Every LLC you put in a Self-Directed IRA needs an operating agreement. But if you don’t draft the operating agreement properly, you could make your LLC nearly impossible to run, and even endanger your Self-Directed IRA’s eligibility for the federal tax advantages we normally associate with these accounts. This could result in substantial taxes and penalties.
Here are several of the most common mistakes LLC principles who own these entities within Self-Directed IRAs make:
Failure to limit compensation to owners. LLCs in IRAs cannot pay compensation to owners outside of the IRA. That means they can’t pay you a salary, no matter how much labor you’re doing and how much consulting you’re doing for your LLC, as long as it’s in the IRA. The same goes for your spouse, your children, grandchildren, parents, grandparents and those of your spouse, as well as any professional advising you on your LLC in a fiduciary capacity.
Prohibited transactions are governed by IRC § 408(e)(2), which disallows most transactions between the IRA and disqualified persons. “Prohibited transactions” and “disqualified persons” are defined in § 4975(c)(1) and § 4975(e)(2).
You should put language to that effect in your LLC operating agreement.
Failure to limit investments. If you own your LLC within a Self-Directed IRA or 401(k), you should specify in your operating agreement that you cannot invest directly in prohibited investments like collectibles, life insurance contracts, alcoholic beverages, jewelry, gems and certain precious metal coins and bullion of inconsistent or insufficient purity.
Failure to plan for the endgame. All operating agreements, in and out of the Self-Directed IRA, should contain language specifying what to do with the interests of any owner in the event that owner dies or becomes disabled. Too many owners fail to come to an agreement, and are asking for trouble if the unthinkable should happen. Think the unthinkable – and plan for it.
Failure to restrict debt to non-recourse. IRA rules strictly prohibit owners from signing personal guarantees on loans or pledging anything outside of the IRA itself as collateral for a loan. Creditors must have no claim on any assets outside of the IRA. Failure to abide by these rules could result in some or all of your IRA’s tax status being revoked, resulting in significant taxes and possible penalties – plus likely legal bills. If you own an LLC within an IRA, 401(k) or any other tax-advantaged retirement account, your operating agreement should reflect these restrictions.
Failure to define “units.” This is a particularly important mistake when there are multiple owners of an LLC, and/or when people are making contributions of capital that are not readily defined. Also, if you ever want to sell an interest in your LLC – or sell the whole business outright – it’s important to define who gets what. LLCs don’t come pre-subdivided the way corporations are with shares. Owners/partners in LLCs must define how the fractional interest of the company is broken up – and the tool for doing this is the operating agreement.
Otherwise, if the company ever issues a dividend, no one will know who is supposed to get how much!