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The Limited Liability Company (LLC) is a powerful entity that originally started in Wyoming in 1977 and became more popular in the late 1990’s. It is a hybrid between a partnership and corporation. Most are unaware that an LLC can be taxed in four different ways: disregarded, partnership and S or C corporation. The IRS established federal default rules to simplify this determination in 1997. A one member LLC by default will be taxed as a disregarded entity for tax purposes and a two member LLC will be taxed as a partnership for tax purposes.
Now let me share with you 10 LLC secrets that will not only keep you up out of tax trouble but help you better avoid pitfalls down the road.
- Can an IRA invest in an LLC? Yes, but…This is a popular strategy when looking for different investment options for retirement funds. Many are looking to take advantage of the real estate market to invest in and find they do not have the money personally to invest, but their IRA does. This strategy involves moving your IRA to a self directed IRA and the IRS becomes the member of an LLC. In other words, the investment is in the membership interest of the LLC. There are a couple of major issues with this strategy that could create problems with the IRS. First, if you are the manager of the LLC and you are on the LLC checking account that has IRA funds, that means you have “check book control”. There are prohibited transactions in where you can not use that money, but more importantly is that the signer on the account may use the LLC money for personal use which is a big problem and could create serious IRS issues. The second issue centers around who can be the manager of the LLC. Can it be you also? Is that self-dealing? That means you are running the same entity that is owned by the IRA in which you own and that is an issue by the IRS. It appears that having a separate self directed IRA only to own the real estate may be a better approach. You do want to isolate the safe and risk investments also. A resource is Entrust Arizona. You can contact them at 1-480-306-8404.
- What are the advantages of an LLC over an S corporation? Assuming the LLC is taxed as a partnership vs. the S corporation, there are differences. When you capitalize an S corporation, code section 351 allows shareholders to transfer appreciated assets to the corporation tax free. BUT…the shareholder who is transferring the asset MUST own 80% of the S corporation. This is fine if you have a one person corporation, but what if you have a partner? What happens if you own it 50/50? Is it now a taxable event? Yes! How does an LLC taxed as a partnership differ? There is no such rule for an LLC. Transfers are tax free under IRC §721 to an LLC taxed as a partnership. There is no 80% rule. An LLC can rarely lose its status as a partnership for tax purposes, but the S corporation can forfeit the S election, in many ways including having a foreign owner, an owner that is a C corporation….(the S corporation has restrictions on who can be a shareholder. This is especially important when you are looking for investors. The LLC has the charging order protection which offers more protection vs. an S corporation. Yes, you can get the best of both worlds and have an LLC taxed as an S corporation and have the charging order protection (which will be covered in bonus point #12).
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