10 Myths About Checkbook IRAs Exposed. Discover What Checkbook Promoters Don t Want You to Know

10 Myths About Checkbook IRAs Exposed Discover What Checkbook Promoters Don’t Want You to Know

10 Myths About Checkbook IRAs – Exposed Self-directed IRAs have been growing in popularity among savvy investors. Self-directed investors realize that they’re able to take control of their own financial future by taking advantage of a myriad of investment options, including real estate, notes, tax liens and precious metals, while benefiting from tax advantages. But with any good investment strategy comes opportunists who look to exploit people or the system to make a few bucks while destroying your life savings. Among the most prevalent practices some companies promote is providing investors with direct access, or “checkbook control” of their self-directed IRA. This involves using a self-directed IRA to invest in a singlemember limited liability company (LLC) where the IRA owner is the managing member. This gives the investor the appearance of increased ability to directly manage his or her funds (i.e., to have “checkbook control” of the IRA). But is “checkbook control” really increasing investor’s ability to directly manage their IRA and is this an approved strategy with the IRS? Unfortunately, there are many myths and inaccuracies on the topic that could be very dangerous for investors. The truth is that the tactic rarely helps anyone amass wealth.

“There’s pretty much no question that the standard checkbook IRA and its variations are violating a number of IRS laws dealing with prohibited transactions and self

1. Checkbook IRAs are IRS-Approved While many believe that checkbook control IRAs are IRS-approved, nothing could be further from the truth. In fact, these accounts appear to be a major concern of the IRS, as evidenced by their repeated inclusion in the agency’s annual “Dirty Dozen” list of tax scams. Under the title “abusive retirement plans,” the IRS specifically mentions, “the use of limited liability companies to engage in activity that is considered prohibited.” Many checkbook control promoters would have you believe this practice is legal, and as a result it couldn’t create any problems in the eyes of the IRS, but that’s not the case.

dealing. It sounds great to be able to access your IRA money today without any tax or penalty, but it won’t work. The checkbook IRA structures will eventually be officially declared illegal by the IRS. The penalty can be as high as the loss of your entire IRA.” – Attorney Lee Phillips, Counsel to the U.S. Supreme Court

“There’s pretty much no question that the standard checkbook IRA and its variations are violating a number of IRS laws dealing with prohibited transactions and self dealing,” according to Attorney Lee Phillips, Counsel to the U.S. Supreme Court. “It sounds great to be able to access your IRA money today without any tax or penalty, but it won’t work. The checkbook IRA structures will eventually be officially declared illegal by the IRS. The penalty can be as high as the loss of your entire IRA.” 2

When the IRA holder has direct access to the funds via a single-member LLC arrangement, it violates U.S. Tax Code Section 4975, causing a prohibited transaction. The penalty for a prohibited transaction can result in an immediate distribution, which will be subject to taxation if the IRA owner is not yet 59½ years old. See the note below from IRS Publication 590 on consequences: “Generally, if you are under age 59½, you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59½ are called early distributions. “The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.” – IRS Publication 590 In one of the only Tax Court rulings on the subject, Swanson v. Commissioner, the court decided that if the LLC becomes a disqualified person with respect to the IRA, then further transactional dealings between the IRA and the LLC may result in a prohibited transaction. Some checkbook control advocates point to this case as an endorsement for checkbook control, but many attorneys counter by saying the case never directly addressed the issue of checkbook control, had several holes in it and wasn’t relevant to the issues that the average investor faces when he or she operates a checkbook IRA. In fact, many take the position stated below – forming a checkbook control IRA is not a prohibited transaction, but actually using the checkbook control IRA to invest may be a prohibited transaction. “In light of Swanson and FSA 200128011, the formation and capitalization of a new LLC for purposes of self directing IRA investments in itself should not be considered a prohibited transaction under Internal Revenue Code Section 4975. We note, however, that transactions involving the LLC and a disqualified person or that directly or indirectly a disqualified person may be prohibited under Internal Revenue Code Section 4975.” – Attorney Adam Bergman (www.bergmanlawgroup.com/clientalert1.php)

3

2. I Am Not Putting My Entire Retirement at Risk By Using a Checkbook IRA When your Checkbook IRA is deemed prohibited, you will likely lose your entire IRA. Repeat – you will likely lose your entire IRA. The value of your IRA will likely be deemed income to you and you will be taxed accordingly, face paying interest on the amount that was distributed, and be subject to additional penalties up to 15%. The tax code clearly spells out a need for an independent custodian, stating that if you own the LLC and basically have unfettered access to the money (which is what checkbook control IRAs provide) you are breaching the clear intent of the law. Below is the definition of a prohibited transaction, according to U.S. Tax Code Section 4975: The term “prohibited transaction” means any direct or indirect— (A) sale or exchange, or leasing, of any property between a plan and a disqualified person; (B) lending of money or other extension of credit between a plan and a disqualified person; (C) furnishing of goods, services, or facilities between a plan and a disqualified person; (D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan; (E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account; or (F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan. Section 4975 also states that the tax on prohibited transaction “shall be equal to 15% of the amount involved with respect to the prohibited transaction for each year (or part thereof ) in the taxable period.” Most independent attorneys have great concerns about the potential for prohibited transactions to occur, mainly because the process is extremely complex. “The lack of investment oversight by a qualified IRA or a custodian increases the potential for adverse tax consequences and the penalties that can ensue can result in a significant reduction in what the IRA owner thought was a building of his retirement nest egg,” according to Ron Kahn, partner and chair of the tax practice group Ulmer & Berne LLP. Another respected source, “The self-directed IRA workbook” by real estate investors and speakers Dyches Boddiford and Peter Fortunato, put it this way: “There is a perception that investing an IRA through an entity is somehow a ‘prohibited transaction washing machine’ which will protect the IRA from all the pesky rules of Section 4975. In fact, the opposite is true, since the additional layers of complexity make it more likely that an inadvertent prohibited transaction may occur.” If you think these consequences won’t be felt or that the IRS will overlook any missteps, keep in mind that the IRS is not known to have compassion for these types of faux pas.

4

The penalties are real and potentially large. Why risk losing all the wealth you worked so hard to build?

3. The Promoter I am Using to Set Up My Checkbook LLC Guarantees the Safety of My IRA and Will Defend Me Against the IRS Promoters of the checkbook IRA scheme will often make outrageous claims online to the benefits and validity of this program, however, what really matters is what is in the document that you sign with them. Be sure to read the fine print. These promoters typically have a clause hidden in the document that basically states, “we cannot be sure that this will work and if an issue arises in the future you are on your own.” How could any reputable business put their firm at such risk by accepting the responsibility of this scheme working and in return make just $3,000-$5,000? When speaking with a promoter ask them how they will specifically support you if your checkbook control IRA performs a prohibited transaction. Ask if such a clause that is listed above exists. Be sure to read the documents very carefully. You will be amazed at how little they believe in this scheme that they are selling to you.

4. I Will Have Legal Support After I Set Up My Checkbook LLC On many Checkbook LLC websites, legal support is “included.” Be very cautious when you see this, and ask what this support really covers. Typically, before you buy you will be told that you will have the help of attorneys and former IRS employees to stay compliant; however, once your LLC is set up, this support evaporates. These attorneys are hired by the promoters, or are the promoters themselves, and their focus is to sell you the LLC, set up the LLC, and move on to the next sale. Many prospective clients assume that for the $1,500-$3,000 investment to set up an LLC, they will get complete legal coverage for the life of the LLC. This is simply not the case. These attorneys do not have a formal relationship with you and typically offer broad and inconclusive direction—if you can even get in touch with them. The simple fact is that it does not make economic sense to a checkbook LLC promoter to earn $1,500 from you and then turn around and pay a qualified ERISA attorney $300 per hour to cover all of your investment and structural issues. Keep in mind that using a checkbook LLC adds a layer which complicates any transaction and the majority of prohibited transactions don’t occur during the setup, they occur when you start investing. Assuming you plan on using the LLC regularly to invest, you shouldn’t count on detailed support from the promoters. To review any deal, you need to know the specifics and at least two to three hours to understand and review all of the details. How would they make money if they took this much time for each client?

5

5. Promoters of Checkbook LLCs are Regulated or at Least Have Some Form of Oversight This is one of the biggest surprises about the promoters of checkbook control IRAs. Even though they deal with such a complicated topic, the promoters are not regulated, have no regulatory oversight, no capital requirements, and no insurance to protect you - nothing. In fact, you [Checkbook IRA] accounts appear could go to an office store today, buy an operating to be a major concern of the IRS, agreement and start selling it on the internet as a checkbook LLC. Do your homework and ask as evidenced by their inclusion in questions. You will be surprised by how small these the agency’s annual “Dirty Dozen” firms are, and more importantly, how little they have list of tax scams again. Under the in terms of assets to back up their claims. Keep in mind as well that the firm will have you sign a document when you set up your LLC. This document will basically say that they cannot guarantee that this scheme will work and that if there is an issue with the IRS you will be responsible to fight it and that they will have no liability! You must read the fine print. These promoters do a great job of selling this product and that is all they care about.

title “abusive retirement plans,” the IRS specifically mentions, “the use of limited liability companies to engage in activity that is considered prohibited.”

Once you have the LLC, you are responsible for it. Imagine buying a new car today and the manufacturer asks you to sign a document that states they don’t know if it will run, they don’t know if it meets all of the legal requirements, and if it doesn’t, or if the car harms you, the manufacturer is not responsible. Would you buy that car? Questions to ask Checkbook LLC promoters • How long have you been in business? • Are you regulated by any financial regulator? • Do you have capital in case something happens to the firm? • Can I see the firm’s balance sheet? • Do you have insurance? What type and what are the limits? • Do you require me to sign an indemnification when I set up an LLC releasing you from claims?

6. My Checkbook IRA Will Not Be Subject to an Additional Tax of Up to 35% Promoters of checkbook control will sell you on all of the “benefits” of this scheme, but they don’t tell you the whole truth about it. By using a checkbook control LLC to manage your ongoing buying and selling of assets, you will most likely be subjecting your IRA to unrelated business income tax (UBIT). This tax rate rises to 35% for income your LLC generates over

6

$1,000. Additionally, you now have to incur the cost and hassle of filing a 990T with the IRS. Most accountants will charge approximately $1,000 to complete this filing. Estates and Trusts If Taxable Income Is:

The Tax Is:

Not over $2,400



15% of the taxable income

Over $2,400 but not over $5,600

$360 plus 25% of the excess over $2,400

Over $5,600 but not over $8,500

$1,160 plus 28% of the excess over $5,600

Over $8,500 but not over $11,650

$1,972 plus 33% of the excess over $8,500

Over $11,650

$3,011.50 plus 35% of the excess over $11,650



This occurs because more than likely, your checkbook LLC is engaging in activities that would classify it as a business and anytime an IRA owns a business that is held in an LLC it is subject to Unrelated Business Income Tax, pursuant to Section 511 of the Internal Revenue Code. It is hard to defend that the LLC is not a business when the LLC has a manger, a business checking account, its own tax identification number, buys and sells property, and is not an IRA directly (the way it would be if the IRA was buying the house itself ). When you are buying and selling property through your IRA, you enjoy the tax advantages that it provides. When the activity is done through an IRA you lose that benefit even though your IRA owns the LLC. All businesses operating in the United States are subject to taxation. UBIT applies if ALL of the following are true: • Income is derived from “trade or business” activity (i.e., sale of goods and services). • Business activity is not substantially related to exempt status. • Business is regularly carried on by organization.

7. I Will Save Time Using a Checkbook LLC vs. Using a Self-Directed IRA Custodian Checkbook LLC promoters often focus on the paperwork and time commitment issues that come along with an IRA custodian as one of the main arguments for the need for an LLC. There is no question that the time you spend dealing with a custodian is directly related to how prepared you are. If all of the information is provided in good order, investments can typically be made in 24-48 hours. When information is missing or incorrect, delays likely occur. The delays, however, ensure that your account is in good order and that you have a detailed account of your IRA. Just because you use a checkbook LLC doesn’t eliminate the need for this documentation; it simply transfers the burden and work to you. Do you have the settlement statement from a deal you did four years ago? How about the receipt from the plumber you used last summer? If you are using a full-service custodian, they will. The amount of bookkeeping and administrative work required to properly maintain a checkbook LLC can be enormous. Full-service custodians keep complete records for your 7

account, including images of all documents, an accounting of all income and expenses in your account, and all correspondence with third parties. As the manager of your IRA LLC, you will be responsible to keep and maintain all of these records. If you plan on buying rental property or tax When you crunch the numbers, liens with your IRA LLC, be prepared! These two investments have a tremendous amount of it becomes apparent that administration involved with them. Tax liens are by promoters are selling the far the worst. Although the process to buy them is checkbook scheme for $1,500relatively simple, the difficulty begins after the sale. Often, investors will buy a number of these liens $3,000! At best, you are looking at at the same time and sometimes buy liens on the a seven- to 10-year payback just same property for different years. Tax lien sales often confuse county workers and mistakes are commonly for the fee to set up the LLC – not made. Imagine buying 20 liens at an auction and necessarily a great return. receiving a confirmation three weeks later from the county with the wrong liens and to make it worse, five of the liens have already been redeemed and you have deposited the checks. This really happens! And now, you are responsible to unwind this mess. If you used a full-service custodian they would handle this for you and it’s typically included in your annual fee. Remember, this isn’t a normal LLC, it is one owned by your IRA and it needs to be segregated and kept in order. In fact, because you are using a scheme considered so questionable that the IRS has included it in its Dirty Dozen, you should assume that you will be thoroughly audited and be prepared to defend every action taken by the LLC. Using a custodian instead of a checkbook LLC has additional benefits as well. Although self-directed custodians will not review your investment for suitability, you do receive the benefits of numerous eyes working on your investment. If they see what they feel could be a prohibited transaction, you will be contacted. This additional layer of review can be invaluable in your investment process and it is included in your annual fee! Using a full-service custodian also provides another huge benefit when it comes to valuation. By law, each year your custodian must provide the IRS with a fair market valuation of your IRA. This valuation can be simple when your IRA owns, stocks, mutual funds, real estate, and precious metals, however the process becomes more complicated when you own an LLC in your IRA. Each year you will need to hire an independent valuation expert to provide your custodian with a qualified and independent value of your LLC. This can easily cost $500$1,000 per year and under no circumstance can you perform this valuation yourself. Although the marketers of checkbook LLCs would like you to believe that using an LLC will help you save time, it simply is not the truth. Without question you save time when you are able to write your own check to buy an investment however managing your LLC does not end there and involves much more including the possible need to hire a bookkeeper and an independent valuation firm every year.

8

8. I Will Save Money Using a Checkbook LLC The greatest myth purported by checkbook LLC promoters is that you will save money using an LLC vs. a self-directed IRA custodian. Assuming you aren’t using a trust department at a local bank, this is simply not true. In fact, in most cases you will be spending more than double – even triple – what you actually need to spend. Full-service custodians typically charge between $300-$500 per year for most accounts. This fee is often all-inclusive, which means it covers all of your transactions for the entire year so you don’t get nickel-and-dimed every time you want to do something with your IRA. If you open a checkbook LLC you still need to use a limited service custodian, which is likely a separate company from the checkbook promoter you choose. Here’s a breakdown of the typical charges associated with a checkbook IRA: • Checkbook IRA setup fee: $1,500 to $3,000 • Limited-service custodian: $150 per year • State fee to maintain LLC status (varies by state): Anywhere from $150 to more than $300 per year, depending on size of LLC • Fee to have a 990T tax form prepared (required if your LLC produces income): $1,000 –This is the cost just to complete and file the 990T. Keep in mind that your IRA likely will be subject to UBIT (Unrelated Business Income Tax). This tax quickly jumps to 35%!* *A note about the 990T form: If your LLC produces income, there is a high likelihood that it will be subject to unrelated business income tax (UBIT). This means you will have to file a 990T form and income generated by the LLC in your IRA will be subject to a tax of up to 35%. Both 990T filing and the UBIT can be avoided in many cases by using a full-service custodian. Beyond these straightforward costs, don’t forget that you are also responsible for the full administration and bookkeeping of this LLC. As an investor, your time is valuable so in many cases you will be paying someone to handle this. Again – an additional cost that is not mentioned by checkbook LLC promoters. When you crunch the numbers, you are looking at a seven- to 10-year payback – at best – just for the fee to set up the LLC – not necessarily a great return. The bottom line is that you end up spending a lot more money, all while putting your retirement at tremendous risk with a scheme from the IRS’s Dirty Dozen! If using a checkbook IRA provides any benefits, saving money is definitely not one of them. Instead of saving you money, your checkbook LLC will only increase your costs!

9

9. I Cannot Use My IRA to Purchase Investments at an auction if I Don’t Have a Checkbook LLC One of the most popular myths of self directed IRAs is that you need a checkbook LLC to participate in auctions of tax liens, foreclosed properties, and distressed properties. This is not the case; in fact, thousands of investors using full-service custodians participate in auctions each month. There are a number of solutions that make it extremely simple to participate with your IRA while not placing your retirement at risk.

When your Checkbook IRA is deemed prohibited, you will likely lose your entire IRA. The value of your IRA will likely be deemed income to you and you will be taxed accordingly, face paying interest on the amount that was distributed, and be subject to additional penalties up to 15%.

Although having a checkbook in your pocket would seem to make this process effortless, purchasing the investments are just the first step. The real work begins after the auction. Often times, the work includes a tremendous amount of paperwork and administration, including ensuring the county recorded the right liens, the proper title is being used, redemptions are not sent in error, etc. With a full-service custodian, all of these functions are handled by the custodian, allowing you to participate in the auction and not have to worry about any possible headaches afterwards. By using a full-service custodian, you receive the best of both worlds: the security of knowing that you aren’t using a risky scheme which places your IRA at extreme risk and the convenience of participating in the auction and not having to deal with the administration after the auction.

10. I’ve Already Set up an LLC in my IRA – I Can’t Reverse It You are probably beginning to realize that checkbook control IRAs are not as great as the promoters would like you to believe. In fact, checkbook control LLCs present a tremendous amount of risk, and potential costs that are never mentioned by these promoters. If you have already purchased one of these LLCs you might be a bit concerned and second-guessing your choice. The good news is that it is extremely easy to shut down your checkbook LLC and move the assets directly to a full-service custodian. And unlike these checkbook control promoters, a full-service custodian offers multiple options that allow investors to make any legal transaction in their IRA with a simple process and behind-the-scenes support to make it convenient. Full-service custodian Equity Trust Company, which has been in business since 1974, provides that support in the form of cutting-edge online technology and a knowledgeable staff that makes transactions easier. The experience is there – Equity Trust completes an average of 10,000 transactions per week and custodies $12 billion in assets. Better yet, full-service custodians – including Equity Trust – ask for the minimal amount of 10

information to get your deal done while keeping accurate, up-to-date records. Self-directed investors have the convenience of one-stop shopping when it comes to their IRAs – no need to seek out a custodian elsewhere, as is the case when you’re working with checkbook control promoters. This convenience comes with an all-inclusive fee, as opposed to all the “a la carte” charges that accompany a checkbook control IRA.

Reverse Your Checkbook IRA in 3 Easy Steps 1) Establish an IRA with a trusted and qualified self-directed IRA custodian such as Equity Trust. The company is very familiar with this process and can guide you through it step-bystep – call a senior account executive at 888-382-4727. 2) Consult with a professional, such as CPA or attorney, familiar with the dissolution process of a single-member LLC. While a professional will provide the appropriate process for your unique situation, generally you will need to complete these steps: • File a certificate of dissolution or cancellation in all states the LLC is registered. • The LLC must be in good standing, so any fees or taxes must be current. • Notify any creditors of your intent for the LLC to dissolve. In some states, all creditor claims must be settled before you can move forward. • Depending on the structure, you might have to file a corporate dissolution form with the IRS. 3) You will have to transfer assets from the checkbook IRA to this new IRA. Instruct all assets/liabilities of the former checkbook IRA to be distributed/re-titled to your new IRA custodian. It’s as simple as 1-2-3, but it is important that you have an experienced custodian to help during the transition process. If you want to learn more or take the next steps to remove this liability from your IRA, call Equity Trust for a free transition consultation with one of our specialists. While Equity Trust doesn’t provide tax advice, our specialists can help you get through the transition process.

Don’t Fall Victim to the Taxes, Penalties, Time Requirements and Extra Fees of a Checkbook Control IRA Call for a FREE Checkbook Control IRA Liquidation Consultation:

888-382-4727

11

1 Equity Way, Westlake, OH 44145 888-382-4727 www.TrustETC.com

© 2013 Equity Trust®. All Rights Reserved. ET0002-15