If you want to invest in an active business with your IRA or other retirement account, there are big time tax benefits to going offshore. Here is how to maximize the benefits of offshore IRA LLC for business investors.
First, let’s talk about investing in active businesses with your IRA. The rules are straightforward – you can invest in any type of business, or lend money from your IRA to any business, so long as you do not own more than 50% of the company and are not a highly paid employee of the company.
The reasons for these rules is simple. You should not be receiving a benefit from your IRA and all transactions must be fair and at arm’s length. That is to say, any investment or loan that you make should be for the benefit of the IRA, not for your personal gain or the benefit of a business you control.
For example, you can’t take money out of your IRA as salary by lending it to your company. Likewise, you should not invest money from your IRA into a business you control if that transaction is unfair – the interest rate and repayment terms must be market rate. If you own less than 50% of a business, you are less likely to invest or make loans that are not at arm’s length.
Who is a “highly compensated employee” can become complicated. Some define this as anyone making over $100,000. Others as anyone who is among the highest-paid 20 percent of employees of the company.
In a small business, this becomes even more intricate and your salary is likely to change over time. Once you make the investment, if you get a raise, you might become in violation of these rules.
For this reason, I tell clients they should not invest in any business from which they draw a salary. This is the safest position to take and eliminates the concern. If you are working for a large corporation, or one that is publically traded, go ahead and buy stock in the business through your retirement account. If you are in a small business, avoid the problem and invest after tax money.
All of these rules stem from one simple principle – you are to manage your offshore IRA LLC for the benefit of the account. You are the investment manager handling money for your client, the IRA. Follow that basic rule, and all will be well.
Ok, enough of the rules. On to the fun part. Here’s how to maximize the benefits of offshore IRA LLC for business investors.
When your IRA invests in an active business in the United States, or invests in a hedge fund that owns active businesses, you may be hit with 35% tax on your return. That’s right, certain investments don’t just flow into your IRA tax free… you pay a tax of 35% on income from active businesses.
This type of income, called Unrelated Business Income in the IRS parlance, results from active businesses structured as partnerships or LLCs. These companies pass untaxed income to their shareholders and the shareholders must pay the tax. This avoids the double tax of a c-corporation.
Well, the government is not going to allow IRAs to invest in partnerships and receive earnings and profits without getting their cut first. Thus, the IRS invented UBI and Unrelated Business Income Tax at 35% for IRAs.
- Income from a c-corporation is not UBI because it’s taxed at the corporate level first and your IRA receives a dividend.
It’s possible for you to eliminate this tax by placing a c-corporation between your active business investment and your IRA. This is called a UBIT blocker corporation.
Income flows from the partnership to the corporation and then to your IRA as a dividend. There is not tax benefit to doing this in the US because the corporation will pay tax before remitting the dividend to your IRA.
But, what about creating an offshore UBIT blocker corporation in a country that will not tax the gains of the company and that will allow it to send a tax free dividend up to your LLC?
This offshore UBIT blocker strategy is the tool so many American billionaires have used to their advantage, and one that 99.9% of IRA owners have no idea exists.
Offshore UBIT blockers have been around for years and made headlines in 2012. The offshore IRA LLC with UBIT blocker is how Mitt Romney held his IRA investments. He grew his IRA to over $100 million with this strategy… very impressive considering the contribution limit is $5,500 to $6,500 per year!
To review Mitt’s strategy, here’s a 2012 article from the Wall Street Journal.
The key to maximizing the benefits of offshore IRA LLC for business investors is the offshore UBIT blocker. When setup in a country that won’t tax your profits, income can flow up to your IRA tax free.
I hope this article on the benefits of offshore IRA LLC for business investors has been helpful. For more information on taking your IRA offshore or forming an offshore UBIT blocker, please contact us here.
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