IRA LLC vs. IRA Trust

When to Consider an IRA Trust over an IRA LLC

Historically, for those clients who have wanted a “checkbook control” feature for their self- directed IRA investing, the IRA LLC structure has been the tool of choice. While not well known, the IRA Trust should garner strong consideration with the IRA investor. The IRA LLC and the IRA Trust are similar in that:

Both permit a “checkbook control” feature; and,
Appearance-wise, both look almost identical to each other in its legal construct

But, are they?

All IRA account owners should understand the differences between these two plans. It is not that one is better than the other…but, a trust can bring distinct advantages over an LLC that should at least be considered by the IRA account owner.

What is being Covered:

What is an IRA Trust;
LLC Filing Requirements;
Investments Made in Other States;
How to Decide: LLC or Trust;

What is an IRA Trust?

If you conduct internet research on the topic of an "IRA Trust", you may become confused with seemingly contradictory information. To help clarify, let’s start with what a self-directed IRA (SDIRA) Trust is not.

Ed Slott and Company, America’s IRA experts, answers the question “Can I place my IRA in a Trust?” with a resounding NO. The Slott Report is correct, in the context of the question answered. However, they are addressing a different concept than an IRA Trust which is described in this article.

Consider an IRA owner who also has a revocable living trust. Their IRA account is with a financial services company and invested in mutual funds. Rather than having that account in the name of their IRA, the individual wants the account titled in the name of their revocable trust. Essentially, transfer the mutual funds from their IRA account to their trust account (which is not an IRA). The Slott Report is correct, the IRS will consider that transfer as a taxable distribution because it no longer is in an IRA account held by an IRA approved custodian. So, what is the difference between this Trust scenario vs. that of an SDIRA Trust, where the IRA funds end up in an account in the name of a Trust?

In this concept, the SDIRA Trust is not just any trust, certainly not someone’s personal revocable living trust. It is a specifically crafted trust document in which the IRA is both a grantor and beneficiary. This SDIRA Trust must be accepted by the holding custodian…our SDIRA Trust document is approved for use by IRA Services Trust Company. IRA Services Trust Company signs the SDIRA Trust document on behalf of the grantor (similar to signing for the member (IRA) with an IRA LLC). In this SDIRA Trust, you (the IRA account owner) are the trustee of the SDIRA Trust. As trustee, you have control over the investment choices of the SDIRA Trust. Your actions and investments, of course, must not trigger violations of IRS Prohibited Transactions.

Think of it this way. Most SDIRAs use an LLC. If, however, you create your own LLC, in which you are the member, and you move your IRA assets into that LLC, you have just created a taxable distribution. Not a good idea. However, if you direct the custodian to invest your IRA into a properly crafted LLC, in which the IRA is the member, and you act as manager, you are ok. The IRA Trust concept simply uses a Trust arrangement rather than an LLC…we will examine some benefits and negatives in using the Trust. However, may an SDIRA use a Trust rather than an LLC to manage its assets? Yes, when the properly-created trust follows correct steps.

Keep in mind….

There is a concept commonly referred to as an IRA Trust. In that concept, one creates a Trust to be the beneficiary of one’s IRA. The IRA Trust we are speaking of is not making the Trust your IRA beneficiary. The trust created to receive IRA assets as a beneficiary of the Trust is constructed differently than the SDIRA Trust used to manage IRA assets.

Or, think of this visual. The IRA beneficiary trust does not come into effect until the IRA owner passes away. The IRA beneficiary trust manages the assets of the deceased account owner for one or more beneficiaries of the trust. The IRA beneficiary trust can pay the taxes on the distributions or pass the taxes through to the beneficiaries. If you want to use a Trust as the IRA’s beneficiary, that trust will be a completely different trust than a trust to manage assets. Whether to make a Trust the beneficiary of your IRA is a different topic than this article…also, a topic that has varying opinions.

In the SDIRA Trust concept, the IRA is both the grantor and the beneficiary of the Trust. Similar words, yes…but, very different concepts. Accordingly, the IRA account owner will still complete and file a beneficiary designation form for the IRA account itself with the IRA custodian.

In this concept with the SDIRA Trust that you manage as the Trustee, you are alive (yay!) and managing your IRA’s assets through the trust for the benefit of your IRA. In the other one, also called an IRA Trust, you have passed away (ugh, depressing) and someone else is managing your IRA’s assets for the benefit of your beneficiaries.

LLC Filing Requirements

Potential cost savings are of concern for all of us, and the IRA Trust may save the IRA account owner money. The IRA Trust will typically incur a slightly higher establishment fee, but the IRA account owner may still experience savings with the Trust when compared to the ongoing expenses associated with the IRA LLC.

Depending on one’s state of residence, an IRA LLC can become expensive. There is the establishment fee, and some States have annual re-filing requirements. Trusts are not registered with the State, thus do not incur filing fees or ongoing renewal costs.

Consider the LLC fees associated with the following States:

State of California — $70 establishment with an $800 annual fee (commonly referred to as the “LLC tax”) for the LLC;
State of Delaware — $90 establishment with a $300 annual fee;
State of Florida — $125 establishment and approximately $140 per year to maintain;
State of Illinois — $500 establishment and $250 per year to maintain;
State of Massachusetts — $500 establishment and $500 per year to maintain;
State of Maryland — $100 establishment and $300 per year to maintain;
State of Nevada — $75 establishment and up to $500 per year to maintain;
and,
State of Tennessee — $300 establishment and a minimum of $300 per year to maintain.

Yikes!!

And, if your State is not listed here, perhaps you many still incur high fees. There are many States that have annual fees between $100 and $200. Obviously, if you operate the LLC for a period of 10 years, you could incur additional fees to the tune of $1,000 to $2,000. With the Trust, you escape these potentially high LLC costs.

Every State has the requirement that an LLC must have a registered/statutory agent who has a physical mailing address in that State. The registered/statutory agent can be an individual or an entity. The registered agent’s address is a matter of public record, and the address to which people may deliver legal service documents. If you reside in the State in which you want to set up the LLC, you may serve as the agent. If the LLC is in a different State, you will need to arrange for a registered agent, which can be costly.

Although not as common, some States aggressively collect fees, taxes, penalties, etc. for those residents who the State says should have secured the LLC in the State of residency of the LLC manager. For example, a California resident creates an LLC in neighboring Oregon to save money on the filing fee, then possibly receives correspondence from the California Franchise Tax Board that the CA resident owes the State of California $800 per year plus penalties only because they are a resident of CA. Fair? No. Does it happen? Yes.

Again, Trusts are not registered with a Secretary of State and, as a result, have no registration or annual renewal fees like the LLC….so these LLC fees are non-existent. In addition to the ongoing fees, the Trust also relieves the account owner of on-going LLC reporting requirements with the Secretary of State (with some States this can be a hassle). This saves you money, relieves the LLC of ongoing LLC reporting requirements with the Secretary of State, and removes a fear of owing more in fees and penalties to your resident State. It is not uncommon that many people will allow an LLC to lapse (they forget they need to file annually with the State) not only due to the annual fee but forgetting to complete annual LLC reporting requirements. Finally, the Trust creates a greater degree of privacy than offered by an LLC setup.

Company policies – Are there company policies that are particularly important to your business? Perhaps your unlimited paternity/maternity leave policy has endeared you to employees across the company. This is a good place to talk about that.

Investments Made in Other States

Every state has its own rules about when an LLC created in a different State is required to file as a foreign entity in that State. If your IRA-LLC is registered in one State, and you want to, for example, purchase real estate in a different state, does that purchase trigger a requirement to register your LLC in that State? The specific answer to that question varies too much between States to answer that question here. The key takeaway for this point, though, is the same for any State. Trusts are not a State registered entity and thus do not have this issue.

How to Decide: LLC or a Trust

So far, this article leans toward favoring a Trust over an LLC as the preferred vehicle for those who want local control over their IRA investments and transactions. Do I ever recommend an LLC over a Trust? Yes, if the investment desired is better suited for an LLC. Saying this, however, I have only run into this a few times.

For example. some jurisdictions do not seem to like a Trust owning real estate. It can mess up the title insurance. In this case, I would probably suggest paying a bit more with an LLC and forgo some of the IRA Trust benefits, than mess around with title insurance on an investment property.

In addition, for the IRA investor who is considering making a leveraged investment (e.g., the IRA securing a non-recourse loan for the purchase of property) with their IRA, securing financing may be easier to do through the LLC structure than the IRA Trust.