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Rollovers as Business Startups (ROBS)

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Accessing Retirement Assets For Business Financing

In recent years, a new financing technique has surfaced for aspiring entrepreneurs: Rollovers as Business Startups, or "ROBS". The basic concept is that by following specific provisions in the tax code, it is in fact possible to finance a business using funds from an existing 401k plan. Perhaps you have been thinking about starting your own franchise business for years and are ready to take a chance on yourself, or perhaps your long-time experience in an industry makes it feel like the right time to become the business owner instead of the employee. Whatever the motivation, in today's tight credit market - particularly for small businesses - tapping into your retirement fund may result in a major step towards achieving these goals. The funds from the retirement plan rollover are generally used in conjunction with conventional business loans or SBA loans to acquire and open a new franchise or other small business venture. The ROBS investment provides the equity investment required of borrowers by most small business lenders. One very common use of a ROBS is to contribute additional equity for a start-up business loan.

Risks Of Accessing Retirement Funds For Your Business Using A ROBS Plan

ROBS are not for the faint of heart nor the inexperienced. There is of course risk associated with investing your retirement assets into a new business. In addition, due to the technical requirements of the Internal Revenue Code, Treasury Regulations and the Employee Retirement Income Security Act (ERISA), strict compliance is necessary in setting up the ROBS and administering the plan thereafter. Failure to adhere to the rules could be extremely costly, subjecting the rollover funds to immediate tax as well as a potential penalty for early withdrawal of retirement funds. For this reason, it is strongly recommended that entrepreneurs engaging in a ROBS transaction work with a reputable financial services company that specializes in ROBS transactions and administration (BoeFly can help combine ROBS financing with a traditional business loan - contact us to learn more).

Steps to Access Retirement Funds for your Business

The basic steps to forming a Rollover as Business Start-Up plan for business financing are as follows:

  1. Form a C corporation.
  2. The newly established corporation sponsors a 401k plan tailored to meet the necessary requirements. The plan provides that all fund assets may be used to purchase the new corporation's stock.
  3. The funds from a previous plan (401k, IRA, or similarly qualified plan) may now be transferred, without tax or penalty, into the new 401k plan.
  4. The new plan acquires all issued corporate stock, which is now held as a plan asset with a value equal to the rollover funds received.
  5. The cash gained from this sale is now available as equity capital to open a franchise or new venture, or to acquire an existing business.

Given that ROBS are relatively new, there is still some uncertainty regarding compliance issues. An IRS memorandum was released by the Director of Employee Plans in October 2008, outlining concerns regarding the transactions. Citing the various ways in which ROBS could violate certain code provisions, the memorandum essentially serves as a guideline for the professionals in this field. The overarching concern is: "While ROBS would otherwise serve legitimate tax and business planning needs, they are questionable in that they may serve solely to enable one individual's exchange of tax-deferred assets for currently available funds, by using a qualified plan and its investment in employer stock as a medium" (Julianelle). In other words, the retirement assets must be invested in the growth of a business and not for personal gain. To satisfy this requirement, strict compliance with the key issues raised in the memorandum - as outlined below - must be met.

Rules For Using Your Retirement Assets As Business Capital With A ROBS Plan

Benefits, Rights, & Features (BRF) Discrimination: The plan may not favor highly-compensated employees (HCEs), defined as any employee who either owns 5% or more of the company and/or receives compensation of over $80,000. If certain plan benefits are provided to HCEs and not NHCEs (non-highly compensated employees), this plan violates anti-discrimination provision and is subject to penalties. In relation to ROBS, at the start the entrepreneur is generally the corporation's only employee. So even though this individual may be defined as an HCE, there are no NHCEs and so no discrimination provision is violated. Additionally, because the retirement plan purchased all of the stock, ownership is attributed to the plan trust as opposed to an individual. As long as the cash invested is used for the benefit of the corporation as a whole, discrimination penalties are not applicable. Keep in mind, however, that BRF evaluation is an ongoing process.

Valuation of Stock for a ROBS plan: Tax deferral on the purchase and distribution of fund assets - for example, the purchase of corporate stock - is considered a code violation unless "adequate consideration" is met in the valuation of non-marketable securities. This means that proper due diligence is necessary, and that the company must be valued and documented in strict accordance with the requirements set out by ERISA. The evaluation should be carried out by an independent appraiser. If a valuation problem is discovered by IRS investigation, whether the ROBS funds are used for a new venture or acquisition of an existing business, there are potential penalties. It is beneficial for the entrepreneur to ensure thorough valuation both to avoid these taxes, and moreover, to understand the full scope of their investment.

Promoter Fees: Similarly, there are possible violations when fees are paid to the plan "promoter". If the payment is taken from the stock acquisition proceeds, then the promoter will have personally benefitted from the plan that they have designed - defined by the IRS as a "self-dealing transaction." If the promoter is found to be a fiduciary, or any person that either has discretionary authority over the administration of the plan or continues to give on-going advice to the business, these penalties may apply. So in order to comply with the Internal Revenue Code, the promoter should not evaluate the stock themselves (instead find an independent appraiser) nor offer plan advice to participants ongoing. In addition, promoter fees should be taken from the entrepreneur's personal accounts, not the retirement funds. If not, both entrepreneur and promoter may be liable for any violation.

Permanency: Treasury Regulations require qualified retirement plans to be deemed permanent as opposed to temporary, since they were created to provide "systematic" retirement benefits for employees. If a plan is terminated or discontinued within a few years without a valid business reason, it will be presumed not to have been permanent in nature.

Exclusive Benefit: Retirement funds are only tax exempt when the plan's assets are used solely for the benefit of the employees. Retirement assets used for individual benefit will disqualify the plan. The memorandum specifies that each ROBS is determined on these grounds on a case by case basis, as the utilization of funds by each business must be evaluated independently.

The above summarizes the key issues expressed in the 2008 IRS memorandum, but there are certainly other pitfalls to avoid in forming a ROBS. For example, the IRS is paying particular attention to a startup's dividends once in operation. If the entrepreneur receives a large salary but no dividends are issued by the corporation, the transaction may be called into question for using tax exempt funds for personal benefit. Thus it is best for the new small business owner to pay their own salary from operating revenues, not from capital invested by the retirement fund.

What Kind Of Retirement Plan May I Use To Access Capital In Forming A ROBS?

Another important factor in this strategy is determining which retirement plan is excludable from tax under the new corporation, in part due to the past plan holding the savings. According to IRS code, the following table demonstrates allowable rollover transactions:

ROLL FROM ROLL TO
  Roth IRA Trad IRA Simple IRA SEP-IRA Gov. 457 (b) Qual. Plan1 403 (b) Roth Acct2
Roth IRA YES NO NO NO NO NO NO NO
Trad. IRA YES YES NO YES YES YES YES NO
Simple IRA YES YES YES YES YES YES YES NO
SEP-IRA YES YES NO YES YES YES YES NO
Gov. 457 (b) YES YES NO YES YES YES YES YES
Qual. Plan YES YES NO YES YES YES YES YES
403 (b) YES YES NO YES YES YES YES YES
Roth Acct YES NO NO NO NO NO NO YES

  1 Qualified plans include 401(k), money purchase, and defined benefit plans.
  2 Designated Roth Accounts include Roth 401(k), 403(b), or 457(b)

The IRS has continued to work on a case by case basis regarding ROBS. In December 2009, a project was initiated called the Employee Plans Compliance Unit (EPCU) to investigate the strategy and ensure it was not being used for individual gain. The stated goals of the program were listed as:

  1. Identify ROBS plans that were non-compliant and take action to correct;
  2. Define similarities and traits of compliant versus non-compliant ROBS plans;
  3. Use results to design compliance strategies focusing on identified issues and trends.

The project was completed in September 2010 and concluded that ROBS encompass a variety of businesses, spanning across industries as well as being a set of both franchises and stand-alone ventures. It was also noted that a common deficiency with ROBS plans was the failure to file required reporting forms, particularly due to confusion regarding the Form 5500 (Annual Return/Report of Employee Benefit Plan). This report among many others, such as Form 1120 (US Corporation Income Tax Return) and Form 1099-R (Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans), are all necessary filing provisions as mandated by the IRS.

Despite some popular notions on the strategy, Rollovers as Business Startups are not tax loopholes. There is nothing fundamentally different about a business venture kick-started with retirement fund rollover than any other startup, but it does allow for the use of capital otherwise locked away. The framework is fully permitted and can help to realize a long-time startup goal that was previously unattainable. Nonetheless, a ROBS entrepreneur must be extremely and continuously aware of the necessary compliance measures, mandated by the Internal Revenue Code and ERISA. Ensuring the business follows these provisions will save a great deal of time, difficulty, and cost.

Works Cited

Julianelle, Michael D. "Guidelines Regarding Rollovers as Business Start-ups." IRS Employee Plans
    Director Memorandum (October 1, 2008). PDF.

"Rollover Chart." IRS Forms & Publications. (April 10, 2014). PDF.