The Self-Directed Roth IRA Structure has been in use for some 35 years. The Tax Court and the IRS have firmly established that the funding of a new entity by an IRA for self-directing assets was a permitted transaction and not prohibited pursuant to Code Section 4975. In fact, the IRS, in an advisory memorandum to audit agents, confirmed that a newly established entity owned by an IRA and managed by the IRA owner may make investments using IRA funds without violating the prohibited transaction rules under Internal Revenue Code Section 4975.
In 1997, Congress, under the Taxpayer Relief Act, introduced the Roth IRA to be like a traditional IRA, but with a few attractive modifications. The big advantage of a Roth IRA is that if you qualify to make contributions, all distributions from the Roth IRA are tax-free – even the investment returns – as long as the distributions meet certain requirements. In addition, unlike traditional IRAs, you may contribute to a Roth IRA for as long as you continue to have earned income (in the case of a traditional IRA, you can’t make contributions after you reach age 70 and 1/2). The rules for the Roth IRA are found in the Internal Revenue Code under Section 408A.
A Roth IRA is an IRA that the owner designates as a Roth IRA. A Roth IRA is generally subject to the rules for Traditional IRAs. For example, traditional and Roth IRAs and their owners are identically affected by the rules treating an IRA as distributing its assets if the IRA engages in a prohibited transaction or the owner borrows against it. The reporting requirements for IRAs also apply to Roth IRAs. However, several rules, described below, apply uniquely to Roth IRAs.
The most attractive feature of the Roth IRA is that even though contributions are not deductible, all distributions, including the earnings and appreciation on all Roth contributions, are tax-free if certain conditions are met.
The following is an overview of the tax characteristics of the Roth IRA
- Contributions are not Tax-Deductible: Unlike a Traditional IRA, an individual is not permitted to take an income tax deduction for their Roth IRA contributions. All Roth IRA contributions are made with after-tax dollars. What this means is that the amount of the contribution is treated as basis in the IRA.
- Earnings are Tax-Deferred: Earnings and gains from a Roth IRA are tax-deferred and may be tax-exempt if certain conditions are met. What this means is that all income and gains generated by a Roth IRA investment are not subject to income tax.
- Tax-Free Earnings: The attraction to the Roth IRA is based on the fact that qualified distributions of Roth earnings are tax-free. As long as certain conditions are met and the distribution is a qualified distribution (the Roth IRA has been established for greater than five years and the Roth IRA owner is over the age of 59 and 1/2), the Roth IRA owner will never pay tax on any Roth distributions received.
The Self-Directed Roth IRA LLC structure has become a popular choice for gaining total investment control (“checkbook control”) over IRA funds and making investments tax-free. In each case, a limited liability company (“LLC”) is established that is owned by the IRA account and managed by the IRA account holder. The IRA Holder’s IRA funds are then transferred by the Custodian to the LLC’s bank account providing the IRA holder with “checkbook control” over his or her IRA funds.
- Are Roth IRAs protected from creditors in a bankruptcy proceeding?
- If I decide to take distributions from a Roth IRA, do I have take distributions in a certain order?
- Do I have to start taking distributions when I reach a certain age with a Roth IRA?
- Can I use a Roth IRA in a Self Directed Roth IRA LLC?
- Who should make Traditional IRA-to-Roth IRA conversions?
- Is there an age limit on when I can set up and contribute to a Roth IRA?
- What happens to the spouse of a Roth IRA Owner who dies?
- Are Distributions to beneficiaries from a Roth IRA subject to tax?
- What happens to the Roth IRA after the holder dies?
- Are you required to take Roth distributions from a Roth IRA you started during your lifetime?
- Do I pay tax when I rollover a Traditional IRA into a Roth IRA?
- Who qualifies for a rollover from a Traditional IRA to a Roth IRA?
- What are the Rollover rules for Roth IRA?
- Do I have to file a form with the IRS just because I received distributions from a Roth IRA?
- Are you required to take distributions from a Roth IRA during your lifetime?