the company or partnership. When making this selection as the manager, it is key that you do not give yourself unlimited control and authority. If you do give yourself unlimited control as manager, your investors may be deemed to have purchased a security since their voting rights will have been extinguished by placing to much control and power in the manager/management. What is recommended is that the members have the ability to remove the manager by majority vote and that the manager may only make key decisions (e.g. incurring debt, selling an asset, setting management salaries, etc.) upon the agreement and majority vote of the investors. While key decisions and issues should be left to the members, day to day decisions can be handled by the manager without a vote of the members/investors.
Don’t Combine Too Many People Into One LLC, JV or Partnership
The Courts have consistently held that even if an investor is given voting rights and has an opportunity to vote on company matters that the investor’s interest can be deemed a security if there are too many other investors involved in the LLC, JV, or Partnership. Holden, 978 F.2d 1120. As a general rule of advice, you should only structure investments and partnerships that include 5 or less cash investors as the securities laws and the involvement of more individuals than this could potentially cause the investment to be deemed a security. When there are more than 10 investors it is critical for clients to consider structuring the investment as a Regulation D Offering and that they complete offering documents and memorandums and make a notice filings to the SEC. Many people refer to this type of investment structure as a PPM. When there are a lot of investors involved, a Regulation D Offering provides the person organizing the investment with exemptions from the securities laws and can allow someone to raise an unlimited amount of money from an un-limited amount of investors.
In sum, there are many factors and issues to consider when raising money from others in an LLC, JV, or partnership and it is crucial that you properly structure and document these investments so that they can withstand thes challenges of securities law violations. For help in structuring your investments please contact the law firm at 602-761-9798.
by Mat Sorensen | Apr 22, 2014 | Retirement & IRAs, Tax & Legal Updates and Policy Changes
In 2012, the SEC and NASAA issued Investor Notice 5866, Self-Directed IRAs and the Risk of Fraud. In the notice, the SEC and NASAA outlined how self directed IRAs can be susceptible to numerous types of fraud and how self directed IRA investors can be bilked. The notice outlined some significant cases where investors with self directed IRAs were involved and where the investors incurred significant losses as a result of fraud and misrepresentations in the companies where the self directed IRAs invested.
The due diligence issues for self directed IRAs are not any different from the due diligence issues for individual investors. The concern, however, is that for many self directed IRA investors, their retirement account is their largest source of funds. Consequently, those accounts can be targeted by crooks. The bottom-line point of the SEC Notice is that self directed IRA owners should carefully conduct due diligence before investing their self directed IRA funds.
I have my own thoughts as to appropriate due diligence, which are in accordance with the SEC Notice, and I have outlined those thoughts in the following due diligence “top ten list”.
DUE DILIGENCE TOP TEN LIST
Before you invest your self directed IRA into a “non-traditional” private business or into a real estate investment, you need to ask some hard questions to the person or business receiving your money. Here are some tips to minimize investment risks with your self directed IRA.
- If you don’t understand how the business or investment makes the returns being promised, then don’t invest.
- If you aren’t given adequate documents outlining what has been explained to you verbally or what has been put into a presentation, then don’t invest.
- If you’re told that you can get a commission for bringing others to invest into the same company and if you don’t have a license to receive such commissions, then don’t invest. If the investment sponsors are willing to violate the law to pay an non-licensed person to raise money from others, then what’s stopping them from misappropriating your IRA investment? It is only the law preventing them, which they’ve proved they will disregard.
- If your self directed IRA is loaning money for a real estate venture, then demand a recorded deed of trust or mortgage on title to the property, protecting your investment. Also, make sure that you get a copy of the title report or commitment showing what position your loan is being placed into when the deed of trust or mortgage is recorded. Many savvy investors (and what all banks do) create lending instructions to the title company or attorney closing the real estate transaction that instruct the closing agent to only use the funds being loaned when the borrower signs the note/loan documents, when the closing agent verifies the priority of the deed of trust or mortgage you are getting (1st position, 2nd, etc.), and when all other defects to title have been cleared.
- If you’re investing into a PPM, a private offering, or a crowdfunding offering, you should receive numerous documents outlining the investment, the use of funds, the background of those managing the company, and also documents regarding your rights as an investor (e.g., offering memorandum and LLC operating agreement or LP limited partnership agreement). Also, check to see if the PPM or private offering was properly filed with the SEC by going to SEC.gov and checking the company name in the SEC database. If no filing record exists for the PPM or private offering with the SEC, then the person raising the funds has possibly disregarded the law. As stated earlier, if someone is willing to disregard the law to get your money, what is stopping them from disregarding the law to not pay you back (it’s just the law)?
- Investigate the background of the person(s) with whom you are entrusting your money. When you are investing with others, you need to think like the bank and do what the bank does. What is this person’s credit worthiness? What is their employment or prior business experience? What is their business or investment plan? What are the terms of the investment? Is there a realistic rate of return that fairly recognizes the risk being taken?
- If you’re pressured that this opportunity will pass if your self directed IRA doesn’t invest now, then let the opportunity pass. Most scams use this technique, and most legitimate investments never have this funding crisis.
- Make sure a lawyer representing your interests reviews the documents. If a lawyer drafted the documents, it is still important to have a lawyer look at the documents as they relate to your interests and with an eye towards protecting your self directed IRA. Sometimes, unfortunately, the devil is in the details, and many investments have clauses that can significantly impact your ability to get your money back or that give the company raising the money the ability to pay whatever compensation to themselves that they desire. These are obvious problems that will eat into the bottom line of the profits you may be expecting.
- Seek the opinion of another investor, business owner, or friend whose opinion you trust. Sometimes, when you explain the investment to someone else, he or she can help you find issues to consider and questions you should be asking.
- Be comfortable saying no and only invest what you are willing to lose. Non-traditional investments have made many millionaires over the years, but they have also caused lots of financial ruin. Just keep the risk in perspective and don’t “bet the farm” in one deal.
I don’t want investors to be scared about self directed IRA investments, but I also don’t want investors going into them without having conducted adequate due diligence. It seems that some investors determine whether their IRA can invest based on the prohibited transaction rules but they neglect to determine whether their IRA should invest. Keep in mind that you can make great investment decisions that result in large gains in your self directed IRA, and you can also make terrible decisions that can result in huge losses for your self directed IRA. It’s all up to you.
Just remember that you, the self directed IRA owner, may need to get out of your comfort zone by asking a lot of questions, by demanding additional documentation, or by simply saying no. Remember: you are the best person to protect your self directed IRA.
This article is a modified except from The Self Directed IRA Handbook.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook.
by Mat Sorensen | Oct 29, 2013 | Tax & Legal Updates and Policy Changes, Uncategorized
The SEC finally issued their proposed regulations for Crowdfunding last week in a 538 page proposed set of regulations. These regulations are open for comment for 90 days and will then go into effect in their present or modified form shortly thereafter.
Crowdfunding is the newest form of raising capital for small business or investments and it will eventually dominate as a primary method of raising capital in amounts under $1,000,000. 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.
Here’s a summary of what we already knew.
- Total amount that may be raised in a Crowdfunding offering is $1,000,000.
- The company raising funds under the Crowdfunding rules must prepare disclosure and legal documents which comply with the rules.
- An investor may invest an amount between $2,000 and $100,000 depending on their annual income or net worth. This is a total for all Crowdfunding projects from that person annually.
- Crowdfunding deals must be processed through a Corwdfunding portal that acts like the title or escrow company in the transaction. Crowdfunding portals will be on-line companies registered with the SEC.
Here’s what is new in the regulations.
- Crowdfunding offerings up to $500,000 do not need to have audited financial records. Offerings over $500,000 must complete audited financials.
- Crowdfunding portals must be registered with the SEC and must also register with FINRA.
- Annual reports need to be filed with the SEC by any company that conducted a Crowdfunding offering.
- The income or net worth of an investor, which determines how much they can invest, does not have to be verified by the portal.
If you’re looking to raise capital from others in amounts under $1,000,000 you should consider a Crowdfunding offering. While the implementation process has taken nearly 2 years the end of the tunnel is in sight and Crowdfunding will be available soon.
