Roll Overs for
Business Startups ROBS IRS of Tax Revenues
So Look Carefully before Rolling Over
Promoters have been marketing on the internet the use of
401(k) funds to purchase franchises or startup businesses, which normally require
up-front material sums of monies to launch. The procedure typically
involves the creation of a C-corporation by the business owner, then
the setup of a retirement plan by it for its employees, followed by the
roll over of the new business owner-employee's 401(k) funds into this
new plan, and ultimately the exchange of corporate stock for the funds
in the plan. Hence, the acronym ROBS: roll overs as business startups.
However, if you are seriously contemplating pursuing such a financing
maneuver to fund your new business, tread carefully. A recent memo
issued by the Internal Revenue
Service characterized the roll over for a business startup as a
"scheme" in the marketplace to
access retirement funds to evade income
taxes and the withdrawal penalty of 10% on their premature
distribution. Although the IRS has not yet classified ROBS as
non-compliant per se to federal laws, regulations, and codes, it will
scrutinize their setup on a "case-by-case" basis. In other words, you
may be flagging yourself for an audit.
If you are already sold on this procedure and wish to pursue it,
nevertheless, here are a few recommendations that may help:
The consequences of entering into any prohibited transactions and of
carelessly setting up a ROBS are staggering penalties of
110% or more of the amounts
involved in the transactions or the roll over itself. On November 5,
2008, the IRS issued the following warning
to all business owners contemplating the implementation of a ROBS
- Hire an appropriate attorney to prepare the new
retirement plan document. Avoid using the M&P (master and
prototype) plan provided by the franchise seller. A number of promoters
of ROBS transactions are on the IRS's watch list.
- Have an objective valuation of the stock of the new
corporation prepared with supporting detailed analysis. An obvious red
flag to the IRS would be the value of the corporate stock being
assessed at the amount of funds rolled over into the retirement plan.
The value of the stock should be set as the value of the available
assets, its true enterprise value. The lack of a bona fide appraisal
would raise a question as to whether the entire exchange is a
- Before purchasing a franchise through promoters
charging fees out of the proceeds of the stock purchase, consider
whether they can be construed by ERISA or the IRS as "fiduciaries"
rendering "investment advice" or administering the plan. If a fiduciary
receives a payment from plan assets, it may constitute a violation of
the Internal Revenue Code.
- Enable future employees to acquire employer stock.
Often ROBS transactions are designed to take advantage of a one-time
only stock offering, failing to satisfy the available benefit
requirement of retirement plans. In order for the plan to not
discriminate in favor of highly compensated employees, an extension of
the stock investment option must be afforded to non-highly compensated
employees to be hired in the future.
- Establish the plan as permanent; do not discontinue
it within a few years after its adoption.
- Never pay purely non-business expenses from the plan.
- Communicate in writing the existence and availability
of the plan to all new employees; otherwise, your plan will be in
violation Treasury regulations, and may result in its failure.
For these reasons, we intend to scrutinize
ROBS arrangements. Our guidelines will serve as instructions to our
technical specialists to resolve issues they encounter when evaluating
these plans. We believe that ROBS arrangements may endanger the
qualified status of otherwise tax-qualified employee plans and may be
prohibited transactions, requiring complete undoing of the transaction,
and imposition of excise taxes.
So tread carefully, and obtain the necessary legal, accounting, and
other professional advice before adopting a ROBS arrangement. Or
perhaps even consider other alternatives, such as borrowing from your
401(k) plan. For more information on ROBS, 401(k) loans, or other tax
and accounting issues, please contact William
Brighenti, Certified Public Accountant, Hartford CPA Accountants.
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