A Checkbook LLC is an investment structure that has been used by investors to circumvent the poor operational abilities of legacy self-directed IRA custodians.
This article will describe what a Checkbook LLC is, how it works, and why investors have used it historically.
Meeting tax code requirements
To meet tax code requirements, IRAs need a custodian. A custodian holds onto the IRA assets and also needs to approve and sign off on all investment activity.
For a typical IRA that only invests in public equities, that is not a big deal, because the approvals can be automated. All public equity transactions are the same. However, private transactions, like startup investments, are all different, so approvals can’t be automated. That can be a problem for the investor, if the custodian is slow or difficult to work with.
AnchorZero IRAs have a modern custodian, AZ Trust Company, a state-chartered financial institution that AnchorZero started. AnchorZero formed its own custodian, because working with legacy custodians would have led to a terrible customer experience.
If AnchorZero were working with a legacy custodian, even if AnchorZero built a great web application, behind the scenes, the fundamental customer experience of working with an antiquated financial institution would not have changed.
What if an IRA custodian is slow and difficult?
Now suppose the investor wasn’t working with AnchorZero and its modern custodian, and instead was working with a legacy custodian, who is slow and difficult to work with.
Even though the custodian is obligated to follow the investor’s directions, practically, it may be very difficult to manage investments, because the custodian significantly delays or blocks investments.
The custodian’s operational problems transform into the investor’s investment problems.
Historically, we advised clients not to invest through their IRAs, because custodians wanted all sorts of indemnities. We once had a sale blocked for weeks, because the custodian was holding it up.
— Partner at Band 1 law firm
This is more common than one would think. Custody is a sleepy business, often running on the back of fax machines that are turned off after 5pm. Imagine trying to get a health insurance company’s customer service representative to sign off on investment paperwork. It may be possible, but the investor will lose her mind.
We no longer take IRA investments from legacy self-directed IRA custodians, because chasing them down, became too much of a pain, and they held up investment too many times.
— Founder of prominent angel syndicate
Attorneys proposed a potential solution, introducing a layer between the investments and the IRA custodian, and that layer is the Checkbook LLC.
A layer between the investor and the IRA custodian: Checkbook LLC
A Checkbook LLC is a term for the following LLC structure:
- The LLC is a single-member LLC, whose sole member is the IRA,
- The LLC is managed by the investor.
The idea is that the custodian only needs to be involved in investment activity between the IRA and the LLC, and the LLC’s investment activity does not need to concern the custodian.
Additionally, the investor’s control and tax requirements may be met:
- The manager of the LLC is the investor, so the investor retains control of investments,
- Because taxes flow through single-member LLCs, taxes flow through to the member, which is the tax-exempt IRA.
Put another way, the investor put a layer between herself and the custodian, potentially a neat solution to the thorny operational problem of having to work with someone the investor didn’t really want to work with in the first place.
The costs of setting up and maintaining a Checkbook LLC can be significant. Investors who go down this path have a special LLC agreement drafted, register the LLC with the state, and then maintain the LLC thereafter, including making annual state filings.
The biggest cost may be that it’s unclear whether checkbook LLCs even are compliant with IRA tax code requirements; many tax practitioners believe that recent tax court cases have increased the likelihood that a checkbook LLC will disqualify an IRA.
Work with a custodian investors love
It’s important to remember why investors historically went through the trouble to set up and maintain this structure: it’s because they worked with custodians who could not meet investors’ needs.
To solve this, AnchorZero started its own financial institution, AZ Trust Company, a South Dakota chartered trust company.
AnchorZero is building a modern financial institution from the ground up. AnchorZero gives investors the modern investment control and experience they expect, not expensive and risky legal hoops.
To invest freely, work with a custodian who is able to enable investors. Get in touch today.