Dec 07

The Minimum Distribution Rules (RMD) for Solo 401(k) Plans

What is an RMD?

Once you reach the age of 70½, you must start to better understand the required minimum distributions (RMD) rules. That’s because, upon reaching this age, the IRS requires you to withdraw at least a minimum amount each year from all your IRAs and retirement plans—except Roth IRAs—and pay ordinary income taxes on the taxable portion of your withdrawal.

The Minimum Distribution Rules (RMD) for Solo 401(k) PlansDuring the April following the calendar year that the owner reaches age 70½ and is no longer employed (this does not apply in the case of a business whether the owner owns more than 10% of the stock), they are legally required to take a Required Minimum Distribution (RMD), also called a Minimum Required Distribution (MRD). Distributions taken late are taxed at the rate of 50%, whereas the account owner can elect the tax withholding rate for RMDs taken on time. RMDs are partial annual payments required by the IRS. The rule is in place to ensure that retirees actually withdraw from retirement accounts rather than using them as a vehicle to pass money to heirs. The RMD amount is based on the preceding December 31 value of the account balance and life expectancy tables.

For any account with an RMD, any distribution from that account during the year will count toward that year’s RMD. You may take more than your RMD in any given year. However, amounts withdrawn in excess of your annual RMD won’t satisfy your RMD requirements in future years.

That’s because the IRS requires each year’s RMD to be calculated using the previous year’s fair market value.

Are RMD Distributions Subject to Withholding?

When you take your RMD, you can have state or federal taxes withheld immediately, or you may be able to wait until you file your taxes.   An RMD distribution is not treated as an eligible rollover. If you request a rollover and an RMD is due for the year, you must satisfy the RMD before rolling over the remainder of your eligible money. In general, since an RMD is not an eligible rollover distribution it is not subject to the 20% withholding tax.  Hence, there is no 20% withholding tax on an RMD, but a 10% federal income tax would be withheld on the taxable portion of your RMD. RMDs may also be subject to state taxes. However, in most cases, you may elect to have no federal or state income tax withheld or to have more than 10% federal tax withheld would apply, although it may be waived.

Satisfying the RMD Rules

The Solo 401(k) plan participant is responsible for satisfying the RMD. The Code does not permit participants to satisfy their RMD from another plan of the same type [e.g., 403(b), 401(k), etc.].  RMDs are to be satisfied from each individual plan subject to that plan’s rules for RMDs.

Calculating the RMD

RMD is calculated by dividing the adjusted market value of the account as of December 31 of the prior year by the applicable life expectancy factor, which is obtained from

the appropriate life expectancy table. The Uniform Lifetime Table is generally used to determine the RMD. If a participant’s spouse is more than 10 years younger and is the sole designated beneficiary, the Joint Life and Last Survivor Expectancy Table is used.

For example, to calculate your RMD you would do the following:

Your RMD amount is determined by applying a life expectancy factor set by the IRS to your account balance at the end of the previous year. To calculate your RMD:

  • Find your age in the IRS Uniform Lifetime Table.
  • Locate the corresponding life expectancy factor.
  • Divide your retirement account balance as of December 31 of the prior year by your life expectancy factor.

How is the RMD calculated Upon death of the Participant – Spousal Beneficiary

Spousal beneficiary refers to the surviving husband or wife who was legally married to the originating participant on the date of the originating participant’s death. The General Board will pay the benefit to the spousal beneficiary if the participant dies before receiving a benefit or a complete distribution from his or her account, unless another beneficiary is entitled to the plan’s benefits.

When is a spousal beneficiary required to begin taking RMDs?

If the participant dies before the required beginning date, and no election was made by the required beginning date prior to the participant’s death, the spousal beneficiary will begin receiving RMDs. The spouse’s required beginning date is December 31 of the year the deceased participant would have reached age 70ó or December 31 of the year following the year of his or her death, whichever is later. Subsequent RMDs must be paid no later than December 31 of every year thereafter.

The RMD is calculated by dividing the adjusted market value of the account as of December 31 of the prior year by the applicable life expectancy factor, which is obtained from the appropriate life expectancy table.

If the participant dies before his or her required beginning date, the spouse’s life expectancy is determined using the Single-Life Table and recalculated each year that an RMD is due. If the participant dies on or after his or her required beginning date, life expectancies are determined using the Single-Life Table. The life expectancy of the participant (using his or her age in the year of death) is compared to the life expectancy of the spouse, and the longer life expectancy is used. If the longer life expectancy is that of the participant, it is reduced each year by one. If the longer life expectancy is that of the spouse, it is recalculated each year. (Recalculation generally will reduce the amount of each RMD, causing the payments to be made over a longer period of time.)

How is the RMD calculated Upon death of the Participant – Non-Spousal Beneficiary

Non-spousal beneficiaries are the persons or entities (such as estates or trusts) to whom the General Board will pay account balances if the participant dies before receiving complete distributions of his or her accounts.

When is a non-spousal beneficiary required to begin taking RMDs?

If the participant dies before the required beginning date, and if no election is made by December 31 following the calendar year of death for a distribution over the life of the non-spousal beneficiar(ies), the non-spousal beneficiar(ies) will receive the entire account balance by December 31 of the fifth year following the participant’s death. If the participant dies on or after his or her required beginning date, the non-spousal beneficiary must continue to receive RMDs. If the non-spousal beneficiary is an estate, trust or other entity, it may elect to receive the remaining benefits in a lump-sum or to defer payment until as late as December 31 of the fifth year following the participant’s death.

What life expectancy table is used to calculate the RMD?

If the participant dies before his or her required beginning date, and if the beneficiary elects to receive distributions over his or her life, the beneficiary’s life expectancy is determined using the Single-Life Table. Each year thereafter, the life expectancy is reduced by one. If more than one beneficiary shares in each RMD, the life expectancy of the oldest beneficiary is used. If the participant dies on/after his or her required beginning date, the beneficiary must continue to receive annual RMDs. The life expectancy of the participant is compared to the life expectancy of the beneficiary, and the longer life expectancy is used. Each year thereafter, the life expectancy is reduced by one.

How to Calculate RMDs with multiple retirement accounts?

If you have more than one retirement plan, you’ll need to calculate the RMD of each plan separately. However, you may add the RMD amounts of all IRAs (including traditional, rollover, SIMPLE, and SEP-IRAs) and withdraw the total amount from any one or more of your IRAs. The same rules apply to 403(b) accounts.

For example, assume that you have three IRAs. Your RMDs are $3,000 from the first IRA; $2,000 from the second IRA; and $2,000 from the third IRA. If you wish, you can take $7,000 from any one or more of your IRAs to satisfy your RMD for the year.

If you have accounts in several 401(k) or other employer-sponsored plans, such as a solo 401(k) Plan, the IRS generally requires you to calculate a separate RMD for each retirement plan in which you participate and withdraw the appropriate distribution from each plan.

Work with the IRA Financial Group

Your assigned tax partner and CPA will work with you to understand and help calculate the annual RMD amounts for your Solo 401(k) plan, if applicable. For additional information on the Solo 401(k) Plan RMD rules, please contact a retirement tax expert at 800-472-0646.

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Nov 14

What is the Rollover Business Start-up Solution?

The Business Acquisition & Compliance Solution Structure (BACSS), also known as the “Rollover Business Start-Up” (“ROBS”) Solution, is an IRS and ERISA approved structure that allows an individual to use retirement funds, such as an IRA or 401(k), to purchase a new or existing business or franchise tax-free and penalty-free.

The ROBS arrangement typically involves rolling over a prior IRA or 401(k) plan account into a newly established 401(k) plan, which a start-up C Corporation business sponsored, and then investing the rollover funds in the stock of the new C Corporation.

What is the Difference between using a Self-Directed IRA Vs. ROBS structure to buy a business?

At first glance, using a Self-Directed IRA LLC to purchase stock in a corporation would seem to share many similarities with the ROBS structure.

Rollover Business Start-Up, Rollover Business StartupWith IRA Financial Group’s ROBS transactions, the structure typically involves the following sequential steps: (i) an entrepreneur or existing business owner establishes a new C Corporation; (ii) the C Corporation adopts a prototype 401(k) plan that specifically permits plan participants to direct the investment of their plan accounts into a selection of investment options, including employer stock, also known as “qualifying employer securities.”; (iii) the entrepreneur elects to participate in the new 401(k) plan and, as permitted by the plan, directs a rollover or trustee-to-trustee transfer of retirement funds from another qualified retirement plan into the newly adopted 401(k) plan; (iv) the entrepreneur then directs the investment of his or her 401(k) plan account to purchase the C Corporation’s newly issued stock at fair market value (i.e., the amount that the entrepreneur wishes to invest in the new business); and finally (v) the C Corporation utilizes the proceeds from the sale of stock to purchase an existing business or to begin a new venture.

With IRA Financial group’s ROBS strategy, the newly formed business will also be able to borrow from third parties, pay salaries to employees (including shareholders/plan participants), and engage in other routine business transactions with disqualified persons. Commonly, a corporate officer or shareholder will make or guarantee loans to the business.

With a Self-Directed IRA LLC, an entrepreneur could use retirement funds to purchase business assets like with the ROBS strategy. However, that individual would not be able to be actively involved in the business, earn a salary, or even personally guarantee a business loan.

The recent U.S. Tax Court case Ellis v. Comm’r of Internal Revenue, No. 14-1310 (8th Cir. 2015) highlights the risk and limitations involved when using a Self-Directed IRA to purchase business assets. In the Ellis case, the taxpayers used IRA funds to invest in a corporation that ultimately purchased business assets. Because Mr. Ellis used an IRA and not a 401(k) Plan to purchase the C Corporation stock, Mr. Ellis was not able to earn a salary or personally guarantee a business loan, which ultimately was the cause of the IRS prohibited transaction rule violation.

If Mr. Ellis had used IRA Financial Group’s ROBS strategy, he would have been able to purchase business assets with retirement funds, earn a salary from the business, as well as personally guarantee the business loan without triggering the IRS prohibited transaction rules.

Legal Foundation for the ROBS Solution

An individual retirement account investor is able to use retirement funds to invest in an active trade or business with tax or penalty because the ROBS solution qualifies for a special exemption set forth under IRC 4975(d) to certain prohibited transaction rules. The exemption to the prohibited transaction rules under IRC 4975(d) is centered around ERISA Section 408(e). It is IRC Section 4975(d) and ERISA Section 408(e) which shields employers from scrutiny of routine (non-abusive) corporate transactions by the plan sponsor and other “disqualified persons,” which might otherwise constitute technical violations of the prohibited transaction rules (due to the employer-sponsored retirement plan’s ownership of employer securities). If the plan sponsor and other fiduciaries’ routine corporate transactions did not fall within the purview of ERISA Section 408(e), the prohibited transaction rules would needlessly prohibit a myriad of legitimate business transactions and would ultimately nullify the exemption that Congress intended to provide. To accomplish its intended effect, ERISA Section 408(e) must be read to exempt the natural and necessary commercial consequences of owning corporate stock, rather than just the stock purchase or divestiture.

Important tax and economic policy considerations also compel a different result for 401(k) plans than IRAs. Congress specifically intended to encourage 401(k) plans to invest in employer securities, within certain limits. The opportunity to invest in employer securities through retirement plans benefits employers and employees alike by aligning their economic interests.

Outside the context of ROBS arrangements, many 401(k) plans permit participants to invest in employer stock. A number of large 401(k) plans, including plans sponsored by Apple and Pepsi, include substantial allocations of employer stock.

To learn more about the benefits of the ROBS (Rollover Business Startup) strategy, please contact a retirement tax expert at 800-472-0646.

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Sep 01

Solo 401(k) Asset Protection

Retirement accounts have become many Americans’ most valuable assets. That means it is vital that you have the ability to protect them from creditors, such as people who have won lawsuits against you.

In general, the asset/creditor protection strategies available to you depend on the type of retirement account you have (i.e. Traditional IRA, Roth IRA, or 401(k) qualified plan, etc.), your state residency, and whether the assets are yours or have been inherited.

Federal Protection for 401(k) Plan Qualified Plan for Bankruptcy

Effective for bankruptcies filed after October 17, 2005, the following rules give protection to a debtor’s retirement funds in bankruptcy by way of exempting them from the bankruptcy estate. The general exemption found in sec­tion 522 of the Bankruptcy Code, 11 U.S.C. §522, pro­vides an unlimited exemption for retirement assets ex­empt from taxation for Section 401(a) (tax qualified retirement plans—pen­sions, profit-sharing and section 401(k) plans). Thus, ERISA qualified plans as well as Solo 401(k) plans are afforded full bankruptcy exemption. What this means is that if a participant of a 401(k) Plan declares bankruptcy, his or her 401(k) plan assets will be exempt from the bankruptcy proceeding and could not be attached by the bankruptcy’s estates creditors.

Federal Protection for 401(k) Plan Qualified Plan Funds Outside of Bankruptcy

In the case of a debtor who is not under the ju­risdiction of the federal bankruptcy court but rath­er has become involved in a state law insolvency, enforcement, or garnishment proceeding, the 2005 Bankruptcy Act is inapplicable and the ERISA rules and state laws would govern.

Solo 401(k) Asset ProtectionTitle I of ERISA requires that a pension plan provide that benefits under the plan may not be assigned or alienated; i.e., the plan must provide a contractual “anti‑alienation” clause. For the anti-alienation clause to be effec­tive, the underlying plan must constitute a “pension plan” under ERISA. Such a plan is any “plan, fund or program which…provides retirement income to employees.” ERISA §3(2)(A).. Therefore, a plan that does not benefit any common-law employee is not an ERISA pension plan. As a result, a Solo 401(k) Plan is not treated as an ERISA Plan.

In addition to the ERISA protection, the Internal Revenue Code Section 401(a)(13(A) provides that “[a] trust shall not constitute a qualified trust under this section unless the plan of which such trust is a part provides that benefits provided under the plan may not be assigned or alienated. Thus, a retirement plan will not attain qualified status unless it precludes both volun­tary and involuntary assignments.

Note – neither ERISA nor Code protections apply to assets held under individual retirement arrange­ments, simplified employee pension plans, govern­ment plans, or most church plans.

Furthermore, ERISA sec­tion 514(a) provides that ERISA supersedes state laws insofar as such laws relate to employee benefit plans. The ERISA anti-alienation and preemption provisions combine to make state attachment and garnishment laws inapplicable to an individual’s benefits under an ERISA-covered employee ben­efit plan.

Exceptions

There are a number of exceptions to ERISA’s and the Code’s anti‑alienation provisions:

1. Qualified domestic relations orders (“QDROs”), as defined in Internal Revenue Code Section 414(p), may be exempted (Internal Revenue Code §401(a)(13)(B); ERISA §206(d)(3)). This means that retirement plan assets are a marital asset sub­ject to division in divorce and attachment for child support.

2. Up to 10 percent of any benefit in pay status may be voluntarily and revocably assigned or alienated (Internal Revenue Code §401(a)(13)(A); Treas. Reg. §1.401(a)-13(d)(1); ERISA §206(d)(2)).

3. A participant may direct the plan to pay a ben­efit to a third party if the direction is revocable and the third party files acknowledgment of lack of en­forceability (Treas. Reg. §1.401(a)-13(e)).

4. Federal tax levies and judgments are exempt­ed. The Treasury Regulations under Code section 401(a)(13) provide that plan benefits are subject to attachment by the IRS in common law and com­munity property states.

In addition to the statutory exceptions noted above, several court decisions have held that an individual’s retirement plan benefits may be sub­ject to attachment for federal criminal penalties or restitution arising from a crime

Solo 401(k) Plans

A debtor’s plan benefits under a pension, prof­it-sharing, or section 401(k) plan are generally safe from creditor claims both inside and outside of bankruptcy due to ERISA and the Code’s broad anti-alienation protections. However, case law and Department of Labor Regulations have held that such a plan that benefits only an owner (and/or an owner’s spouse) are not ERISA plans, thus voiding the anti-alienation protections generally afforded to ERISA plans. Thus, state law will govern the protection afforded to Solo 401(k) Plans outside the bankruptcy context.

State Law Protection of Solo 401(k) Plan Assets Outside of Bankruptcy

Because case law and Department of Labor Regulations have held that such a plan that benefits only an owner (and/or an owner’s spouse) are not ERISA plans, thus voiding the anti-alienation protections generally afforded to ERISA plans, state law will govern the protection afforded to Solo 401(k) Plans outside the bankruptcy context.

Asset Protection Planning

The different federal and state creditor protection afforded to 401(k) qualified plans and IRS inside or outside the bankruptcy context presents a number of important asset protection planning opportunities.

If, for example, you have left an employer where you had a qualified plan, rolling over assets from a qualified plan, like a 401(k), into an IRA may have asset protection implications. For example, if you live in or are moving to a state where IRAs are not protected from creditors or have in excess of $1million dollars in plan assets and are contemplating bankruptcy, you would likely be better off leaving the assets in the company qualified plan.

Note – If you plan to leave at least some of your IRA to your family, other than your spouse, the assets may not be protected from your beneficiaries’ creditors, depending on where the beneficiaries live. IRA assets left to a spouse would likely receive creditor protection if the IRA is re-titled in the name of the spouse. However, you will likely be able to protect your IRA assets that you plan on leaving to your family, other than your spouse, by leaving an IRA to a trust. To do that, you must name the trust on the IRA custodian Designation of Beneficiary Form on file.

The Solo 401(k) Asset & Creditor Protection Solution

By having and maintaining a Solo 401(k) Plan, the people to whom you owe money – as a result of normal debt, bankruptcy or a civil court judgment – will likely not be able to reach your Solo 401(k) assets to satisfy the debt. However, Solo 401(k) Plan assets are not federally protected from divorce settlements or federal tax liens. As illustrated above, most states will afford Solo 401(k) Plans full protection from creditors outside of the bankruptcy context.

Please contact one of our 401(k) Experts at 800-472-0646 for more information.

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Aug 22

Is a Solo 401k Subjected to the Same UBTI Rules as a Self-Directed IRA?

Yes and No. Like an IRA, the tax advantage of a Solo 401K Plan is that income is tax-free until distributed. In general, an exempt organization is not taxed on its income from an activity that is substantially related to the charitable, educational, or other purpose that is the basis for the organization’s exemption. Such income is exempt even if the activity is a trade or business. However, to prevent tax-exempt entities from competing unfairly with taxable entities, tax-exempt entities are subject to unrelated business taxable income (UBTI) when their income is derived from any trade or business that is unrelated to its tax-exempt status.

What is Unrelated Business Taxable Income?

UBTI is defined as “gross income derived by any organization from any unrelated trade or business regularly carried on by it” reduced by deductions directly connected with the business. The UBTI rules only apply to exempt organizations such as charities, IRAs, and 401(k) Plans. Congress enacted the UBTI rules in the 1950s in order to prevent charities from competing with for-profit businesses since charities do not pay tax giving them an unfair advantage over for- profit businesses. With the enactment of ERISA in 1974, IRAs and 401(k), who are considered tax-exempt parties pursuant to Internal Revenue Code Sections 408 and 401 respectively, became subject to the UBTI rules.

As a result, if an IRA or 401(k) invests in an active business through an LLC or partnership, the income generated by the IRA or 401(k) from the active business investment will be subject to the UBTI rules. In other words, a 401(k) Plan that is a limited partner, member of a LLC, or member of another non-corporate entity will have attributed to it the UBTI of the enterprise as if it were the direct recipient of its share of the entity’s income which would be UBTI had it carried on the business of the entity.   For example, if a Solo 401(k) Plan invests in an LLC that operates an active business such as a restaurant or gas station, the income or gains generated from the investment will generally be subject to the UBTI tax. However, if the Solo 401(k) Plan invested in an active business through a C corporation, there would be no UBTI since the C Corporation acts as a blocker blocking the income from flowing through to the Solo 401(k) Plan. This is why you can invest IRA and 401(k) funds into a public company, such as IBM without triggering the UBTI tax. Remember that if an IRA or 401(k) Plan makes a passive investment, such as rental income, dividends, and royalties, such income would not be subject to the UBTI rules.

Is a Solo 401k Subjected to the Same UBTI Rules as a Self-Directed IRA?UDFI and The Solo 401k Plan

However, unlike a Self-Directed IRA LLC, in the case of a Solo 401(k) Plan, UBTI does not apply to unrelated debt-financed income (UDFI). The UDFI rules apply when a 401(k) Plan uses leverage to acquire property such as real estate. Pursuant to Internal Revenue Code Section 514(c)(9), a 401(k) Qualified Plan is not subject to the UDFI rules and, thus, the UBTI tax if nonrecourse leverage is used to acquire property such as real estate. With the UBTI tax rates at approximately 40% for 2017, the Solo 401(k) Plan offers real estate investors looking to use nonrecourse leverage in a transaction with a tax efficient solution.

Exceptions to the UBTI Rules

There are some important exceptions from UBTI: those exclusions generally exclude the majority of income generating investment activities from the UBTI rules – dividends, interest, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate.

What is an Unrelated Business?

For a Solo 401(k), any business regularly carried on or by a partnership or corporation of which it is a member/partner is an unrelated business. For example, the operation of a shoe factory by a pension trusts, the operation of a financial consulting business for high net worth individuals by a university, or the operation of an computer rental business by a hospital would likely be treated as an unrelated business and subject to UBTI.

UBTI & Real Estate Investments

Although there is little formal guidance on UBTI implications for Solo 401(k) Plans investing in real estate, there is a great deal of guidance on UBTI implications for real estate transactions by tax-exempt entities. In general, Gains and losses on dispositions of property (including casualties and other involuntary dispositions) are excluded from UBTI unless the property is inventory or property held primarily for sale to customers in the ordinary course of an unrelated trade or business. This exclusion covers gains and losses on dispositions of property used in an unrelated trade or business, as long as the property was not held for sale to customers. In addition, subject to a number of conditions, if an exempt organization acquires real property or mortgages held by a financial institution in conservatorship or receivership, gains on dispositions of the property are excluded from UBTI, even if the property is held for sale to customers in the ordinary course of business.

The purpose of the provision seems to be to allow an exempt organization to acquire a package of assets of an insolvent financial institution with assurance that parts of the package can be sold off without risk of the re-sales tainting the organization as a dealer and thus subjecting gains on re-sales to the UBIT.

How Do I Avoid UBTI?

In general, if you make passive investments with your Solo 401(k) Plan, such as stocks, mutual funds, precious metals, foreign currency, rental real estate, etc the passive income generated by the investment will generally not be subject to the UBTI tax. Only if your Solo 401(k) Plan will be making investments into an active business, such as a retail store, restaurant, software company using a passthrough entity such as an LLC or partnership will your Solo 401(k) Plan likely be subject to the UBTI tax.

Please contact one of our 401(k) Experts at 800-472-0646 for more information.

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Aug 10

How to Use ROBS to Start a Business with 401k Funds

The Business Acquisition & Compliance Solution Structure (BACSS), also known as the “Rollover Business Start-Up” (ROBS) Solution, is an IRS and ERISA approved structure that allows an individual to use retirement funds, such as an IRA or 401(k), to purchase a new or existing business or franchise tax-free and penalty-free.

The ROBS arrangement typically involves rolling over a prior IRA or 401(k) plan account into a newly established 401(k) plan, which a start-up C Corporation business sponsored, and then investing the rollover funds in the stock of the new C Corporation.

What is the Difference between using a Self-Directed IRA Vs. ROBS structure to buy a business?

At first glance, using a Self-Directed IRA LLC to purchase stock in a corporation would seem to share many similarities with the ROBS structure.

How to Use ROBS to Start a Business with 401k FundsWith IRA Financial Group’s ROBS transactions, the structure typically involves the following sequential steps: (i) an entrepreneur or existing business owner establishes a new C Corporation; (ii) the C Corporation adopts a prototype 401(k) plan that specifically permits plan participants to direct the investment of their plan accounts into a selection of investment options, including employer stock, also known as “qualifying employer securities.”; (iii) the entrepreneur elects to participate in the new 401(k) plan and, as permitted by the plan, directs a rollover or trustee-to-trustee transfer of retirement funds from another qualified retirement plan into the newly adopted 401(k) plan; (iv) the entrepreneur then directs the investment of his or her 401(k) plan account to purchase the C Corporation’s newly issued stock at fair market value (i.e., the amount that the entrepreneur wishes to invest in the new business); and finally (v) the C Corporation utilizes the proceeds from the sale of stock to purchase an existing business or to begin a new venture.

With IRA Financial group’s ROBS strategy, the newly formed business will also be able to borrow from third parties, pay salaries to employees (including shareholders/plan participants), and engage in other routine business transactions with disqualified persons. Commonly, a corporate officer or shareholder will make or guarantee loans to the business.

With a Self-Directed IRA LLC, an entrepreneur could use retirement funds to purchase business assets like with the ROBS strategy. However, that individual would not be able to be actively involved in the business, earn a salary, or even personally guarantee a business loan.

The recent U.S. Tax Court case Ellis v. Comm’r of Internal Revenue, No. 14-1310 (8th Cir. 2015) highlights the risk and limitations involved when using a Self-Directed IRA to purchase business assets. In the Ellis case, the taxpayers used IRA funds to invest in a corporation that ultimately purchased business assets. Because Mr. Ellis used an IRA and not a 401(k) Plan to purchase the C Corporation stock, Mr. Ellis was not able to earn a salary or personally guarantee a business loan, which ultimately was the cause of the IRS prohibited transaction rule violation.

If Mr. Ellis had used IRA Financial Group’s ROBS strategy, he would have been able to purchase business assets with retirement funds, earn a salary from the business, as well as personally guarantee the business loan without triggering the IRS prohibited transaction rules.

Legal Foundation for the ROBS Solution

An individual retirement account investor is able to use retirement funds to invest in an active trade or business with tax or penalty because the ROBS solution qualifies for a special exemption set forth under IRC 4975(d) to certain prohibited transaction rules. The exemption to the prohibited transaction rules under IRC 4975(d) is centered around ERISA Section 408(e). It is IRC Section 4975(d) and ERISA Section 408(e) which shields employers from scrutiny of routine (non-abusive) corporate transactions by the plan sponsor and other “disqualified persons,” which might otherwise constitute technical violations of the prohibited transaction rules (due to the employer-sponsored retirement plan’s ownership of employer securities). If the plan sponsor and other fiduciaries’ routine corporate transactions did not fall within the purview of ERISA Section 408(e), the prohibited transaction rules would needlessly prohibit a myriad of legitimate business transactions and would ultimately nullify the exemption that Congress intended to provide. To accomplish its intended effect, ERISA Section 408(e) must be read to exempt the natural and necessary commercial consequences of owning corporate stock, rather than just the stock purchase or divestiture.

Important tax and economic policy considerations also compel a different result for 401(k) plans than IRAs. Congress specifically intended to encourage 401(k) plans to invest in employer securities, within certain limits. The opportunity to invest in employer securities through retirement plans benefits employers and employees alike by aligning their economic interests.

Outside the context of ROBS arrangements, many 401(k) plans permit participants to invest in employer stock. A number of large 401(k) plans, including plans sponsored by Apple and Pepsi, include substantial allocations of employer stock.

To learn more about the benefits of the ROBS (Rollover Business Startup) strategy, please contact a retirement tax expert at 800-472-0646.

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Jul 31

What The Law Says About UBTI In Non-Real Estate Investments

This article, written by Adam Bergman, about the UBTI rules when making non-real estate investments, first appeared on Forbes.com

For many retirement account investors, understanding how the Unrelated Business Taxable Income Rules work, also known as UBTI, UBIT, or debt-financed income rules, and how they may potentially apply to one’s retirement account investment has been a challenge.  The main reason is that the majority of IRA or 401(k) plan investors invest in traditional types of investments, such as equities, mutual funds, and ETFs, which do not trigger the application of the UBTI tax rules since most passive investments that a retirement account might invest in are exempt from the UBTI rules, such as interest, dividends, and capital gains.

Understanding the potential impact of the UBTI rules is crucial for retirement account investors Understanding the potential impact of the UBTI rules is crucial for retirement account investors seeking to make non-real estate alternative investments in their retirement accounts, including options, stock short sales, and commodity futures contracts.  In general, the UBTI tax rules are triggered in three instances: (i) use of margin to buy stock, (ii) use of a nonrecourse loan to buy real estate, and (iii) investment in a business operated through a flow-through entity, such as an LLC or partnership.  The tax imposed by triggering the UBTI rules is quite steep and can go as high as 40 percent.

When it comes to non-real estate transactions, such as securities and other financial products involving retirement funds, understanding the application of the UBTI or debt-financed income rules have been somewhat difficult. Neither the Code nor the Treasury regulations define “indebtedness” for purposes of the debt-financed income rules. Generally, when a retirement account borrows funds and has a clear obligation to repay the funds, the debt-financed income rules are applicable. However, many financial product type investments that involve “leverage” but not a direct borrowing are not considered debt-financed property and are not subject to UBIT.

Below is a summary of how the UBTI/debt-financed income rules apply to some of the more common type of financial product investments involving retirement funds:

Purchase of Stock or Securities on Margin:  It is well established that the purchase of securities on margin gives rise to unrelated debt-financed income (Elliott Knitwear Profit Sharing Plan v. Commissioner, 614 F.2d 347 (3d Cir. 1980).

Repurchase Agreements:  In a repurchase agreement, one party (usually a bank) purchases securities from another party (the bank’s customer) and agrees to sell the securities back to the customer at an agreed price. Such transactions are treated as a loan of money secured by the securities and give rise to unrelated debt financed income (Rev. Rul. 74-27, 1974-1)

Securities Lending Transactions: IRC Section 514(c)(8) provides that payments with respect to securities loans are deemed to be derived from the securities loaned, not from collateral security or the investment of collateral security from such loans.

Short Sales of Stock: The IRS has ruled that neither the gain attributable to the decline in the price of the stock sold short nor the income earned on the proceeds of the short sale held as collateral by the broker constituted debt-financed income (Rev. Rul. 95-8, 1995-1)

Options: IRC Section 512(b)(5) excludes from UBTI all gains or losses recognized, in connection with an organization’s investment activities, from the lapse or termination of options to buy or sell securities.

Commodities Futures Transactions: The IRS has concluded that gains and losses from commodity futures contracts are excluded from UBTI under Code section 512(b)(5). The IRS has rules that the purchase of a long futures contract entailed no borrowing of money in the traditional sense.  Likewise, the IRS found a short contract was merely an executory contract because there was no property held by the short seller that produced income and thus there could be no acquisition indebtedness.

Notional Principal Contracts: The IRS has issued regulations providing that all income and gain from notional principal contracts is excluded from UBTI. (Treas. Reg. § 1.512(b)-1(a)(1).)

The Internal Revenue Code permits retirement account investors to make a wide range of financial product investments using retirement funds. While the majority of financial product type investments would not trigger the UBTI or debt-financed income rules, (including mutual funds and options) transactions involving margin, however, would likely trigger the tax.  The burden falls on the retirement account holder to make the determination of whether the financial product type transaction triggered the UBTI rules and, if so, file the IRS Form 990-T. Therefore, it is important to work with a tax professional who can help one evaluate the financial product transaction to determine whether the transaction will trigger the UBTI or debt-financed income rules tax.

For more information, please contact the IRA Financial Group @ 800.472.0646!

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Jun 26

When Using ROBS to Fund a Business, What Type of Corporation Should You Use?

The Internal Revenue Code and ERISA law require the use of a “C” Corporation for using the Rollover Business Start-up solution (ROBS) to acquire stock in a business. The reason for this is that Section 407(d)(1) of ERISA defines the term “employer security,” in part, to mean a security issued by an employer of employees by the plan, or by an affiliate of such employer. Under section 407(d)(5) of ERISA, the term “qualifying employer security” includes an employer security, which has been understood to mean stock. The term “stock” is not defined in Title I of ERISA, however, most tax commentators believe this to mean the stock of a corporation and not an interest in a limited liability company or partnership. The use of an S Corporation for this structure is not permitted because a qualified plan cannot be an S Corporation shareholder. Generally only individuals are permitted to be S Corporation shareholders.

When Using ROBS to Fund a Business, What Type of Corporation Should You Use?

Please contact one of our ROBS Experts at 800-472-0646 for more information.
IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Jun 20

Does the UBTI Tax on Unrelated Debt Financed Income Apply to Solo 401k Plans?

No. Unlike a Self Directed IRA LLC, when a Solo 401K Plan uses nonrecourse leverage to purchase real estate that is leveraged, it is exempt from paying any Unrelated Business Taxable Income (UBTI) tax on the income or gain generated.

When an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (a type of Unrelated Business Taxable Income) on which taxes must be paid. A Solo 401(k) plan is exempt from UDFI pursuant to Internal Revenue Code Section 514(c)(9).

With the UBTI tax rates at approximately 40% for 2017, the Solo 401(k) Plan offers real estate investors looking to use nonrecourse leverage in a transaction with a tax efficient solution.

Does the UBTI Tax on Unrelated Debt Financed Income Apply to Solo 401k Plans?“Debt-financed property” refers to borrowing money to purchase the real estate (i.e., a leveraged asset that is held to produce income). In such cases, only the income attributable to the financed portion of the property is taxed; gain on the profit from the sale of the leveraged assets is also UDFI (unless the debt is paid off more than 12 months before the property is sold).

Why does this Exemption Apply to 401(k) Plans and Not IRAs?

When Internal Revenue Code Section 514(c)(9) was enacted in 1980, it applied only to qualified pension, profit sharing, and stock bonus plans, but its scope was broadened in 1984 to include schools, colleges, and universities. The provision brings the history of Internal Revenue Code Section 514 full circle by exempting some organizations, such as 401(k) Qualified Plan, from tax on income from the very sort of leveraged real estate deals that provoked the enactment of the predecessor of Internal Revenue Code Section 514 in 1950. As per the legislative history, the only reason given in the committee reports for the exemption is that some people wanted it: “Trustees of these plans are desirous of investing in real estate for diversification and to offset inflation. Debt-financing is common in real estate investments.”

Please contact one of our 401(k) Experts at 800-472-0646 for more information.

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Jun 17

What Are the Advantages of a Solo 401k Plan vs a Self-Directed IRA?

A Solo 401(k) Plan is an IRS approved retirement plan, which is suited for business owners who do not have any employees other than themselves and perhaps their spouse. The “one-participant 401(k) Plan” or individual 401(k) Plan is not a new type of plan. It is a traditional 401k Plan covering only one employee.  Unlike a Traditional IRA, which only allows an individual to contribute $5500 annually or $6500 if the individual is over the age of 50, a Solo 401k Plan offers the Plan participant the ability to contribute up to $60,000 each year.  Before the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) became effective in 2002, there was no compelling reason for an owner-only business to establish a Solo 401(k) Plan because the business owner could generally receive the same benefits by adopting a profit sharing plan or a SEP IRA.  After 2002, EGTRRA paved the way for an owner-only business to put more money aside for retirement and to operate a more cost-effective retirement plan than a Traditional IRA or 401(k) Plan.

There are a number of options that are specific to Solo 401k Plans that make the Solo 401k Plan a far more attractive retirement option for a self-employed individual than a Traditional IRA for a self-employed individual.

1. Reach your Maximum Contribution Amount Quicker: A Solo 401(k) Plan includes both an employee and profit sharing contribution option, whereas, a Traditional IRA has a very low annual contribution limit.

Under the 2017 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $18,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $54,000.

What Are the Advantages of a Solo 401k Plan vs a Self-Directed IRA?For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $24,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $60,000.

Whereas, a Traditional Self-Directed IRA would only allow an individual with earned income during the year to contribute up to $5500, $6500 if the individual is over the age of 50.

For example, Joe, who is 60 years old, owns 100% of an S Corporation with no full time employees.  Joe earned $100,000 in self-employment W-2 wages for 2017.  If Joe had a Solo 401(k) Plan established for 2017, Joe would be able to defer approximately $49,000 for 2017 (a $24,000 employee deferral, which could be pre-tax or Roth, and 25% of his compensation giving him $49,000 for the year).   Whereas, if Joe established a Traditional Self-Directed IRA, Joe would only be able to defer approximately $6,500 for 2017.

2. No Roth Feature: A Solo 401k Plan can be made in pre-tax or Roth (after-tax) format.  Whereas, in the case of a Traditional Self-Directed IRA, contributions can only be made in pre-tax format.  In addition, a contribution of $18,000 ($24,00, if the plan participant is over the age of 50) can be made to a Solo 401(k) Roth account.

3. Tax-Free Loan Option: With a Solo 401K Plan, you can borrow up to $50,000 or 50% of your account value, what ever is less.  The loan can be used for any purpose.  With a Traditional Self-Directed IRA, the IRA holder is not permitted to borrow even $1 dollar from the IRA without triggering a prohibited transaction.

4. Use Nonrecourse Leverage and Pay No Tax: With a Solo 401(k) Plan, you can make a real estate investment using nonrecourse funds without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI or UBIT) tax (IRC 514).  However, the nonrecourse leverage exception found in IRC 514 is only applicable to 401(k) qualified retirement plans and does not apply to IRAs. In other words, using a Self-Directed SEP IRA to make a real estate investment (Self Directed Real Estate IRA) involving nonrecourse financing would trigger the UBTI tax.

5. Open the Account at Any Local Bank: With a Solo 401k Plan, the 401k bank account can be opened at any local bank or trust company.  However, in the case of a Traditional Self Directed IRA, a special IRA custodian is required to hold the IRA funds.

6. No Need for the Cost of an LLC: With a Solo 401(k) Plan, the plan itself can make real estate and other investments without the need for an LLC, which, depending on the state of formation, could prove costly. Since a 401(k) Plan is a trust, the trustee on behalf of the trust can take title to a real estate asset without the need for an LLC.

7. Better Creditor Protection: In general, a Solo 401(k) Plan offers greater creditor protection than a Traditional IRA.  The 2005 Bankruptcy Act generally protects all 401(k) Plan assets from creditor attack in a bankruptcy proceeding.  In addition, most states offer greater creditor protection to a Solo 401(k) qualified retirement plan than a Traditional Self-Directed IRA outside of bankruptcy.

The Solo 401k plan is unique and so popular because it is designed explicitly for small, owner-only business.  The many features of the Solo 401k plan discussed above is why the Solo 401k Plan or Individual 401k Plan it so appealing and popular among self-employed business owners.

To learn more about the benefits of a Solo 401(k) Plan vs. a Self-Directed IRA, please contact a tax professional at 800-472-0646.

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page

Jun 01

Is a Solo 401(k) Plan Subject to the Same UBTI Rules as a Self Directed IRA?

Yes and No. Like an IRA, the tax advantage of a Solo 401K Plan is that income is tax-free until distributed. In general, an exempt organization is not taxed on its income from an activity that is substantially related to the charitable, educational, or other purpose that is the basis for the organization’s exemption. Such income is exempt even if the activity is a trade or business. However, to prevent tax-exempt entities from competing unfairly with taxable entities, tax-exempt entities are subject to unrelated business taxable income (UBTI) when their income is derived from any trade or business that is unrelated to its tax-exempt status.

What is Unrelated Business Taxable Income?

UBTI is defined as “gross income derived by any organization from any unrelated trade or business regularly carried on by it” reduced by deductions directly connected with the business. The UBTI rules only apply to exempt organizations such as charities, IRAs, and 401(k) Plans. Congress enacted the UBTI rules in the 1950s in order to prevent charities from competing with for-profit businesses since charities do not pay tax giving them an unfair advantage over for- profit businesses. With the enactment of ERISA in 1974, IRAs and 401(k), who are considered tax-exempt parties pursuant to Internal Revenue Code Sections 408 and 401 respectively, became subject to the UBTI rules. As a result, if an IRA or 401(k) invests in an active business through an LLC or partnership, the income generated by the IRA or 401(k) Is a Solo 401(k) Plan Subject to the Same UBTI Rules as a Self Directed IRA?from the active business investment will be subject to the UBTI rules. In other words, a 401(k) Plan that is a limited partner, member of a LLC, or member of another non-corporate entity will have attributed to it the UBTI of the enterprise as if it were the direct recipient of its share of the entity’s income which would be UBTI had it carried on the business of the entity.   For example, if a Solo 401(k) Plan invests in an LLC that operates an active business such as a restaurant or gas station, the income or gains generated from the investment will generally be subject to the UBTI tax. However, if the Solo 401(k) Plan invested in an active business through a C corporation, there would be no UBTI since the C Corporation acts as a blocker blocking the income from flowing through to the Solo 401(k) Plan. This is why you can invest IRA and 401(k) funds into a public company, such as IBM without triggering the UBTI tax. Remember that if an IRA or 401(k) Plan makes a passive investment, such as rental income, dividends, and royalties, such income would not be subject to the UBTI rules.

UDFI and The Solo 401(k) Plan

However, unlike a Self-Directed IRA LLC, in the case of a Solo 401(k) Plan, UBTI does not apply to unrelated debt-financed income (UDFI). The UDFI rules apply when a 401(k) Plan uses leverage to acquire property such as real estate. Pursuant to Internal Revenue Code Section 514(c)(9), a 401(k) Qualified Plan is not subject to the UDFI rules and, thus, the UBTI tax if nonrecourse leverage is used to acquire property such as real estate. With the UBTI tax rates at approximately 40% for 2017, the Solo 401(k) Plan offers real estate investors looking to use nonrecourse leverage in a transaction with a tax efficient solution.

Exceptions to the UBTI Rules

There are some important exceptions from UBTI: those exclusions generally exclude the majority of income generating investment activities from the UBTI rules – dividends, interest, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate.

What is an Unrelated Business?

For a Solo 401(k), any business regularly carried on or by a partnership or corporation of which it is a member/partner is an unrelated business. For example, the operation of a shoe factory by a pension trusts, the operation of a financial consulting business for high net worth individuals by a university, or the operation of an computer rental business by a hospital would likely be treated as an unrelated business and subject to UBTI.

UBTI & Real Estate Investments

Although there is little formal guidance on UBTI implications for Solo 401(k) Plans investing in real estate, there is a great deal of guidance on UBTI implications for real estate transactions by tax-exempt entities. In general, Gains and losses on dispositions of property (including casualties and other involuntary dispositions) are excluded from UBTI unless the property is inventory or property held primarily for sale to customers in the ordinary course of an unrelated trade or business. This exclusion covers gains and losses on dispositions of property used in an unrelated trade or business, as long as the property was not held for sale to customers. In addition, subject to a number of conditions, if an exempt organization acquires real property or mortgages held by a financial institution in conservatorship or receivership, gains on dispositions of the property are excluded from UBTI, even if the property is held for sale to customers in the ordinary course of business. The purpose of the provision seems to be to allow an exempt organization to acquire a package of assets of an insolvent financial institution with assurance that parts of the package can be sold off without risk of the re-sales tainting the organization as a dealer and thus subjecting gains on re-sales to the UBIT.

How Do I Avoid UBTI?

In general, if you make passive investments with your Solo 401(k) Plan, such as stocks, mutual funds, precious metals, foreign currency, rental real estate, etc the passive income generated by the investment will generally not be subject to the UBTI tax. Only if your Solo 401(k) Plan will be making investments into an active business, such as a retail store, restaurant, software company using a passthrough entity such as an LLC or partnership will your Solo 401(k) Plan likely be subject to the UBTI tax.

Please contact one of our 401(k) Experts at 800-472-0646 for more information.

IRA Financial Group Facebook pageIRA Financial Group Twitter pageamazon-logoIRA Financial Group Tumblr pageIRA Financial Group Pinterest page