Over the last few years, self directed IRA and solo 40(k) plan clients have turned to crowdfunding websites as a popular way to invest in small businesses. Crowdfunding generally refers to a financing method in which money is raised through soliciting relatively small individual investments or contributions from a large number of people. Before you elect to make crowdfunding IRA investments, you should make sure you understand the various crowdfunding rules.
Title III of the JOBS Act established crowdfunding provisions that allow early-stage businesses to offer and sell securities. The SEC subsequently adopted Regulation Crowdfunding to implement the crowdfunding provisions of the JOBS Act.
Under rules adopted by the SEC in 2015, the general public, including self-directed IRA and solo 401(k) plan investors, the opportunity to participate in the early capital raising activities of start-up and early-stage companies and businesses by way of crowdfunding
Anyone can invest in a securities-based crowdfunding IRA offering. Because of the risks involved with this type of investing, however, one is generally limited in how much can be invested during any 12-month period in these transactions. In general, the limitation on how much one can invest depends on the individual’s net worth and annual income.
Generally, If either ones annual income or net worth is less than $107,000, then during any 12-month period, one can only invest up to the greater of either $2,200 or 5% of the lesser of their annual income or net worth. Whereas, if both one’s annual income and net worth are equal to or more than $107,000, then during any 12-month period, that can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $107,000.
Crowdfunding offers investors an opportunity to participate in an early-stage venture. However, one should be aware that early-stage investments may involve very high risks and you should research thoroughly any offering before making an investment decision. In addition, one can only invest in a crowdfunding offering through the online platform, such as a website or a mobile app, of a broker-dealer or a funding portal. Companies may not offer crowdfunding investments directly—they must use a broker-dealer or funding portal.
In sum, new crowdfunding rules cover three broad areas:
- Limitations placed on the amount of money investors can invest;
- Requirements placed on the form and mechanism for the transactions; and
- Offering limitations and disclosure obligations and placed on companies
Under the new rules, the company raising the funds would be required to disclose to the investors various company and business information and must publicly file annual financial statements that have, at a minimum, been reviewed by an independent accountant. Whereas, in a Regulation D 506(c) investment opportunity any individual who is an accredited investor can invest.
Crowdfunding investments have become a popular investment option for retirement account holders either through a self-directed IRA or solo 401(k) plan. The advantage of using a retirement account to make a crowdfunding investment is that, in general, all income and gains generated by the investment will be tax-deferred or tax-free in the case of a Roth IRA or Roth 401(k) plan. However, a little-known tax known as UBIT or UBTI, or the Unrelated Business Taxable Income tax could apply and turn a potential tax-deferred or tax-free crowdfunding investment into a very tax-inefficient investment. In general, under the UBTI tax rules, if the crowdfunding investment is operated via a passthrough entity, such as an LLC, and is engaged in a trade or business, the retirement account investor may be subject to the UBTI tax of 37% if the IRA or solo 401(k) is allocated more than $1000 of annual income. Whereas, in the case of a crowdfunding investment in a small business or start-up that is taxed as a C Corporation would not trigger the application of the UBTI tax.
To learn more about how to use a self-directed IRA to make crowdfunding investments, please contact a self-directed IRA Expert at 800-472-0646 or visit www.irafinancialgroup.com
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