DIY Investment Management of Retirement Assets: Is There an LLC in Your Self-Directed IRA’s Future?

An idea worth considering.

As baby boomers begin to retire, the burden of making management decisions regarding their retirement assets may seem daunting. This is especially true for those who choose to forego using professional investment advisors and instead manage their assets by themselves. If DIY appeals to you, just know there are many pros and probably as many cons.

 First, the pros of choosing to manage your own retirement funds, particularly if you are a business owner with expertise in the area in which you invest. By doing it yourself, you can:

  • Exercise greater control over investment choices,
  • Enjoy greater flexibility in allocating and diversifying these investments, and
  • Avoid high fees associated with having a financial advisor.

If you choose to pursue the DIY method, a reasonable option for you to explore is the self-directed Individual Retirement Account (IRA). A self-directed IRA is like other retirement accounts that allow individuals to save for retirement. A self-directed IRA can take the form of any of the more common ROTH, SEP, and traditional IRAs, allowing your investments to enjoy benefits like tax-free growth or specified tax-deferment. The self-directed IRA’s unique attribute relates to the types of investments that are permitted. Unlike standard IRAs, a self-directed IRA extends beyond mutual funds and stocks. With a self-directed IRA, a custodian can also invest in real estate, private company stock, precious metals, and all other investments available by law.

(Some investors have taken the self-directed IRA a step further and set up what is referred to an “IRA/LLC” or “checkbook control IRA,” an arrangement by which investors may directly manage their IRA investments through an LLC owned 100% by a self-directed IRA. This arrangement is beyond the scope of this short blog post, but since it’s an option worth considering, it’s one worth mentioning.)

Pros inevitably are accompanied by cons. Self-directed IRAs are no exception. In fact, there are considerable risks and other considerations, you should take into account:

  • Clarity of Goals. One significant limitation for individuals attempting to manage their own retirement accounts is that they haven’t given serious thought to their financial goals, let alone their retirement plans. To successfully manage retirement assets, you must understand exactly what you are trying to achieve and strategically align your investments with those goals. Failure to do so may result in inadequate savings or over-spending. Both mistakes can lead to complications once you retire.
  • Understanding of Financial Concepts. In addition to having a clear vision for your financial future, you must understand basic financial concepts associated with investing. For example, anyone interested in managing their retirement funds should be able to develop an asset allocation strategy that incorporates factors like tax rates, age of retirement, required income, and current assets. Without a solid understanding of how these various factors influence each other, you could under-save and outlive your retirement funds.
  • Compliance with complex investment rules. Understanding your goals and navigating complex financial concepts will not matter if you violate one of the many rules associated with investments. The federal government has a variety of regulations that govern the types of permitted transactions, who can be a party to such transactions, and the extent to which various taxes apply. For example, in a self-directed IRA, clearly defined rules prohibit certain transactions characterized as self-dealing. To that end, your self-directed IRA is not allowed to engage in transactions with certain people, including the account owner, family members, and business partners. What constitutes self-dealing is defined by the Internal Revenue Service and case law. Figuring out which transactions are allowed is tricky, and failure to comply with IRS rules can result in hefty fines.

In short, going DIY? Be careful out there. Better, don’t DIY in every aspect of managing your retirement funds. Be honest with yourself: Seek advice where you lack knowledge.

Series LLCs: (Some of) What You Need to Know

A series LLC, a relatively recently authorized form of LLC, is composed of a master LLC—the Mother Ship—which houses a series of LLCs. Each series, silo, or cell (the potential synonyms are almost endless) within the series LLC often has separate owners, and each must always maintain separate records, especially records that account only for the assets of that series—at least if the series LLC is formed in Utah or Wyoming and other ULLCA states that allow for series LLCs.

Series, Silos, or Cells: more protection at less cost?

Similar to a corporate/subsidiaries business model and like their more well-known parent LLCs, series LLCs offer asset-protection benefits, but they avoid the complexities of corporate taxes, structure, and other required formalities. 

This type of entity is well suited for certain businesses that may benefit from its relative simplicity, reduced costs, and increased asset protection. But especially because they are so new, there are also some uncertainties associated with the series LLC.

Potential Benefits of the Series LLC:

1. Simplicity

  • Reduced Administration

Although each series must be administered separately, series LLCs have the potential to save time and administration costs.

2. Reduced Costs

  • One Registration

Each of the individual series is formed and governed by the master LLC’s operating agreement.  In most states—Wyoming and Utah, included—only the master LLC must be registered with the state, which means reduced fees.

  • Potential Sales Tax Savings

Some states may not require sales tax to be paid on rent that one series pays to another series.

3. Asset Protection

  • Mixed Signals

Under most series LLC statutes, each series is protected from judgments against assets in other series under the master LLC.  But it’s not clear that this protection will be respected in bankruptcy proceedings or in states that don’t recognize series LLCs.

Potential Downsides of the Series LLC:

1.  Some Additional Costs

  • Registered Agent

Many states require a separate registered agent for each series in the series LLC, which may mean additional expenses.

  • Formation Cost

The up-front registration fee for a series LLC may be higher than the registration fee of a regular LLC.  In some states, it may be less expensive to register multiple single-member LLCs rather than a series LLC with multiple series. This is generally not the case in Wyoming and Utah.

2. Governance Issues

  • Overlap Jeopardy

The operations may not be as streamlined as anticipated. The records of each series must be maintained separately, and each series must have its own separate bank accounts.  Can administrative functions among the series overlap without jeopardizing the limited liability? Can the ownership or management overlap? Does inadequate capitalization of one series impact the other series in the series LLC? At this point, these types of questions remain unanswered.

3. Liability Questions

  • Bankruptcy Issues

Federal bankruptcy laws do not yet address series LLC issues.  Can an

individual series within a series LLC file for bankruptcy? Are the assets of the non-filing series and the master LLC protected from the filing series?  At this time, there are no clear answers to these and other bankruptcy-related questions.

  • Choice-of-Law Issues

If a series LLC gets sued by a third party in a state that doesn’t authorize series LLCs, the assets of each series and the master LLC may be at risk. For LLCs that operate in states with and without series LLC statutes, this may make a series LLCs much less attractive.

The series LLC is potentially a star on the rise and is definitely worth watching.  If your business is particularly well suited to this compartmentalized approach—real estate investing, for example—and you live in one of the states[1] that currently authorizes series LLCs, you may want to this novel entity.


[1] As of November 2019, Alabama, Delaware, DC, Illinois, Indiana, Iowa, Kansas, Missouri, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Texas, Utah Wisconsin, Wyoming, and Puerto Rico provide for series LLCs in their statutues.

Transferring LLC Membership Interests Part 3—Involuntary Transfers

An involuntary transfer of an LLC membership interest is just that—a transfer prompted by a creditor action or the occurrence of a triggering event outside of the member’s control. An individual or entity obtaining a membership interest as a result of an involuntary transfer usually cannot fully step into the shoes of the transferring member.

This statutory protection—often called a pick your partner provision—acts as a safeguard that provides LLC members with a certain amount of personal asset protection. For example, whereas the creditor of a corporate shareholder could reach and exercise shareholder rights to their full extent, the creditor of an LLC member can reach and exercise only the economic rights associated with membership interests—not the voting or management rights. The recipient of this type of membership interest is called an assignee.

Statutory Provisions – Creditor Action

If an LLC does not specify any transfer provisions, creditor actions are subject to state LLC laws. Each state, in its LLC statute, has provisions limiting what actions a creditor can take against an LLC member for personal debt. Depending on the state, the statutory remedies available to an LLC member’s personal creditors may include:

  • A charging order, which is a court order requiring the LLC to pay all the distributions due to the member-debtor from the LLC to the creditor.
  • A foreclosure on the member-debtor’s LLC ownership interest.
  • A court order to dissolve the LLC.

These remedies protect the other LLC members from the risk of having the creditor of a debtor-member step into the debtor-member’s place and share in the control of the LLC. To a varying degree, they also address the creditor’s right to satisfaction of the debt.

Transfer Provisions – Other Triggering Events

Transfer provisions are typically specified in the LLC’s operating agreement or in a separate buy-sell agreement. There may be some overlap with creditor actions, as these are often included as triggering events in the transfer provisions.

Examples of triggering events that can be specified in an LLC’s transfer provisions include the following:

  • A deceased member’s membership interest passes to a prohibited individual or entity
  • A member’s bankruptcy or other involuntary transfer of a membership interest to the member’s creditors
  • A member’s separation or divorce, or the transfer to a member’s spouse under property division or under a divorce or separation decree
  • A member’s membership interest becomes subject to a valid court order, levy, or other transfer that the LLC is required by law to recognize
  • A member’s breach of the LLC’s confidentiality
  • A member’s failure to comply with any mandatory provision of the operating agreement
  • A member’s failure to maintain a license or other qualification that disqualifies the member from engaging in the LLC’s primary business

If a triggering event occurs, the transfer provisions may prompt a mandatory redemption of the member’s membership interest or a right of first refusal to the LLC or to the other members. If an involuntary transfer does occur, the recipient of the membership interest—the assignee—typically receives only an economic interest in the LLC with no management or voting rights.

Transferring LLC Membership Interests Part 2—Voluntary Transfers

An LLC affords its members a certain amount of personal asset protection. Part of this protection hinges on the restricted transferability of LLC membership interests.  Restricted transferability protects the non-transferring members from creditors and unwelcome new members, which upholds the integrity and value of the non-transferring members’ membership interests.

  • Most (but not all) LLCs impose requirements or restrictions on the transfer of a member’s interest.
  • If the LLC’s operating agreement is silent on the transferability of interests, you must look to state law to be sure there are no default provisions restricting transferability.

This article, part 2 in a 3-part series, focuses on voluntary membership interest transfers done with the intent to grant full membership rights to the recipient.

Step 1 – Determine the Transfer Process

The LLC’s operating agreement should specify the process for transferring a membership interest. If the LLC has a buy-sell agreement in place, that must also be consulted.

  • Find the provisions that detail allowable transfers, the steps to complete them, and the method for calculating the value of the membership interest, if any.
  • The membership interests may be freely transferable but are likely subject to restrictions set forth in the operating agreement, the buy-sell agreement, or by state law.
  • Some transfers may be permitted without prior approval of the other members, such as transfers to a member’s immediate family or to a trust for the benefit of a member or a member’s immediate family.
  • The LLC or the other members may have a right of first refusal before a transfer can be made.

If the operating agreement or buy-sell agreement doesn’t specify the process for transferring a membership interest, you will have to look to state law. Once you determine the authority governing the transfer process—the operating agreement and buy-sell agreement or state law—be sure to note all requirements and restrictions.

Step 2 – Determine the Value

Calculate the value of your membership interest. If the operating agreement or a separate buy-sell agreement doesn’t address this, you will have to work with the other LLC members to determine and agree upon the value of the membership interest.

Step 3 – Follow Transfer Process

Complete the LLC transfer process as determined in Step 1. Make sure you follow all requirements. For example, if the operating agreement requires the unanimous written consent of all LLC members (a common requirement), meet with all of the LLC members to obtain their written consent.

Step 4 – Obtain or Draft the Transfer Document

If the LLC does not have a standard transfer document, you will need to draft a transfer document.

  • Check the operating agreement or state law to determine what the transfer document must include.
  • Typically, it must include the transferor’s name, the LLC’s name, the recipient’s name, and the percentage of the membership interest being transferred.
  • If a form is not provided by the LLC, note that the form of the transfer document is usually subject to the LLC’s approval; make sure to obtain this approval if necessary.

Step 5 – Execute the Transfer Document; Other Documents

Sign and date the transfer document. Make a copy for your records, for the recipient, and for the LLC.

  • The recipient typically receives the original transfer document.
  • The LLC may have additional documents that the recipient must sign in order to be admitted as a member.
  • State law may require the operating agreement and certificate of formation to be updated with the new member information.
  • The LLC may pass the costs associated with the transfer to the new member.

Conclusion

Making a proper transfer of membership interests requires the transferor to jump through a lot of hoops. The first step in the process is determining which hoops are required. Taking the time to properly transfer membership interests ensures that the recipient obtains full membership rights and protection.

We offer proactive business planning strategies. We help businesses draft thorough operating agreements that provide clear directions to the LLC members—to exercise membership interest transfers and other important member rights. We also assist existing LLC members who want to properly transfer their membership interests in the absence of a thorough operating agreement.  Contact us today to learn more about our business services.

Transferring LLC Membership Interests Part 1—An Overview

Say you are a member of an LLC. You own membership interests in the LLC. But what if you want to leave the LLC? What if you get a divorce? What if you have creditors seeking immediate repayment? What can you do with your membership interests? The answer depends on how transferable those membership interests are.

A transfer of LLC membership interests can mean selling, donating, assigning, or gifting—basically one LLC member turning over his or her membership interests to another individual or entity. The transfer can be voluntary or involuntary.

  • Examples of voluntary transfers include selling membership interests to a third party or to the remaining members, donating membership interests to a charity, or leaving membership interests to a trust upon death.
  • Examples of involuntary transfers include those prompted by divorce, bankruptcy, and termination of employment.

The transferability of LLC membership interests is subject to competing interests.  On the one hand, freely transferable membership interests can be more attractive to members because they are easier to dispose of or cash out of—in other words, the membership interests are more liquid and marketable.

On the other hand, LLC members usually want to maintain the right to “pick their partners.” If membership interests are freely transferable, the remaining members have no control over who comes in as a business partner when a member decides to transfer membership interests. Restricted transferability places limits on transfers and the status of the recipient.

Are Membership Interests Freely Transferable or Restricted?

The members decide. The good news about forming an LLC is how flexible the structure is. At the outset, the founding members can adopt transferability provisions— either in the operating agreement or in a separate buy-sell agreement.

  • If neither document addresses transferability, the default provisions of state law prevail.

In other words, if the founding members fail to address transferability in the operating agreement or in a buy-sell agreement, they’ve relinquished control and subjected the members and the LLC to the state law default provisions.

  • Although planning for a member’s departure from the LLC when you’re just forming it may be difficult, thinking through all the possible exit scenarios—and planning for them—is essential.

If your LLC is already up and running and you don’t have transferability provisions in place, the members can amend the operating agreement or adopt a buy-sell agreement. Look to the operating agreement for directions on how to amend the LLC’s terms.

How are Membership Interest Transfers Restricted?

While membership interests are freely transferable in the sense that any member generally can transfer his or her economic rights in the LLC (subject to the operating agreement, a stand-alone buy-sell agreement, and state law), the management or voting rights in the LLC are usually what are restricted—otherwise, other members would be forced to become “partners” with someone not of their choosing.  Typically, a recipient of restricted membership interests can receive economic and management rights—a full membership interest—only with unanimous member consent.

In the next two articles in this series, we’ll look at voluntary and involuntary transfers of LLC interests.

Limited Liability Companies in the News (I wrote)

So I haven’t been writing on my blog a lot lately. But I have been writing. Here are just three examples:

  1. The October 2018 issue of The LLC & Partnership Reporter, a publication of the ABA’s Business Law Section, sports an article I wrote titled, “Wyoming’s Series Limited Liability Company Act: (Virtually) All in the Operating Agreement.” You can find it on page 31. The piece makes clear that Wyoming’s new series act is straightforward and allows an LLC’s operating agreement to do most of the heavy lifting regarding how a particular LLC is managed and how members relate with one another and with third parties.
  2. Another article I wrote appears in the same issue, this one titled, “Utah’s ‘Benefit Limited Liability Company Act”: A Bridge Too Far?” My answer is Yes, the bridge isn’t even needed. You’ll have to read the piece to understand why. You can find it on page 42.
  3. My most recent article appears in the February 2019 issue of Wyoming Lawyer, a publication of the Wyoming Bar. Titled “2018 Case Law Review,” the story discusses a number of recent cases from around the country. I’m particularly interested in whether other states, including Wyoming and Utah, will follow the Fourth Circuit Court of Appeals’ holding in Sky Cable, LLC v. DIRECTV and recognize the creditor’s remedy of reverse veil piercing. What’s reverse veil piercing, you ask? Read my article in Wyoming Lawyer!

The Corporate (or LLC) Veil: “sufficient corporate formalities were followed”

An interesting article at Lexology, regarding the fact that, as the title says, “Creditors Find Piercing the Corporate Veil is Not So Easy.” The piece tells the story of three different cases involving disgruntled plaintiffs suing either a corporation (2 cases) or an LLC (1 case), under the so-called “piercing the veil” theory. That theory basically says that if someone is basically hiding behind the facade of a corporate business form (or an LLC) when, in fact, the business is really no more than an individual, with one foot inside the corporation and one foot out.

As the opening paragraph explains:

[V]eil piercing is an equitable remedy only rarely allowed by courts and is limited to situations in which the corporation’s principals (or parent company) (i) so dominated the corporation that they can be said to be the “alter-ego” of the corporation; and (ii) misused the corporate entity to perpetrate a fraud or crime or otherwise work an injustice. A number of factors have been found relevant to a veil piercing analysis, including whether the corporation is undercapitalized, whether the corporation failed to observe corporate formalities or failed to maintain corporate records; whether the debtor corporation was insolvent; whether the corporation’s funds were siphoned off by the dominant shareholder; and whether the corporation served merely as a façade for the operations of the dominant shareholder or shareholders. (Emphasis supplied)

Though veil piercing sounds good and reasonable in theory, the veil is more teflon than chiffon. Take the LLC case for example:

The court [in Ossa v. Kalyana Mitra LLC, a New Jersey case noted that “sufficient corporate formalities were followed.” Apparently, the record showed that at least some regular corporate practices had not been observed but the court did not find them troubling, given the “documentation of minutes of meetings, notes, and agendas, and tax and bank records indicating that company funds were not siphoned for personal use.” The documents, in fact, showed that Miller was using the money to repay her husband’s company, which was one of Kalyana Mitra’s creditors. (Emphasis supplied)

Sufficient is apparently sufficient, but my advice continues to be, make the letter (and spirit) of the corporate form your mantra; otherwise, that protective veil may disappear just when you need it most.

 

To C or LLC? That’s Today’s Question

I just read an interesting post over at The Startup Law Blog, a post written six years ago. The writer lists “12 Reasons For A Startup Not To Be An LLC.” The key word in that post is “startup,” and key thing to understand is the author’s audience, largely captured in the following paragraph from the post:

For tech or growth companies planning to follow the traditional path of regular and ongoing equity grants to employees, multiple rounds of financing, and reinvestment of as much capital into the business as possible, with the goal of an ultimate sale to a big, maybe public, company in exchange for cash and/or stock, LLCs are typically not the way to go.

If that paragraph describes you, then maybe the C corporation should be the entity of choice for you.

As for the C corp, the author makes another important point. We’ve all heard that one reason–if not the major reason–to avoid the C corp is the possibility of double taxation. Well, maybe:

The bogeyman that you will hear about most frequently is the “double tax” bogeyman. You will be told—don’t form a C Corporation because you will be subject to a double tax.

What is meant by this is that if the C Corporation makes money, it will pay tax on that money. And if it pays dividends to its shareholders, they will pay tax on the dividends. This is true. And so if you anticipate your business being a cash cow, and immediately generating so much money that you will earn more than you can reasonably pay out in salary to the owner executives, then maybe an LLC is a good choice for you. But for most growth businesses, whose goal is to raise capital, reinvest capital, grow fast, grant equity incentives, and ultimately be acquired or go public, a C Corporation is the way to go.  For these businesses, the double tax bogeyman rarely appears, and most exits are structured as one layer of tax stock sales. (Emphasis supplied)

In the end, the real lesson, make that two lessons, from the blog post is that one size doesn’t fit all and that there are lots of questions to answer on the road to choosing an entity for your new business venture.

Will you know the answers? Better yet, do you know the questions?

Get Your (Valuation) Discounts Now!

Two weeks ago, the Treasury Department released proposed IRS Code Section 2704 valuation regulations that, as proposed, will dramatically change the discounts currently allowed, including so-called minority and marketability discounts. Thus, gift and estate tax planning strategies that rely on such discounts to transfer property from one individual to another via the use of limited liability companies, family limited partnerships, and other such entities may not work so well in the future.

The IRS has scheduled hearings on the proposed regulations for December 1, 2016. Sometime after that hearing the regulations will become final; thus, anyone planning on taking advantage of such discounts has little time to waste.

As I learn more about the proposed changes, I’ll follow-up on this blog. If you can’t wait that long, the AICPA has a number of helpful resources.

Business Start-Ups: Which Entity is Best

DetroitSkylineI’ve been reading Steven B. Gorin’s massive “book” (he calls the 1053 page PDF a “mere compilation of preliminary ideas”) titled Structuring Ownership of Privately Owned Businesses: Taxation and Estate Planning Implications. I’ve yet to do a deep dive–again, it’s 1053 pages of very dense, complicated reading–but I will. And I will because it’s chock full of crystal clear nuggets like this:

“I freely admit to a bias in favor of partnerships . . . Generally, a business with an uncertain future (as is the case of most start-ups) should start as an LLC taxed as a sole proprietorship or partnership . . . Start-up businesses often lose money initially, and an LLC taxed as a sole proprietorship or partnership facilitate loss deductions better than other entities.” (pp. 76, 78)

Okay, sounds good to me, but what if my plan is to take that start-up public down the road? Gorin might respond (he actually did say this, but not in response to that exact question):

“Suppose that one concludes that a C corporation would be ideal. Starting with an LLC taxed as a partnership and then converting to a C corporation the earlier of five years before a sale is anticipated or shortly before its gross assets reach $50 million might be the most tax-efficient approach.” (p. 78)

So there you have it, the advice of one of the top estate and business planning attorneys in the U.S. on where to begin with your start-up. Of course, every case is different, so don’t take his advice to the bank just yet. Consider all your options, talk with your attorney and a good CPA, but I’m thinking Gorin is probably right.

 

 

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