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Making a tax-efficient investment in a closely held business

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  • Making a tax-efficient investment in a closely held business

    I am planning to make an investment in a friend’s business. I will not be involved in “transacting business” at all, other than providing some capital. There will be no hard feelings if the business is not successful; this is money I can easily afford to lose. The friendship is secure regardless of outcome.

    If the business goes well, it may become cash flow positive during the next year or so, and may be attractive for acquisition. Should we be so fortunate, what is the best way to make an initial investment? Maximizing contributions to profit sharing plan, cash balance plan, and spouse’s TSP, combined with charitable donations (using appreciated shares) keeps us in the 35% federal bracket (for now).

    It is conceivable that we could have an estate tax problem some day if we continue to save for the next 25 years the same way we have for the last 5 years, or more likely, if political tides result in the estate tax exemption being reduced from current levels.

    So, my question is this: what is a tax efficient way for making this investment in a closely held business (LLC)? Are there IRA custodians that would make this possible? Would it be more complicated for my friend to provide transfer of the LLC interest to a self-directed IRA custodian than it would be to interact with me directly? Would it make sense to make the investment through a trust (intentionally defective grantor trust?) to remove it from our taxable estate? Should I just send him a personal check and not over complicate this?

    Any suggestions, or resources you could direct me to would be helpful.


  • #2
    Phil Demuth's "Overtaxed Investor" has a section about much of this--I didn't pay too close attention since it didn't apply to me, but I remember it having the words you're using.  Might be a good place to start; he also has an annotated bibliography.


    • #3
      I remember reading an article or comment from this website on this subject, but cannot remember where I found it.

      Anyone have experience investing in a company through a self-directed (Roth or Traditional) IRA? I would potentially be involved with the company as a consultant so don't know how that could effect things.


      • #4
        I'd write the check and keep it simple. I like keeping stuff like this in a taxable account where it is easily dealt with, even if the tax treatment isn't ideal.
        Helping those who wear the white coat get a fair shake on Wall Street since 2011


        • #5
          I second Jim's vote, in general. However, in a partnership (presuming that is what this LLC is organized as), the devil is in the details of the partnership agreement. One of the beauties of partnerships is that you can allocate income and deductions pretty much in any manner you want, whereas you must follow specific rules with s-corps. So the answer could be a little more complex, something to toss around with your financial consultant.
          Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087