Question: Hello, I am in Austin and hoping to set up my own online business through my IRA. I will be the sole owner. Is this possible? Do I need to form an LLC? And lastly, if the business becomes profitable, would I be able to pay back the IRA and then run it as a regular business from which I can make personal use of the profits?
Answer: Thank you for your inquiry. First let me start by reiterating what it says below, which is that we do not provide tax, legal, accounting, investment or other professional advice. Anything I say is merely educational in nature and you should absolutely consult your own advisors.
I have been asked similar questions many times. First, let me answer your last question. No, if your IRA owns the business, you would not be able to pay back the IRA and then run it as a regular business from which you can make personal use of the profits, unless of course you took the LLC as a distribution from your IRA and paid taxes and, if you’re under age 59 1/2, penalties on it. To the extent your IRA has money in it you can always take a distribution of cash, provided you are willing to pay taxes and/or penalties.
Do you need an LLC to own a business in your IRA? It depends on the business, but under most circumstances an LLC would be a good idea, simply because of all the issues that an active business has to deal with, especially if you have any employees.
Is it possible to set up an online business through your IRA where your IRA (not you) would be the sole owner? Well, that’s the $64,000 question, as they say, isn’t it? There are several issues with doing this. First of all, unless the business is set up to be owned by a taxable entity such as a C corporation or an LLC which elects to be treated as a C corporation, the profits from the business would be considered Unrelated Business Income (UBI) to the IRA and as a result the IRA would owe Unrelated Business Income Tax (UBIT) on its profits. This may take away some of the advantages you hoped to achieve by starting the business in your IRA. You may want to review IRS Publication 598, which describes UBI in more detail. Note that if the business pays its own income taxes (because it is a C corporation or other taxable entity), then the UBI would not pass through to the IRA. The fact that a particular investment may cause your IRA to owe UBIT does not necessarily mean that you should not make that investment, but it certainly is a factor you will want to be very familiar with prior to entering into such an investment.
Another issue with your plan is that the IRS may consider your services to the IRA owned business to be an excess contribution to your IRA under Internal Revenue Code Section 4973, or worse, a prohibited transaction under Internal Revenue Code Section 4975. Your question reminds me of the facts of Chief Counsel Advice No. 200917030, which may be summarized as follows:
Chief Counsel Advice (CCA) 200917030 involved a couple who formed a Roth IRA owned corporation into which they directed payments for consulting, accounting and bookkeeping services they provided to other individuals and businesses. This was found to be a listed transaction similar to the one described in Notice 2008-4, which should have been reported by the taxpayers on Form 8886, Reportable Transaction Disclosure Statement. The CCA said in this case, like the transaction in Notice 2004-8, the structure of the transaction purportedly allows a taxpayer or multiple related taxpayers to create a Roth IRA investment that avoids the contribution limits by transferring value to the Roth IRA Corporation comparable to a contribution to the Roth IRA, thereby yielding tax benefits that are not contemplated by a reasonable interpretation of the language and purpose of Code Sec. 408A (the Code section authorizing Roth IRAs). In this case, the value of the services provided was shifted from Taxpayers or their business to the Roth IRA Corporation when the Taxpayers provided services through the Roth IRA Corporation as employees of the Roth IRA Corporation. Furthermore, the total value of services provided by Taxpayers to clients of the Roth IRA Corporation was not received by Taxpayers in the form of salary or other compensation from the Roth IRA Corporation. As in the Notice 2004-8 transaction, Taxpayers shifted the value of income or property from Taxpayers or a business of Taxpayers to the Roth IRA Corporation, thereby purportedly avoiding the contribution limitations applicable to Roth IRAs. Taxpayers or their business engaged in transactions with the Roth IRA Corporation by providing services to clients through the Roth IRA Corporation. Value was transferred from Taxpayers or their business to the Roth IRA Corporation comparable to a contribution to the Roth IRA whenever the Roth IRA Corporation received payment from clients as a result of the services provided by Taxpayers.
The bottom line is that the IRS naturally wants to collect taxes on services you provide. And an IRA is intended to be used for arms-length investments, not to derive a current benefit. To the extent you change either of those basic premises you may get into trouble with the IRS if they review the transaction.
Having said this, does it mean that you cannot own a business in your IRA? No, it does not mean that at all. It means that you cannot provide personal services to that IRA-owned business. In other words, the business must be an investment only. You may of course invest in a business which you know someone else is starting, assuming the person starting the business is not otherwise a disqualified person. Also, as mentioned above, you will want to investigate the tax structure of the business to see if it will subject your IRA to UBIT, and if it does, whether the after-tax profits you expect your IRA to receive are higher than other investments your IRA might make.
If your need is for current income, some people consider doing what the IRS refers to as a ROBS arrangement (Rollover for Business Startups). The IRS has concerns about this set up, and you may find tons of information on the internet about these types of arrangements. This typically involves 1) setting up a brand new C corporation, 2) appointing yourself as director and President of that corporation, 3) adopting a 401(k) plan for the corporation with you as trustee of the plan, 4) rolling your IRA into the 401(k) plan, and 5) as trustee of the 401(k) plan investing in all the shares of the corporate as employer securities. The set up is fairly expensive, but there are many firms who offer to set up a ROBS arrangement on your behalf who swear by its legitimacy. If you decide to go that route then by all means make sure whoever you go to for the plan is aware of the IRS’ concern and satisfy yourself that they have met those concerns.
I am aware that this information probably conflicts with a lot of the information out there on the world wide web, where anything is possible and you can avoid all these pesky prohibited transaction rules by simply starting an IRA-owned LLC, or what is sometimes referred to as a “checkbook control IRA.” Unfortunately, the prohibited transaction rules still apply in almost all cases, and so if you cannot do it directly in your IRA then you cannot do it simply by imposing an LLC in between the IRA and the transaction.
I hope that somewhat answers your question, although I realize that such a response often creates more questions than it does give answers. Good luck with your investments, and if you need assistance with a self-directed IRA (emphasis on the self-directed part) please feel free to let us know.
Follow Up Question: Thanks so much for your informative and thorough reply. After researching some more, and since I don’t need that much capital, I think the best option for me is to take an annuity distribution from my IRA which apparently is not subject to the 10% penalty.
Follow Up Answer: Correct. As long as you maintain the payments for the LONGER of 5 years or until you are 59 1/2 there is no 10% premature distribution penalty. Note
that there are 3 different methods of calculating the amount of the distributions, but it’s fairly easy to find calculators online. The key thing to know is that you cannot vary the annuity plan during the 5 years or you will have to go back and pick up the 10% penalty amount. If you can live with these restrictions, an annuity payment, or series of Substantially Equal Periodic Payments as it’s more formally known, is a great alternative. Best of luck with your business venture.
Testimonial: Thanks again. Your generosity in sharing your expertise amounts to altruism!