EP 8 – Starting a Business with Your Self-Directed IRA or 401(k)

Join Mark and Mat as they answer your difficult Self-Directed retirement plan questions. Mark and Mat dive deep into all of your questions on Self Directing your Roth IRA, 401(k), Traditional IRA, Coverdale, HSA, and more.

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Mark Kohler: Welcome, everybody, to this week’s episode of the directed IRA podcast. My name is Mark Kohler, a CPA, an attorney practicing in the arena of Self-directed IRAs for the last 20 years. I’m here with my amazing co-host, Mat Sorensen, author of the book The Self-directed IRA Handbook. And I sound like a radio broadcaster. I mean, this sounds really cheesy, like you bet you can reach us at.

Mat Sorensen: This episode is brought to you by Slim Jim. Slap into a Slim Jim now.

 Mark Kohler: Well, everybody, thanks for listening. Yes, we are two hams. We are trying to be the best tax lawyers in America on this topic, but we also try to keep it fun and interesting. You’re going to have to put up with some of our movie quotes and just cheesy humor. But the goal is, is to make this edutainment where you learn something incredible that can bless your life, make you much more wealthy. I hope you live better than the American dream self-direct your retirement accounts is a huge part of that. And just have a little fun. So that’s our goal.

 Mat Sorensen: I love it. So today’s topic is kind of an interesting one, this one can get a little nerdy, I’ll admit that so, you know, put on your glasses or, you know, do whatever things you put on your maybe put your pocket square in, I don’t know, whatever you do to nerd out,

 Mark Kohler: Nerdy meaning technical nerdy meaning could be a little technical. Yeah.

 Mat Sorensen: But could be really powerful because this is where you can combine two of the things we love small business ownership and self-directed IRAs. So we’re going to talk about how your IRA can actually own a small business. And there’s rules to this. We’re going to go over three common options and how you can actually execute and pull this off properly.

 Mark Kohler: And I think the one way you could look at this in a nerdy technical way and still feel pretty cool is think of yourself as Ben Affleck in the accountant. And it was fantastic. I watched it on a regular basis to try to keep my skills.

 Mat Sorensen: I just watched Tom Cruise in the firm, you know, the tax lawyer straight out that would you know, you kind of want to be more the Tom Cruise in the firm than Ben Affleck was a little weird in the accountant. But that because that’s what the roll calls fo.

 Mark Kohler: OK, you know what? You be Tom Cruise. I’ll be Ben Affleck because I thought Affleck was pretty smart. Now I also have a whiteboard that will flip out, will be switched with my image. We broadcast this on iTunes, Spotify and Stitcher from a podcast standpoint, but this is also recorded and put on YouTube. All you have to do is get on YouTube and top type directedira.com/podcast or Sorensen podcast. Kohler podcast. You’re going to see both of our shows. We have the Main Street Business podcast. It’s all about small business tax, legal planning. We’re going to cover all sorts of topics that don’t involve Self-directing. But this year in 2020 the year that will go down in infamy, the covid-19 year we started the directed IRA podcast. So lots of episodes there. You can watch us on YouTube. And if you want to see the visual representation of my whiteboard as the amazing Mat Sorensen takes us through these topics, you can go to YouTube. So Mat’s really the I’m following his lead today. This is his wheelhouse. And so last weekend on Main Street, we talked about year-end tax strategies and I kind of got to shine there.

 Mat Sorensen: I would say you were lead actor. I was best supporting actor. So, yeah. All right. Let me say from the outset, it’s easy to invest your IRA into a company where you’re just an investor, where it’s like you’re not working in the business, you don’t own it 100%. You’re just, hey, there’s someone else running out there selling shares. They need some cash investors. Let me throw my IRA in. Rules are so much easier. Well, when someone comes to us and.

 Mark Kohler: Let me say that could be a rental property business that. Yeah, passive business as well. Now you can own a passive business, but this whole show is about an operational business. Maybe make that distinction to Mat.

 Mat Sorensen: Yeah. About an operation and particularly like the small business that you’re going to own the majority of it. OK, we talked last week about you could partner in on like, you know, about 20% of a company, you know, and that’s totally fine was two weeks ago. But now I’m talking about. All right, Mat, what do we want to make? Most of it, I want my IRA retirement account to put in all the money and own this thing outright or be the 50% or more owner. How can I pull it off? What are the rules

 Mark Kohler: And work the business? That that’s a key thing. And I want to provide a distinction if I can try to do it. And I’m going to go to the whiteboard now and and use this as, I think an example that will help many of you understand. This would be. Like, I’m going to put a line down the middle of the paper here and this would be operational. And on the right side would be passive. So your IRA or 401K or SEP or Roth or simple or any of these types of tax-deferred structures. Can invest in part or in whole into an entity where you buy real estate, currency, invest in raw land, developed land, rent, property, all sorts of passive activities. That’s not today’s topic, but a big line through that we’re talking about. I want to run a business and not only do I want to be a player in this business, I want to be a majority owner and more than likely work in this business. I need my IRA or 401K to be the capital behind a new business. And me as a person is going to work. Is that even allowed? And what are my options?

 Mat Sorensen: Yeah. So let’s go. Yeah, let’s run an example, ok. Let’s say that let’s say that you want to buy a franchise. OK, we get this call quite a bit as a consult. Someone comes in, they say, hey, Mat, I want to buy this franchise business. $200,000. They need that. I need that’s going to buy the franchise. It’s going to get my initial inventory or build out just an example here and. I need to be involved in this business to some degree. Now we’re going to get to the degree you’re going to be involved here because there’s different options. Let’s just start with that premise that you’re buying a franchise business and this could be any small business. But let’s just work with me here, OK? And this is an example. All right.

 Mark Kohler: Diagramming this out. This is Pictionary at its best. So this is good.

 Mat Sorensen: So when a client comes in, I’m going to tell you, you’ve got three lines. You can do this, OK? You’ve got door number one, door number two, door number three, you can log into to do this type of a deal. It depends on, frankly, how involved you want to be in operating this business. Now, let’s go through.

 Mark Kohler: Now, what do you give the three just in general than we can deep dive on each? Is that all right?

 Mat Sorensen: All right, let’s hit the three in general. The first is you’re going to do something called a rollover on business startups. ROBS. You’re going to set up a C Corp, you’re going to have a 401k plan. You can work in the business and take a salary. And it’s the most complicated that gives you the most flexibility if you really want to work in the business day to day. It’s called ROBS been around now for almost 10 years. We’ve helped clients do them in the past. Option one.

 Mark Kohler: Ok, and when we dive into it, we could give a referral or two of the companies we like that help administer that. Yeah, that’s OK. We’re going to come back to that. And that’s where you are, a full time employee and your retirement account really owns the majority, if not 100% of the operation, correct?

 Mat Sorensen: Yeah. You’re just going to own the whole thing but doesn’t have to, typically it will.

 Mark Kohler: All right. That’s option one option two.

 Mat Sorensen: Option two is I’m just going to have my IRA own an LLC. It may be taxed as a C corp. And I’m not going to work this business day to day, I’m going to only be oversight and management, I’m not working in this day to day. This is a franchise or business that I can buy, that you can be an absentee owner. You’re not the manager of this business. You’re not showing up to work every day for that business. Your IRA is basically just the cash investor. You have someone else that’s managing the day to day operations of that business.

 Mark Kohler: And you’re going to explain why we’re going to use a C corp to do that shortly.

 Mat Sorensen: Correct we’ll get to that because you don’t want to pay UBIT tax, but we’ll hit that, OK? All right. Option three. Now, these first two options we hit mean at the end of the day, you don’t make profits when the retirement sorry, when the business is profitable or is sold, your retirement account makes the money right. Your retirement account owns both of those companies. Some people don’t want that. Now we love that. Of course, that can be a great tax strategy. Some people are like, yeah, I want to own this personally. I don’t want to deal with all these restrictions on retirement accounts, but I need access to some money in my retirement account. What we’re going to do in that instance is probably set up a new S-CORP, maybe it’s an LLC, but typically a new S corporation for your new business. Again, let’s say it’s the franchise. We’re going to adopt a solo 401k. We’re going to roll over your existing retirement plan dollars into the Solok, and you’re going to take a loan of $50,000 from the Solok to yourself, which you can then fund into the S-CORP or operational business that’s going to be owning the franchise. Now, you’ve at least got access to $50,000. You’re not going to have all the rules and restrictions of retirement accounts because your retirement account doesn’t own it. You just took the 50K laon, which is a provision you can do from your own 401k. But now you own this S-CORP. It’s just a regular business that you personally own. Retirement account is funded a loan to you again, that got you at least $50K. Now that option’s good. And when a client is like, I just want 50 and that’s all I need and I got one hundred thousand or more in my retirement account. I love to go down that line first, assuming you want to work in the business every day and own it personally.

Mark Kohler: Ok, and I’m going to just why don’t we. OK, so all of you that were able to get to a computer and not be driving down the road or on a treadmill and watch this on YouTube, the link is down there below in the description. You will have seen me show three different columns of options, and I’m going to suggest Mat now that you put all three on the table, let’s work backwards going through them, because you just said with most people, we’re going to typically start with option three because it’s the simplest, easiest and gives you the most flexibility to get a business off the ground by yourself. Now. But there’s pros and cons with each option, would that be OK? Let’s start with three.

 Mat Sorensen: Yeah, yeah, let’s go backwards.

 Mark Kohler: All right. So let’s go back to the white board now, and I’m going to put pros and cons under this column three. Do you want to start with a couple of mention a pro or con from my perspective, too?

 Mat Sorensen: Yep. The pro this is the easiest to pull off. Pro easiest. OK, there’s not a lot of restrictions on it. OK, so it’s easier to pull off.

 Mark Kohler: I think a pro is you as the owner, get all the profit and you get a salary, you get both. Fair enough, right? Yep, OK.

 Mat Sorensen: Less compliance to worry about, OK?

 Mark Kohler: Less compliance.

 Mat Sorensen: Now, let me walk through this, what it is here in a sec. Do you want me to hit that?

 Mark Kohler: Yeah. Why don’t you break down the steps too. Let’s do that. OK,

 Mat Sorensen: So what you’re going to do is you have to set up your new entity. This is generally going to be your S corporation. That’s what most small business owners we’re going to recommend for great for tax planning when you’re personally going to own a business. Now, remember, in this option, the retirement account is not going to own and invest the business. We’re mainly using the retirement account as a vehicle to get some cash out without taking a distribution. We’re going to do the loan here that you can get up to 50 grand that can fund some of your startup and business expenses. So we set up an S Corp that is going to adopt a solo for one K plan.

 Mark Kohler: Step two adopt solo 401k.

 Mat Sorensen: We set those up in the law firm S-Corps’s and Solo(k)s all day long, and the Solo(k)s can loan you $50 grand. Now, if you have an IRA or prior employer 401K, you just left corporate America. Now you’re starting your own small business. You can roll that into your Solok. You take the loan back.

 Mark Kohler: You said loan you money. I think step three would be get money into the solo 401k. So you were just saying that. So step three would be do a rollover from old 401(k), IRA or even make a new contribution. But basically you’ve got to fund the solo before you can even loan to you. Yeah. OK, yeah. 

Mat Sorensen: Most people are going to be using retirement plan. They’re not going to fund a new contribution to take a loan back out, but you would be funding it from existing dollars step three then. You’re right. Step four would be loan yourself the money, which you can take half the balance of your 401(k) not to exceed 50 grand. So if you’ve got a two hundred thousand old employer 401k, you can roll the whole thing over and you can get half the balance of that not to exceed 50. And that example, you could get 50 if you’ve got a $80,000 401K or IRA laying around half the balance not to exceed 50, you could take forty thousand. That’s half the balance as a loan to pay back over five years.

 Mark Kohler: Ok, five-year term. What’s the interest rate?

 Mat Sorensen: Prime plus two percent, so prime pretty low right now, you’re looking maybe five percent total is the rate, but again, you’re paying back your own four one K and you’re taking an interest expense in the business for using your own 401(k)s dollars.

Mark Kohler: Ok, off the whiteboard for a moment. One thing I want to remind everybody is don’t get confused with the Cares Act and this crazy covid year. You may have heard of the news. Oh. The country has been demolished or majorly impacted with this pandemic. You can borrow up to a hundred grand on your 401k and. That was a temporary thing in 2020 that ended in approximately October, right Mat, of 2020.

 Mat Sorensen: End September. Yep.

 Mark Kohler: Ok, so don’t think that’s still on the table. It’s not. We’re back now to the $50,000 rule. Now, at the time of this recording, there is another stimulus package, I guess, for lack of a better word or a PPP program, it’s going to have a variety of things in it, probably some unemployment and all those goodies. There might be another extension of this provision. We don’t know. But under generally accepted rules for the last 20 years or more, it’s been a 50% or 50 grand, whichever’s less. So don’t get confused there. Now, Mat, from an accounting standpoint, I’m going to put step five as the CPA in the house. Let’s go back to the whiteboard. When the 401k loans to you, the person, step five is a contribution to the S-CORP that’s going to be booked as a capital contribution. So there’s a contribution or you can what I like to do is book it as a loan on the books of the S-CORP. So even though the loan is to you, which is technically required, you can let the interest be paid on the loan by the corporation. Now, that’s a nice benefit because the corporation gets the tax write off for the interest that goes back to your 401k tax free. So now your 401k is earning. Prime plus two your corporation is getting a write off as a business loan expense, but there is this clunky step where the documents show a loan to you as a person, but your corporation is going to book that loan on the books of the corporation. Accountants aren’t going to have a problem with this. This is not a publicly traded corporation. It’s a privately held corporation. This is not an IRS problem, but your accountants got to know this is a loan back to the 401k that your corporation is servicing. Anything you want to add to that Mat?

 Mat Sorensen: Yeah. Now that. Yeah. And when he mark says contribution S-CORP don’t get confused with retirement plan contributions. This is just not funding your base that you’re putting the money into the S-corporation, just depositing into the S corporation’s bank account. Now, when you’re operating this business, one nice thing about this is it’s just an S-Corp. You’re just doing regular tax planning. All the stuff Mark and I are always talking about. You’re doing your salary dividend split. You don’t have any restrictions on how much salary you can take, which we’re going to have to hit in some of the other options later. So it’s it’s a lot more flexible and fluid. It’s kind of like the regular small business. Now you just happen to fund it with fifty thousand from your old employer, 401k, without taking the distribution.

 Mark Kohler: Now, before we get to the major con here, because it’s like, oh, my gosh, this sounds great. You probably already knows the con, but I’m going to throw it out to be the good cop today. I’ll be the bad cop. I’ll tell you the con here in a moment. But first, another question. How what are what’s the payment schedule? Can I make a balloon payment in five years or do I have to make monthly or quarterly payments annual.

 Mat Sorensen: Yeah, you have to at least make quarterly payments so you can do monthly on your the five-year loan that you’re paying back that 50K to your 401k. OK, but you can’t just do a lump sum at the end of five, so you’re making you’ll have to amortize it, do a payment schedule, pay over five years. We help with those too at KKOS lawyers and directed IRA when you do this loan from your Solok. OK, we can help with the loan doc if you need to and we’ll do the payment schedule.

 Mark Kohler: Well, Mat, that’s a good point. I was just going to go there for any of you there, like, OK, where do I start? Let’s summarize here and I want to give you a few referral procedures here. If you’re going to set up a new S-CORP for this call our office, KKOS Lawyers information down below and get an hour with an attorney. Explain what you’re doing. And they’re going to answer a lot of your questions, along the way, all of our six tax attorneys on staff can walk you through this. That’s step one. Just make an appointment to get your S-CORP up. Number two, we have a 401k set up solution. We have a DIY do it yourself for $500. And then the attorney assisted full service where you get another hour with the attorney, walking you through the 401K process. If you’re going to do this loan and it’s a little tricky, I would recommend the full service. You’re going to talk to Salana. She’s our paralegal administrator. That gets to 401k’s off the ground. So when you call the office, you’ll set up an hour for your S-Corp and then maybe set up some time for the for one follow up call. And you can start getting applications going. Once those two structures are set up, the S-corp and the solo. Step three, is you can start moving money into the 401K. And that’s where Directed IRA as the administrator as your third party, I guess, third party Mat. What do you like to call directed IRA in their role? What’s the title for there?

 Mat Sorensen: Well, that’s still OK. We if you we will serve as custodian for your Solok account, so we will record keep it and do your statements and do some reporting to the IRS for it. So, yeah, we’re helping make sure that stays in compliance. And of course, updating your plan, as the IRS does require every six years. So so that’s you know, that’s the role Directed IRA plays.

 Mark Kohler: And Mat, can I say. And then number four, when you say, well, how do I do this alone in the binder that you get for your 401k, there’s a procedure that’s set forth for you and Salana or the attorney that’s helping you set up the 401K, we’ll say pull this out, write up a note, and you don’t have to go to a bank. You don’t have to apply with anybody. It’s your 401k and you approved the loan to yourself and you’re going to do it. Then once you execute that loan, then you can direct the custodian Directed IRA to say, hey, I’m ready for my $50,000 or whatever that number is, and then they’ll send you the money. And this process might take two weeks, two to three. We can rush it. We can. But I mean, that’s kind of the steps. And then your money’s in your S-CORP Mat would you anything you’d have to the steps and people to talk to.

 Mat Sorensen: No that’s the process, it’s the again, it’s it’s simpler now there’s a lot of things going on here, right? You’re starting a new business. You’re accessing retirement plan. Sometimes this sounds like a lot, but you’re doing it in a tax efficient way. I think a lot of people, you know, there’s thirty trillion dollars in retirement accounts to start a business. This is like the nest egg where they’ve actually saved money that they could execute this. But we don’t want to take a distribution and pull it out. If you’re 40 years old, starting a new small business, you don’t want a 10% early withdrawal penalty and have all the taxes due on that the same time you’re trying to start a business. That could be brutal. So we want tax-efficient ways to do this. So getting that $50k No. 10% early withdrawal penalty should have been five thousand bucks, no tax on it. You’re going to pay it back in. If you don’t pay it back in, though, by the way, if you fail on the loan, then it is considered a distribution.

 Mark Kohler: And Mat, you just said something I want to highlight here. Probably on a once a month basis, I hear of nightmare stories where and I’m just going to be blunt, I’m going to offend someone here, but I hear nightmare stories of financial advisers, typically people peddling. Sorry. Persuading clients to buy life insurance will actually encourage people to take money out of their 401k and pay the penalty and the tax just to create some sort of infinite banking. Insurance strategy. Now, I’m not saying infinite banking and life insurance and whole life and all those little variable, and I know them very well, they work. But I would really get a second or third opinion and encourage you not to drain a retirement account and pay penalties and tax to fund something like that. Be very, very careful before you go down that path. So this is a non penalty nontaxable scenario that gives you a lot of flexibility. And I love it. OK, the con do I have to say the con?

 Mat Sorensen: Yeah, right in front of everyone.

 Mark Kohler: Here’s the con. It’s 50 grand. Many of you were like, that’s not enough to start a business. And it may not be now I’ve we’ve done a lot of shows in the past on how to start a small business and a side hustle for less than a thousand dollars. We’ve done shows on less than ten thousand dollars. There’s businesses out there. You might be able to get started right away. And there’s franchises that do have a franchise fee less than $50,000. You’re not going to start in McDonald’s where you need half a million. So this this is this could be a really good fit if you can work under the cap of fifty thousand. So don’t get frustrated there. And I would throw out Mat you could borrow from other people’s 401ks you may say, well I can do this for one hundred grand. Well borrow 50 grand from someone else’s 401k as long as you are prohibited party. This could be a good fit.

 Mat Sorensen: Yeah. Here’s what I’ve done. You have got a spouse that has an old airier for one K, we’re going to roll that into the Solok two and you each do $50,000 out now you got 100 grand. So, so there’s, there’s lots of other ways and a lot of times that 50 grand or maybe your spouse at the end you got one hundred grand, maybe you’ve got another 50 grand of personal cash already. Maybe you take a home equity line of credit. I mean, once you start tapping all your resources, this is just one of those things you’re using to get this business off the ground.

 Mark Kohler: And so what are the best strategies is get your ex-wife or ex-husband to loan you the $50,000 and then just don’t pay them back. And I love them. That’s that really. It’s a winner.

 Mat Sorensen: Yeah, yeah. So, yeah, a lot of takers on that one.

 Mark Kohler: Yeah. Yeah. So, you know, do it on a napkin, go to Denny’s and say I got a deal for you. Do you want to loan me money. Never use the I word investor. You’re just going to borrow money and and then you could screw them over later. I think it could really help you capitalize your business quickly. So.

 Mat Sorensen: Yeah. Yeah. Mark Kohler with the hot pick today. Ok, all right. We do not do divorce law or settle those disputes let me just remind you. Right.

 Mark Kohler: We don’t care just if they get pissed. You call it your divorce lawyer, not us. Our jobs, just to get your money, you know. So so don’t blame me.

 Mat Sorensen: Let’s option two, OK, we got we gotta move this along. That’s option. But I know, right. I mean, it’s great. But, you know, you get two guys that bill by the hour together and they can make podcasts go forever. Ok, twenty years of billing by the hour.

 Mark Kohler: I want go back to the whiteboard. Ok, why you describe option two. I’m going to go back to the whiteboard. All right.

 Mat Sorensen: All right. Now sometimes we’ll have clients that come to us and this doesn’t work for everyone. Let me say option two does not work for everyone. Just like option three doesn’t work for everyone. Just like option one doesn’t work for everyone. So and I want you to think.

 Mark Kohler: That’s why they call it an option. That’s right.

 Mat Sorensen: Now, here’s the important part I want to say is before I start option two. These each of these options, you have to color within the lines. OK, don’t take an option and be like, well, I’m going to do that option, but sort of. OK, now you’re doing one or the other. You’ve got to fit in the box. OK, this is unfortunate, but it’s how the tax code works. You got to fit it in the box option two OK, if you’re in the scenario where you say, hey, I don’t need to run the business day to day, this is a business I can buy. Maybe it’s an existing small business or an existing franchise or new whatever, but there’s someone else that’s going to be day to day manager of this. What we like to do is just you can set up an LLC, 100% owned by your IRA. You’re the manager of it. You get no salary or compensation because you can’t receive salary.

 Mark Kohler: IRA or 401k any retirement account.

 Mat Sorensen: Yeah. Any retirement account, your HSA, you know, and you’ve got a day to day manager, though, of that business that’s working the business. This is the operational business, again, we’re talking about here. So requires boots on the ground. Now you can be involved, you can check on things, you can be following up with the manager on a monthly or weekly basis to make sure everything’s going OK. That’s all right. You can be checking financials and signing off on important items. That’s OK. But this cannot be a job. You have to basically be in an administrative and management role in this business. You’re not day to day working in it. Now. That is a prohibitive transaction issue. The reason we’re saying that is because the prohibitive transaction rules, if your like, what the heck is that? Go back to our podcast on prohibitive transactions. You can’t pay yourself from your IRA or a company. Your IRA owns a salary or any compensation that’s prohibited. Nor can you put physical work and labor into a business that your retirement account owns unless you got the right structure. This structure is not one that you can work in every day. You are restricted to management and administrative oversight in this option. But I run into clients who this one works for. Like I wasn’t going to work in this business. I don’t want to. This is just strictly an investment. It’s got management or people who already run it from and hire so and so that’s going to manage it. I’m just my IRA is just acting as the investor to acquire.

Mark Kohler: Ok, now I’m going to add a few things here. The third party manager. That’s going to run the show for you. Cannot be your spouse, yep, a child. Or a parent. And we go through in a separate podcast on prohibited transactions and parties, we’d recommend you go back to that so that you kind of know what’s going on there. And this does kind of relate to the passive businesses as well, whether it’s operational or passive. You can’t be an employee. You can’t hire your spouse, child or parent to be an employee. So you want to know that, make sure that that third party manager is there and. Keep in mind, this is also not a loan. You’ve got to get out of that loan mindset, your retirement account is going to invest. And this is it’s an OK point to use the I word, now. Your retirement account is going to be an investor and it’s going to invest in the business and be typically the 100% owner unless you pool it with some other retirement accounts. And it’s OK if you do if you want to bring in multiple retirement accounts, you can’t bring in spouse and mom and dad and kids to be partners in this entity that’s operational. And you can do any amount. You can go up to a million dollars or more. We don’t care whatever the dollar amount is needed. But Mat, what’s the con? All right, it starts with the letter U.

 Mat Sorensen: Ok, yeah, now we know you can’t work in it, we are back on the other one. Yeah, there’s a track called Cubitt, unrelated business income tax. When your IRA is getting profits from owning a business, an operational business. See, retirement accounts are designed to receive investment income like rental income, interest income, capital gain, income, dividend income. That’s all investment income. That’s what a lot of Self-direct investors get. But when you own a small business. It’s it’s getting pass-through income that passes down to the owners, just business income. This is where this unrelated business income tax applies, just 37% that your IRA ends up paying. Now, there’s a workaround to this. OK,

 Mark Kohler: Or you’re 401k. That’s just a little baby step there. So who whatever retirement account? I’m going to say it a different way. Whatever retirement account owns this business because it’s operational and they want to make it fair with all the other operational businesses in town, if your IRA buys a restaurant, then you’ve got to pay taxes like all the other restaurant owners. But if you buy an apartment building, you don’t have to pay tax because that’s passive. That’s an investment. So there’s none of this UBIT crap when it comes to that operational. There might be UDFI topic for another day, but there’s no UBIT on an operational business, on a passive business. It’s on operations because they want to level the playing field. You can’t have an Italian restaurant down the street that doesn’t pay tax and compete against John Doe down the street with his Italian restaurant. So they want to level it with this UBIT tax and you don’t pay it. Like Mat just said, your retirement account pays it at the end of the year and it sucks and it’s up to 37%. That’s UBIT, and then Mat was about to give us the workaround.

 Mat Sorensen: Yeah, and I don’t think that restaurant would be John Doe’s restaurant, maybe like Don Corleone restaurant or something like that.

 Mark Kohler: Yeah, I don’t know if I go to John Doe’s Italian, I go to Don Corleone’s Italian, OK? Fair enough.

 Mat Sorensen: That’s right. And definitely not olive garden. OK. Here’s the solution, though. You can take corporate tax instead of UBIT tax, so what you can do is you can add a C Corp blocker, is what we call it. There’s a whole chapter in my book on this, on Blocker corporations. You can add what’s called a C Corp blocker on LLC. So we just add an election to the LLC, tax it like a C corp. Now, when the business has profits, it’s going to pay corporate tax at 21%. That’s the current corporate tax rate. If you’re in a state that has corporate tax, you have to pay that too let’s say you got 21% corporate tax, then profits after corporate taxes are paid, passed down to the IRA with no UBIT. So now I’m getting out of 37% for 21%. I basically save 16% in tax. So that’s the structure we like to do where you can have an operational business. You’re going to sit on it and cash flow it over time. That’s the structure we like now. I have had clients buy operational businesses with their one client with a Roth IRA. He owned it for a couple of years. He did not want to cash flow the business. He’s like, I’m going to turn this thing around and I’m going to sell it for a profit to someone else it’s exactly what he did. Now, he didn’t work the business, they already had current employees and management, it was, you know, It had maybe 10 or 15 employees already that ran it and he was able to sell it a couple of years later and get the profit all back in his Roth. Now, when he sold the business, that was capital gains. OK, so if your intent is to own a business and maybe flip it later, you may not add the C Corp blocker, you may just be an LLC because you’re not going to have profits coming through year to year that’s going to crush you. You may just get capital gain on the way out and selling it to someone else. If you’re going to cash flow in on business. Long term, though, we generally add the C-Corp blocker. So you pay 21% instead of 37%.

 Mark Kohler: Now if you’re on YouTube, you’re going to love this diagram. Let’s keep the whiteboard up for a moment. You see that the red is the C Corp blocker at 21% paid before it goes to the retirement account. Now why that works is because the retirement account is now just getting a dividend. The C Corp pays its tax retirement account just got a dividend like it owned Facebook. So there’s no tax down there. Then if you don’t use the blocker, you see a blue, I have UBIT, that’s actually paid down at the retirement account level of 37%. Or we have the escape hatch in green, where we have this arrow go over here and show selling the business for capital gain for a max of 20%. You know, Mat, I got a question for you, because this is where one might go. Well, if the Blocker’s 21% in capital gains 20, that’s not much of a difference. True. Yeah, but what about state taxes? Does state apply to you? Is there a state on top of UBIT?

 Mat Sorensen: Yes, many states have a UBIT tax, I shouldn’t say many, some do think of the usual suspects California, Illinois, Massachusetts, many states don’t, though, so some states have a carry on. It’s kind of like if you have it, if you’re subject to a federal, you’re subject to it in that state. So a lot of times your UBIT could be more than 37%.

 Mark Kohler: And that goes for capital gain, everybody. So down in green I’m going to say max 20% fed plus state questionmark then in blue I’m going to do UBIT plus State.. Questionmark and then in red, I’m going to put C Corp because C corporations pay state tax as well. So you got plus state here. Now, I want to throw some of you may go, oh my gosh, this is so complicated, blah, blah, blah. But here’s the point. This isn’t too bad when you sit down and go, I need to fund a business, I need $200,000 to do it. The loan things isn’t going to work. I want all the profit in the 401k a retirement account anyway. And so I’m going to run this bad boy through the through the retirement account. I’m not going to be involved. Just put together a spreadsheet and you’re going to say hypothetical. We made one hundred grand. What’s the tax in this column. What’s the tax on this column and what’s the tax in this column. And this is what a consultation is about when you call us, we look at it and say, OK, here’s your, you know, scenario ABC. And then under option two, these variations of option two, we can choose the one that’s best for you. And then you can go, here’s where I’m going to go.

 Mat Sorensen: Let me give another example of a client I have that did this option. I have a client that is a homebuilder. And, you know, he built so many homes and does so many with his Roth IRA, he’s going to have UBIT. So when he does this, LLC structured his Roth IRA owns and he’s building and selling houses and he’s doing a lot of them, he’s going to have UBIT at 37%. To him, this Roth IRA with the C Corp blocker at 21% is a gold mine. He loves it because he’s like, wait a second, if I build 10 homes over here per year in this LLC owned by my IRA and I have general contractors that do it, I just go hire it out and I know the people and they know me from the deals. I fund them, build the houses, sell them. I got the team. He’s not working it day to day. Right. He’s like, if I did that personally, by the time I pay my federal taxes on it, he’s like, this is a way better deal doing it in my IRA. It’s going to come out tax free after I pay the 21% rather than max rate, which he’s at on the individual level. Not to mention he’s going to have some self employment taxes. He’s got to get a little you know. So he is he loves that structure.

 Mark Kohler: Example it is, and I don’t not I’m being a little weird right now, I don’t want to say this to pat myself or whatever on the back, but you know what’s awesome and I just love you Mat what’s cool is in this show, many of you don’t realize we don’t start with a script. We don’t need someone like today. We’re like, yeah, we don’t have time just go for it.

 Mat Sorensen: Many of you are surprised to hear that.

 Mark Kohler: Yeah, yeah, yeah. Many people are like, oh my gosh, you guys sound so scripted. No but. But what it was. Of course not. But what I was saying is I learned stuff from Mat on this show. He brings up points that I wouldn’t bring up. And I know I bring up points he wouldn’t bring up. And the synergy here is really quite amazing. Like this is this is really fun in the whiteboard with these different colors and everything, really, I think explain this well. And I really, really encourage all of you to try to get over YouTube. And when you do, please subscribe and hit the bell icon, because every time we shoot a new podcast on video, you’ll get a ping and you’ll go, Oh, I can watch that while I’m doing some work or returns my emails. OK, now I wanted to say two things that because I love what Mat just said about the example of the contractor, but Mat said two things in there that are kind of subtle that I think need to be blown up here or exemplified. One is Mat, said Roth. Now, that’s really important because if I’m going to pay the C Corp Blocker, there are naysayers out there that go well, you pay 21% at the corporate level. Now it goes into your traditional IRA or 401K. When you turn 59 1/2, you’re going to pay tax again. So did you really accomplish much? Well, you have to think about the fact that if I’m investing in Facebook or Microsoft, they were paying tax and I get a dividend. So you have to look at don’t hyperfocus on the tax, hyperfocus on your rate of return. If this money is going to make you 20, 30 percent per year rather than eight percent in a mutual fund or an ETF or a dividend with IBM, you’re going to go, holy crap, after the blocker, I’m still making 15%. That’s what’s important. You’re focusing on the rate of return, not the taxes perse. Number two. Mat didn’t say the word, but I want to say it, and that’s opportunity shifting. When we meet with the contractor, I have a call with a client this week and they were saying, well, what did they say? They said this year, this was two days ago. I’m going to not mention their name or what region of the country that last year they did about 24 wholesale deals. They made approximately $250,000. On average, they made about $10,000 per wholesale this year. They said in 2021 coming up, we’re going to be able to do 50 wholesales. We’re really doubling down on our system. The process, we’ve really figured it out. I was like, great. And they said, Mark, how do we say tax on this? I said, don’t do 50. I was like, oh what are you stupid? We see these deals in front of us. And I go, no, no, no, no. Let’s take all of the kids Roth, your Roth, your retirement accounts, pool them into another sister, LLC, and let’s do 24 of them in your same old structure. But let’s do the next 24 in your retirement account. Now, we may need to do a blocker and they may have a lot of activity there and we’re going to talk about that, sometimes wholesales are not going to be subject to UBIT. It depends on the frequency and a variety of factors. But the point is. Don’t try and do every deal, let your retirement account do some of these, so I love Mat’s example of this contractor that said, you know what, I don’t need to build every frickin house. I’m going to form an entity, hire a friend of mine that’s a contractor and let him do the deal. Yeah, I’m not going to make as much oh oh, but I’m still going to kill it compared to a stupid mutual fund. That’s the point.

 Mat Sorensen: Yeah, exactly. And it’s way better in his scenario than just making the money personally, you know, I mean, it’s so. OK, that’s so that’s option two again, pros are. This is easier than option three, it’s not it’s kind of medium easy, I’ll say, you know, it’s not like the S-CORP that you just owned. You got a loan from your 401k to fund it and kind of you’re off and running now. This takes a little more work because your retirement account still owns it. You might need to add the C Corp blocker like we talked about, because you might have UBIT tax in the operational business. It’s likely you will. It’s cheaper to set up an option three as well. So it’s kind of got medium complexity. Now, of course, the con is you can’t work day to day in the business. This only works for the absentee owner type business where you’ve got someone else running it. You’re just on the sidelines. Your manager is kind of overseeing things, checking on stuff.

 Mark Kohler: Ok, I also put no salary no cap in the dollars invested, right? It could do as much as you want. There’s no $50,000 limit. I’m going to say. A. Gosh darn it, I had a pro or con, which one it was a pro. Oh, here’s the pro, in my opinion, this is where you’re really looking people, and I’m going to say it one more time, a different way. If you’ve got $300,000 sitting in an old 401k from a prior job, we see that every hour of the day. Calls from clerks around the country going, I’ve got this old 401k. I’m thinking about self-directing it what are my options every day. Every hour. Here’s what I want you to focus on. What are my options for this $300,000? I could go out and risk it all and buy Bitcoin who’s on an all time high this week. This may not be the week to buy. You can say I’m going to go buy an ETF, which a lot of savvy investors are. Warren Buffett would say just stick with low, no low to ETFs. You’re going to outperform everybody else every year. You could buy a mutual fund.

Mat Sorensen: Or he said S&P 500 ETF.

 Mark Kohler: This is where I get hate mail like you wouldn’t believe on YouTube when I suggest that you might be able to get a 10 or 15 percent return every year minimum by Self-directing. And so if you know of an operational business where you could make 20 or 30 percent even after a blocker. That’s what you’re doing this for. That’s why I like option two, is because you can get a better rate of return in your retirement account. All right. Yep. Now we go to option one, which is actually going to be probably the shortest of all the conversations. But Mat breakdown, option one for everybody.

Mat Sorensen: All right. Option one, this is if you’re like, all right, I need a lot of money. And that’s a pro. I need to work in the business. This is a pro to this option, you can do both, get a lot of money, you can work in the business. This is called the roll over on Business Startups or ROBS. This has been litigated by the IRS and taxpayers quite a bit. The IRS did an audit rush on it about seven or eight years ago. The strategy is legit, but you guys make sure, again, this is like coloring within the lines. Don’t color outside the lines of this strategy or you’ll mess it up. Now it takes intricate steps to execute. Let me walk you through. Let’s do step one again, OK? You are going to set up a C corp. OK, it could be an LLC taxed as C-corp or a C-Corp. Now this is where you get people that don’t want to Kohler lines Mat. I want to do a S-CORP though. I’ve heard you guys talk about S-Corps that doesn’t work. No, it has to be a C corp for the tax rules and the exceptions and exemptions that make this work to work. If we don’t like it either, we wouldn’t do it if we didn’t have to. But this is what works in this scenario. You’re going to do a C-Corp. Option two you have to create a case. That’s all right. Step two, sorry. Step two. A saw, what is it that’s not absolutely could be at the beginning, but you’re going to have to be able to allow it to add employees so you’re not going to treat it like a solo. Not where you’re thrown in. $57,000 a year, again, you’re using this 401k to fund the business, so you’re not using it more of a tax strategy to throw in $57,000, like a lot of clients do to for solok. OK, you’re using this as a mechanism to roll dollars in. So step two is you’re setting up, let’s just say a 401k. Ok, step three, you’re going to roll over dollars from existing retirement accounts, IRA or old employer 401k into this new 401K. Now, remember this new four one K is a 401K adopted by the new business, which is a C corp that you set up in step one. Mark probably got that diagram pretty well, yes, I’m rolling with you bud, but I just got back and then I love this.

 Mat Sorensen: This is we’re like, you know, we are like a Pictionary game where one person talks and the other person draws. And I don’t know, there’s some type of really cool. Yeah. I mean, we could probably be pretty good. We’ve got national championships on that. Yeah. Yeah. Ok, all right. So we got the money rolled over in step three. Step four is that 401K is going to buy stock in the C Corp you just set up. It’s going to become the owner of the C Corp when you set up that a C Corp to begin with, stock hasn’t been issued yet. The owner of this stock is going to be the 401K plan at the end of the game here.

 Mark Kohler: Isn’t there a unique name for the name of that transaction, maybe I’m getting too nerdy.

Mat Sorensen: Oh, you’re an employer stock purchase. OK. OK, is the 401k is going to have you’re going to have an account in the 401K, that’s your dollars getting rolled then. And you’re considered an employee of this company. And you’re directing your account to buy employer issued stock.

 Mark Kohler: So is that an ESOP is what I’m getting at?

 Mat Sorensen: Yes. Employee stock ownership plan. Yes. So that’s the exception you’re falling under here where your retirement account can own stock in the business. And this is the critical part. You get to be an employee to work in and get a salary.

 Mark Kohler: Now, I’m just going to say this right off the bat. Is this makes life simple? This is very, very similar to option three that we talked about first, except there’s no cap on the amount of money you could use to start this business. And it’s not a loan, but it’s it’s similar. You’re going to still be an employee. You’re going to run the business, but the owner is not you any longer. Is the retirement account and. You don’t have this $50,000 loan limit, and so people that want they may go to a franchise fair and go look at all these cool franchises. And I got a 401k over here that can buy that in a heartbeat. But a lot of franchises require the owner-operator to go through training and be integrated into the business. And so you’re going to hit a $50,000 cap problem with the loan and you’re going to have to be an owner-operator to qualify to run the business. You have to go to McDonald’s University and all that and you’re like, what am I going to do? And that’s where the ROBS is. A very, very powerful solution has been used for years and it’s really quite phenomenal. The con-cost to set up, it’s just the most complex of them.

 Mat Sorensen: Yeah, you’re going to run about $5K in fees to set it up. It requires a new C corp that has some unique stuff in it. It requires a four one K plan that has the unique stuff in it. It requires a little more handholding than any other steps, I should say. A little more. A lot more. And your accountant, whoever your accountant is or CPA, needs to understand the structure because the tax reporting on this structure is the second con. It ain’t easy. It’s not the regular type of tax reporting you might be used to 401K is going to have a tax filing, a fifty five hundred, it files the C corpus, going to have a return that the account needs to be a little more careful about because this does have this ESOP employee stock purchase by the 401K and the amount of salary you can take is pretty tricky. The IRS doesn’t let you just go in and take a three hundred thousand dollars a year salary from this, OK?

 Mark Kohler: In fact. I’ll give you a little. Nerdy point is that your salary cannot exceed the profit of the company and still needs to be reasonable. So if you go, I need to get paid this year and you’re running a loss that’s not allowed in a ROBS, you don’t get a salary if the company’s not at least making money, because think about it. If you’re taking a salary and the company is not making money, doesn’t that mean you’re really using the 401K to give you a paycheck? That’s what they’re trying to avoid. So this and the affordable, but you’ve got to work your ass off so you may be working for your 401k. Now, that’s not a bad thing either. A lot of people love the strategy because you’re building value in the 401K. This business might have a wonderful exit strategy. It could get snapped up under a capital gain treatment. And it’s wonderful in a lot of ways. So we’re not pooh-poohing it. Now the company we love for this and we’ve had the CEO on our show before and I’ve been to the corporate headquarters multiple times is Guidant, Guidant. They’re up in Bellevue. Actually, some would think of that as Seattle. But if you know the northwest area, it’s spelled Bellevue, b l l e v u e  Bellevue. That’s how it’s pronounced. There they know what they’re doing. They are fantastic, they have lawyers on staff, they represent you. If there’s a problem and they’ve cracked the code on this, we do not do this structure at KKOS lawyers. We can help but the accounting reporting and advise you on it if you want to go for it and have questions and you just feel like we speak a little more English at times, you can call us, but. It’s a pro, what would you say the pros are? I mean, did you all Mat or.

 Mat Sorensen: Yeah, I mean, the pro is unlimited amount of money. I guess the limit is how much is in your retirement account that you can use to fund. You can work in the business. You can get a salary once the company starts getting some revenue in operations. The IRS has said you can’t just open up and day one, start sucking out a salary when the company doesn’t make any money. So you’ve got to have revenue in the company to start pulling the salary out. And then, of course, the cons are the cost and documentation and compliance of it. Now, there’s maybe one other con on the long term that I’ll note. I did have a client who did one of these structures and did like a kind of bar and grill in a mountain town, got a pretty successful got a liquor license, which was tough in this area and ended up selling the business. Now one of his things and he went into the eyes wide open. I mean, he got consulted. We actually advised him at the front end of this. And but when he sold the business, here’s what happened. Someone else came and bought it. So now remember, this is a C corp. He’s going to sell the business, he’s got a capital gain. They didn’t want to buy the C Corp stock necessarily, that his 401k owned. They wanted to buy assets of the business and stuff. And so he had some capital gain that had to be recognized that he didn’t get cap gain rates. He got corporate tax, which is 21%. But still, you know, and so there’s there can be like in the long term on the selling as you do need to be a little more strategic because you can have some tax on the way out. And so when you add the C Corp Blocker, this is when you’re looking between option one and two, if you’re kind of like, well, I could work in the business and get a salary or maybe I don’t need to, if you can not have to work in the business day to day and get a salary. I love option two because if this is a business you want to sell later on, you don’t have a C Corp block or you don’t need to worry about corporate tax on the sell. It can go straight to your retirement account. If it’s a Roth no tax versus the ROB structure. Great, because it lets you work in and get a salary. But on the way out, because you have to have the C Corp tax on it, it could be a little painful selling the business or the assets of it.

 Mark Kohler: And what I add to Matt’s comment is not every franchise is created equal. A franchise agreement under Chick fil A is very different than a franchise agreement under McDonalds. And that’s just getting started. There’s thousands of franchises out there and some people have said. They loved the franchise deal they did, and they are thrilled. It’s been a blessing to their family and their legacy and their life. Other people are like, I bought into a franchise. All I did was buy myself a job and that there could be some buyer’s regret. So. Right now, more and more people are moving into the side hustle side gig, trying to control their own destiny. When covid hit, a lot of people’s jobs were eliminated, put on hold. People are on unemployment for the first time in their lives and they’re like, I can’t go down this path again. I got to be more self-sufficient. So they’re taking these 401(k)s that they got out when they lost their job and they’re saying, what should I do with it? To be blunt, we’ve been very, very busy. And companies like Guidant have been very busy helping people redeploy their retirement and reallocate it into a business that they can change their life and help them in a good way. But just don’t rush into it, get a lot of opinions and interview people that have owned franchises and not even sometimes the same franchise you’re going into and talk to another tax. And legal advisers don’t always take the advice from the person that’s selling you the plan as gospel because, yeah, they may have an ulterior motive for that particular structure. I’m not saying that about guidant. They do a great job or our firm work. We want to try to be as bipartisan as possible, which of course means we’re going to give you your options, answer your questions and help you make what’s best for you.

 Mat Sorensen: But yeah, so we’re focused on giving good tax and legal advice, but want you to do the due diligence to and this could be any business. I mean, franchises that became very popular in the ROB structure  I’ll say. A lot of the franchises will promote say, hey, you want to buy into our franchise? Do you have a prior retirement account? You can use this ROB structure. And so I want to just say that’s one of three options. It can be great for the businesses you want to work at. You’re looking forward to that day job. You want to get a salary, you’re going to build up long term wealth in the retirement account and the value of the business. You get some of the tax and compliance issues on it. So but remember, there’s those two other options. Not everyone fits in option two and three that I talked about. You might have to go straight, ROBS, but I hope you can see the the full spectrum of it and kind of pick the lane or door you want to go into as you’re thinking about starting a small business with your Self-directed IRA or 401K.

 Mark Kohler: Yeah, and Mat. What would you say you tell me this is on the record. So really kind of gets this point too, should we really be titling this starting an operational business with your self-directed IRA or 401k, because again a rental property structure is a small business and also we don’t I don’t know if we want to be small. You can start a large business with, but it’s really about operational businesses. Would you say that’s maybe one of the big takeaways of this topic?

 Mat Sorensen: Yeah, I mean, I like the name starting a small business with your self-directed IRA or 401k for the topic. But you’re right, it’s it’s more than just a small business. It could be the big business. And it’s also let’s focus on the operational business. What you do with the rental property is in other podcasts. We did the buying real estate with your IRA podcast. So if feel like I just want to do real estate guys go listen to the buying real estate with your IRA podcast episode, we hammered that one. It’s simpler. It’s simpler. This is more difficult. But let’s be honest. Small business ownership is one of the great ways to build wealth. And if your retirement account is your only source of pulling this off or it’s your best source. I don’t want to be like some people out there, they’re like, don’t do it, hey, what you know, like look at the options, analyze it, determine your opportunity, and then see if one of these three options we ran through works in your situation.

 Mark Kohler: Well, you heard it from the master, the number one educator in the country, Mat Sorensen, author of the best selling book and the most sold book on this topic, The SDIRA Handbook you can pick up a copy of SDI, SDI, SDIRAHandbook.com. It’s a tongue twister, Mat. But I just think Mat does a fantastic job explaining this. So hopefully this was a big help to you. Thanks for listening or watching. Get over to YouTube and watch my amazing Pictionary skills. If you have a chance and catch us next week, please subscribe. If you’ve enjoyed this, give it five star share it with your friends and family. Just trying to make the world a better place. And we’ll see you next week.

Mat Sorensen: Thanks, everyone.


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