In my 27 years of practicing Arizona LLC law I have seen people make the same LLC mistakes over and over. Unfortunately for some LLC owners when they come to me with a problem it is too late to fix without paying a price.
The purpose of this article is to alert you to the common mistakes IRA LLC members and managers make (all of which can bite an IRA owner in the owner’s economic butt) so you will not make any of the mistakes with your IRA LLC. If you do have any of these LLC problems, call me (480-664-7478) to set a meeting so I can help you fix the problem (if it is fixable).
Arizona IRA LLC Attorney Richard Keyt’s List of Common IRA LLC Mistakes
11. Forming a Member Managed LLC. The are two types of LLCs, member managed and manager managed. A single member IRA LLC must be manager managed so that the IRA owner can cause himself or herself or another person to be elected as the manager of the IRA LLC. The person who is the manager of the IRA LLC is the person who has the so called “check book control” because the manager manages the activities of the IRA LLC, including deciding how to invest the IRA LLC’s funds. I recommend that all IRA LLCs be manager managed.
10. The IRA LLC does not set up Quickbooks immediately after it is formed. The LLC must maintain proper accounting and bookkeeping records. The lack of good books will be used against the LLC’s owner if somebody sues to pierce the veil and hold the owner liable for the LLC’s debt. Good books are needed to prepare the LLC’s tax return or to prepare the Schedule E for owners who report income and deductions on their IRS Form 1040. This is really a no brainer. Buy Quickbooks as soon as you form your company. Get somebody like Joy Jaske, CPA, of CPA for Hire, P.C., 33755 North Scottsdale Road #130, Scottsdale, Arizona 85266; Phone 480-437-9022, to set up your Quickbooks and show you how to use it. The bookkeeping can quickly get out of hand if you fail to set up your bookkeeping software from day one and faithfully enter all income and expense information into it.
9. The LLC owns real estate or valuable property, but the property is not insured. If your LLC owns real estate and the structure burns down the insurer will deny coverage unless the LLC is the named insured on the policy, an additional insured named in the policy or there is some language in the policy that causes the LLC’s real estate to be covered. Don’t rely on that last possibility. If your LLC owns real estate or any other valuable asset talk to several business insurance agents to get their recommendations as to the type of policies, coverage amounts and other policy issues and then purchase the appropriate amount of insurance.
8. The IRA Owner is a Member of the LLC. Most IRA LLCs are owned solely by the custodian of the IRA for the benefit of (FBO) the IRA account. If 100% of the funds are coming from the IRA account then the only member of the LLC must be the custodian fbo the IRA account. If the IRA owner who does not contribute any personal funds to the IRA LLC were to acquire any membership interest in the IRA LLC the transfer of the membership to the IRA owner would be a prohibited transaction. If the IRA owner were to contribute X% of the funds to the IRA LLC at the time of its formation the IRA owner could own X% of the membership interests.
7. The IRA Owner Enters into a Contract to Buy the Asset to be Acquired by the IRA LLC. Homer Simpson really wants his IRA LLC to own real property called Blackacre. Before Homer forms his IRA LLC he enters into a contract to buy Blackacre. If Homer were forming a vanilla LLC rather than an IRA LLC he could form the LLC then simply assign the purchase agreement to the LLC or buy the land in his name and deed it to the LLC after closing. Neither of those options works when the ultimate owner of the asset is Homer’s to be formed or already formed IRA LLC because any transaction between Homer and the IRA LLC is a prohibited transaction that causes the disqualification of the IRA. The IRA owner must form the IRA LLC first and then have the IRA LLC be the buyer on the purchase contract.
6. IRA Owner or a Disqualified Person Pays Fees or Costs to Form the IRA LLC. Neither the IRA owner nor a disqualified person can guarantee a debt of the IRA LLC or pay an expense of the IRA LLC. See “Can the IRA Owner Pay the Costs of Forming an IRA LLC?“
5. IRA Owner or a Disqualified Person Uses or Possesses IRA LLC Property. Homer Simpson’s IRA LLC owns a single family home. Homer, as manager of the IRA LLC, enters into a lease with his son Bart. The amount of the rent is commercially reasonable. The IRA owner’s spouse, parents, grandparents, children and descendants are disqualified persons. If the IRA owner or a disqualified person uses or possesses any of the IRA LLC’s property it is a prohibited transaction and the IRA will be disqualified.
4. IRA Owner or a Disqualified Person Gets Money or Property from the IRA LLC. Homer Simpson, as manager of his IRA LLC, pays his son $20 from his IRA LLC’s bank account for mowing the lawn at the IRA LLC’s rental property. Homer’s IRA LLC sells its real estate for a nice profit. Marge Simpson, Homer’s wife, is a realtor for the listing broker that listed the property for sale. Marge is paid a portion of the real estate commission. Both of these payments are prohibited transactions.
3. The Custodian Does not Sign an Operating Agreement. Although Arizona law does not require the members of an LLC to sign an Operating Agreement, the lack of an Operating Agreement signed by all members is a big mistake, especially when any member is a custodian FBO an IRA account. The Operating Agreement should specify who is the manager or managers of the IRA LLC and the authority and duties of the managers. The voting rights of the custodian FBO the IRA account should be limited. The Operating Agreement should give control of the IRA LLC to the manager.
2. The IRA Owner Does not Know Who Disqualified Persons Are. If the IRA owner or a disqualified person engages in a prohibited transaction with the IRA LLC the IRA will be disqualified and all of the assets in the IRA will deemed to be distributed to the IRA owner in the year of the transaction. Therefor the IRA owner and the manager of the IRA LLC if not the IRA owner must know who disqualified persons are so they will know who the IRA LLC cannot in any transactions with. Disqualified persons include members of the IRA owner’s family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant). The IRA owner is a disqualified person. See “Definition of a Disqualified Person.”
1. The IRA Owner Does not Read and Become Familiar with the Prohibited Transaction Rules. The IRA owner must not allow the IRA LLC to engage in a prohibited transaction. If the IRA owner does not know what a prohibited transaction is the IRA owner is relying on pure luck that the IRA LLC will not engage in a prohibited transaction with a disqualified person.
Generally, a prohibited transaction is any improper use of a traditional IRA account or annuity by the IRA owner, the IRA owner’s beneficiary, or any disqualified person. The following are examples of prohibited transactions with a traditional IRA.
- Borrowing money from it.
- Selling property to it.
- Receiving unreasonable compensation for managing it.
- Using it as security for a loan.
- Buying property for personal use (present or future) with IRA funds.
- A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person.
Any act of a fiduciary by which IRA LLC income or assets are used for his or her own interest.
The receipt of consideration by a fiduciary for his or her own account from any party dealing with the IRA LLC in a transaction that involves IRA LLC income or assets.
The sale, exchange, or lease of property between an IRA LLC and a disqualified person.
Lending money or extending credit between an IRA LLC and a disqualified person.
Furnishing goods, services, or facilities between an IRA LLC and a disqualified person.
Hire Attorney Richard Keyt to Form an IRA LLC
To hire me to form an IRA LLC follow the instructions in my article called “How to Hire Richard Keyt to Form an IRA LLC.”
Call me if you have any questions about forming and operating IRA LLCs. I am happy to answer your questions at no charge.
Richard Keyt, LL.M. (federal income tax)
Arizona LLC Attorney, [llcs-formed] LLCs formed
Direct phone: 480-664-7478