Using an IRA Trust Rather Than an IRA LLC?

The IRA LLC is the “go to” for the self-directed IRA investor who wishes to have checkbook control of their IRA funds.  However, though not well known, there is growing interest in using an IRA Trust rather than an IRA LLC.  Let’s get some basics out of the way right off the bat:  both structures permit checkbook control to the IRA account owner and both, on the surface, do not appear to be THAT different from each other.  However, you may just find that using an IRA Trust to be a superior self-directed IRA product.

We are going to break this up into two blogs.  This first blog concentrating on the reasons for using an IRA Trust rather than an IRA LLC.  The second blog will emphasize potential reasons (not many) why an IRA account owner would not want to use the IRA Trust when compared to an IRA LLC, and how to execute your investment transactions in a manner that will not cause you problems later (always need to follow IRS rules and not put yourself in jeopardy!)

Using an IRA Trust Rather Than an IRA LLC

This new shiny automobile (Trust) is pretty in so many ways, but in researching whether the IRA Trust is right for you, you “gotta open that hood” and take a look.   This blog is not intended to suggest that an IRA account owner always use an IRA Trust vs. an IRA LLC and, in fact, the Trust may never rise to the popularity of the IRA LLC….but it should (and we are going to point out why).   Consider the following category of benefits in making the case for the IRA Trust:

What is an IRA Trust? – This is NOT Placing IRA Assets in a Trust

Using an IRA Trust Rather than an IRA LLC? – Potential Cost Savings

Using an IRA Trust Rather than an IRA LLC? – Avoiding Penalties?

Using an IRA Trust Rather than an IRA LLC – Privacy

Using an IRA Trust Rather than an IRA LLC – EIN or No EIN (and what about a tax return)?

Using an IRA Trust Rather than an IRA LLC – At the End of the Day…

 

What is an IRA Trust? – This is NOT Placing IRA Assets in a Trust

If you conduct internet research on the topic of an “IRA Trust”, you may become confused with seemingly contradictory information.  To help clarify, let’s start with what an SDIRA Trust is not.

Ed Slott and Company, America’s IRA experts, answers the question “Can I place my IRA in a Trust?”(1) with a resounding NO.  The Slott Report is correct, in the context of the question answered.  However, they are addressing a different concept than described in this article.

Consider an IRA owner who also has a revocable living trust. Their IRA account is with a financial services company and invested in mutual funds. Rather than having that account in the name of their IRA, the individual wants the account titled in the name of their trust. Essentially, transfer the mutual funds from their IRA account to their trust account. The Slott Report is correct, the IRS will consider that transfer as a taxable distribution. What is the difference between that scenario, and an SDIRA Trust, where the funds end up in an account in the name of a Trust?

In this concept, the SDIRA Trust is not just any trust, certainly not someone’s personal revocable living trust, but a specifically crafted trust document in which the IRA is both grantor and beneficiary. This SDIRA Trust must be accepted by the holding custodian…our SDIRA Trust document is approved by the custodians we work with.  The custodian signs the SDIRA Trust on behalf of the grantor.  In this SDIRA Trust, you are the trustee of the SDIRA Trust.  As trustee, you have control over the investment choices of the SDIRA Trust.  Your actions and investments, of course, must not trigger IRS Prohibited Transactions.

Think of it this way. Most self-directed IRAs use an LLC. If you create your own LLC, in which you are the member, and you move your IRA assets into that LLC, you have just created a taxable distribution. Not a good idea.

However, if you direct the custodian to invest your IRA into a properly crafted LLC, in which the IRA is the member, and you act as manager, you are ok.

This concept simply uses a Trust rather than an LLC for the reasons previously noted.  May an SDIRA use a Trust Rather than an LLC to manage its assets? Yes, when the proper trust is created and correct processes followed.  This is also NOT making a Trust your IRA Beneficiary.

There is a concept commonly referred to as an IRA Trust. In that idea, one creates a Trust to be the beneficiary of one’s IRA. The trust created to receive IRA assets as a beneficiary of the Trust is constructed differently than the SDIRA Trust used to manage IRA assets.

The IRA beneficiary trust does not come into effect until the IRA owner passes away. The trust manages the assets for one or more beneficiaries of the trust, and can pay the taxes on the distributions or pass the taxes through to the beneficiaries.

In the SDIRA Trust concept, the IRA is the beneficiary of the Trust. Same words, different order, very different concepts. The IRA account paperwork will include a beneficiary designation form.

If you want to use a Trust as the beneficiary, that trust will be a completely different trust than the one used to manage the assets. Whether to make a Trust the beneficiary of your IRA is a different topic, on which you will also read varying opinions.

In this concept, you are still alive (yay!) and managing your IRA’s assets for the benefit of your IRA. In the other one, you have passed away (sad face) and someone else is managing your IRA’s assets for the benefit of your beneficiaries.

1 The Slott Report, August 28, 2015. https://www.irahelp.com/slottreport/can-i-place-my-ira-trust

 

Using an IRA Trust Rather than an IRA LLC – Potential Cost Savings

Typically and understandably so, potential cost savings tends to be the most important consideration for a client.  Believe it or not, you may find that while the IRA Trust is slightly more expensive to establish than an IRA LLC, the IRA Trust may still actually save you money…especially if you are self-directing for any period of time.

Depending on what State you reside in, an IRA LLC can become expensive.  You will have the cost to establish your LLC and, in most States, you will also have annual re-filing/renewal fees to maintain your LLC’s active status with the State.  You might be pleasantly surprised that even with low-cost LLC States, the IRA Trust will most likely save you money. With the IRA Trust, you incur no cost (e.g., LLC filing, annual fee) associated with an LLC because there is no LLC.

But, if you reside in a State with higher LLC costs….the IRA Trust makes even more sense!  Consider:

State of California — $70 establishment with an $800 annual fee (tax) for the LLC (yes, you read that correct);

State of Florida — $125 establishment and approximately $150 per year to maintain;

State of Massachusetts — $500 establishment and $500 per year to maintain;

State of Maryland — $300 establishment and $300 per year to maintain;

State of Illinois — $500 establishment and $250 per year to maintain.

OUCH!  Let’s be blunt…you should at least consider comparing the two products.  But, we ain’t done with the comparisons of using an IRA Trust rather than an IRA LLC.

 

Using an IRA Trust Rather than an IRA LLC – Avoiding Penalties?

This is no less important than potential cost savings, but may be even more important.

Why?

Some people do not, understandably, want to spend extra money on an LLC establishment and annual fees so, with this in mind, will establish an LLC in another State.  But, there can be a potential problem with this:

Filing Requirements for an LLC — Every State has the requirement that an LLC must have a registered/statutory agent who has a physical mailing address in that particular State.  The registered agent can be an individual or an entity.  If properly established, there is nothing from stopping this to occur.  But, it does not mean their State of residence cannot have laws/regulations which govern their use of a foreign LLC (i.e., out of state LLC) and whether or not the LLC owes any type of taxes and fees to the resident State.

There is no State more aggressive in the collection of fees/taxes related to this practice than California.  For example, it is not uncommon that a resident in the State of California will secure an LLC in another State when establishing an IRA LLC.  However, by doing so, they risk potential “LLC” taxes and penalties by not originally filing the LLC in California.  The California Franchise Tax Board (FTB) has very strict rules governing California LLCs and California residents holding LLCs in any State.  Suffice it to say, the FTB position, in almost all situations, is that if you live in California or execute any business transactions (e.g., even as a non-resident) with a California company, you will most likely be subject to the California FTB LLC tax…and, yes, you read that correctly!!

Ouch, Part 2 I would say.

Guess What?  Trusts are not registered with a Secretary of State and, as a result, have no registration or annual renewal fees.  This saves your IRA money, relieves the LLC of ongoing LLC reporting requirements, and…one doesn’t have the concern of State LLC fees, taxes, etc.  For many, I use the saying, “you do not have to worry about looking over your shoulder” with your State expecting LLC fees/taxes.

 

Using an IRA Trust Rather than an IRA LLC – Privacy

Let’s start off with a humorous note:  When you have an LLC, you are going to get a lot of junk email.  With an IRA Trust, there is no public filing similar to the LLC; therefore, no junk mail.  Isn’t an IRA Trust worth establishing just for that reason!

LLCs are registered entities within each State.  All LLCs are publicly maintained on file by each State’s Secretary of State (or similarly named State entity).  While there is nothing wrong with the fact that this information is publicized, some individuals would prefer not to have a public showing of this information.  Does this matter to you?  If so, just keep in mind that LLC information is available to the public, Trusts are not.

 

Using an IRA Trust Rather than an IRA LLC – EIN or No EIN (and what about a tax return)?

The topic of whether an IRA Trust needs to have an EIN or file a tax return, can bring varying opinions.    Recently a CPA who specializes in Trust arrangements said simply,

“If a revocable Trust (which is how the IRA Trust is established) establishes an EIN, it must file a return (1041) on behalf of the Trust.  However, a revocable Trust can be established with the individual’s social security number.  If so constructed, there is no tax return.” 

For discussion purposes, let’s assume he is correct that a Trust established with an EIN must file a tax return.  Wouldn’t you prefer the option of NOT having to file a tax return for the Trust by simply establishing the Trust through the responsible party’s social security number?   In his professional opinion, why would one subject themselves to the IRS “thinking” a tax return needs to be filed, when you can simply establish the IRA Trust with the account owner’s social security number.  Bottom line tax opinion by the CPA:   No EIN, no tax return…and, this is significant.

Now, for discussion purposes, let’s assume he is incorrect that a Trust established with an EIN must file a tax return.  One might come back to the same spot…if the EIN is not required, why tempt fate by establishing an EIN where the IRS might still make an inquiry as to whether they should be receiving a tax return?!   Not only would you opt for no tax return (generally), preparing a tax return for a Trust can be complicated.  Again, the CPA would say, if not EIN, no tax return.

But you say an IRA LLC established as a single-member LLC (disregarded entity) does not need to file a tax return either…so, why is the IRA Trust better?   I would say, “great question”…but there is a valid consideration as to why the IRA Trust might be the better option.

Let’s use an example: What if your LLC (needing an EIN) or Trust (can be established with or without an EIN) receives a 1099-INT for interest income of more than $10.  The IRS will receive a copy of the 1099 as well.  Wouldn’t it make sense to most that if the IRS receives a copy of a 1099 for any amount and there is no corresponding tax return associated with the EIN, that the IRS may make an inquiry?    Receiving the 1099 might trigger them to make an inquiry to the responsible party (you) as to why there has been no tax return filed.  According the the CPA, when the Trust is correctly established with the responsible party’s social security number, a 1099 should/would not be generated.  If no 1099 is generated, then no expectation of a tax return.

As the CPA noted, “why even have a question regarding a potential tax return if you do not need an EIN for a Trust (and, as a result, no tax return)?

 

Using an IRA Trust Rather than an IRA LLC – At the End of the Day…

In an IRA LLC, your IRA is the member of the LLC with your IRA custodian signing the LLC Operating Agreement on behalf of your IRA.  Typically, the IRA account owner will also be the LLC Manager.   In the case of the IRA Trust, your IRA is the grantor and beneficiary, and you are the Trustee for the IRA Trust.   Quite honestly, as far as how it would affect you, both structures will be somewhat transparent.  In both you will control your retirement checkbook, but the IRA Trust will give you some additional benefits that may be of benefit to you.

 

In the next blog, we will review the disadvantages of the IRA Trust with thoughts on when you would want to create the IRA LLC.  We will also examine some specific steps you want to take with how you execute transactions/investments from the IRA Trust.

 

As always, the information is intended to be educational in nature.  It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  You must always consult with your respective professional in all such matters.