Referred by the IRS as a Rollover as Business Startup or ROBS transaction, and by some in the industry as a self-directed 401k, ROBS serve as means for aspiring business owners to finance their new or existing business or franchise using their retirement funds, such as IRAs and former employer retirement plans (e.g., 401k, 403b, 457b, defined benefit plans, profit sharing plans, etc.).
While many entrepreneurs are excited at the benefits of financing their business via a rollover as business startup (including the possibility of starting a business that is well capitalized and free of debt), some wonder how the IRS views ROBS transactions.
IRS officials agree that a Rollover as Business Startup (ROBS 401k) arrangement is legal if correctly setup and correctly administered stating that they “do not believe that the form of all of these transactions may be challenged as non-compliant per se…” See IRS ROBS Guidelines here. Because the rules governing ROBS can be easily confused and incorrectly applied, it is important to work with the right team, such as our Harvard Law-trained attorney and other experienced compliance professionals, who can help you navigate the complex provisions of the internal revenue code applicable to 401k plans. This will mitigate substantial tax and penalties that may arise if the 401k is not properly setup or administered properly.
The Employee Retirement Income Security Act of 1974 (ERISA) contains the legal requirements for opening and operating 401k plans, including the types of 401k plans utilized in a Rollover as Business Startup transaction. By working one-on-one with our attorney and other compliance professionals, we will help ensure that your 401k plan meets the ERISA requirements of a properly designed and established qualified plan, and will provide ongoing compliance support in the operation of the 401k plan.
Some of the important items to consider when opening a Rollover as Business Startup (ROBS 401k) plan including the following:
- The business you are looking to fund must be an operating business (e.g., a retail or on-line store providing goods and/or services) not a passive-investing business (e.g., a company setup for day trading stocks).
- Only rollover funds from non-Roth fund sources qualify for funding the C-corporation.
- Only a C-corporation may be used in the ROBS transaction; therefore, other entity types such as an S-corporation, LLC, partnership and sole proprietorship may not be used in the ROBS arrangement.
- The purchase of employer stock must be for adequate consideration (i.e, the 401k profit sharing plan must purchase the employer stock at fair market value).
- No commission may be charged for the 401k profit sharing plan’s purchase of the stock.
- An annual valuation must be performed of the assets of the plan including the employer stock.
- If the business has existing employees, it is likely that those employees will need to be provided the option to rollover their retirement funds and invest in the business if they wish to do so.
ROBS 401k Exit QUESTION:
What is the exit plan for ROBS once paid back in full so we have more flexibility with our money?
The 401(k) Business Financing Plan (ROBS 401k) is a 401(k) plan that allows you to make an equity investment in your business. This is not a loan but an investment in which you would receive shares of stock in proportion to the amount of cash you invest. The most popular exist strategy is a stock buy back. As far as the mechanics of the buyback, the corporation would purchase the stock back from the 401k over one or a series of purchase provided that it would have to do so at the fair market value at the time of each buyback. The value of the company stock should be supported by a third-party business valuation. The money would flow from the corporate bank account back to the 401k brokerage account on a tax-deferred basis. The 401k can then continue to be sponsored by the business and used for saving for retirement.
Flow of Profit QUESTION :
Where does the generated profit go? What percentage is due back when? How do we pay back the plan? How does everything work together logistically?
As mentioned in the response above, the ROBS is not a loan but an equity investment into your business. The profits that are generated by the business could remain in the Corporate bank account or be distributed as dividends to the ownership. The dividends would be paid proportional based on the ownership percentages. For example if the profits were $100,000 after taxes were paid by the corporation and the 401(k) for your benefit owned 90% of the stock and you personally owned 10% of the stock then $90,000 would be paid to the 401(k) for your benefit and $10,000 would be paid to you personally (note: the funds paid to you personally would be subject to capital gains). There is no percentage due back and the stock buy is explained above.
Regulations QUESTION :
Can you please send a list of all ROBS 401k/C Corp regulations? We want to make sure that our business coincides with ROBS and C Corp regulations.
Please review the following link for the top 10 Business Financing 401(k) Items to Know: Please know that our interests are aligned and we we want to make sure our clients qualify. We do this through multiple means: 1) During the initial discussions, we evaluate through our initial conversations and our application process to confirm that you qualify and identify any special compliance issues that need to be addressed. We also spend time educating you on the rules and practical issues that you need to consider. 2) Going forward and as part of our annual compliance process, we follow up with you to capture information needed for the required 401(K) reporting as well as other compliance requirements such as offering the plan to employees. 3) You would work with your business legal and tax advisers to understand the C-Corp rules, but we welcome and encourage setting up time to help coordinate with these professionals to help him/her understand the impact from a 401k Business Financing perspective.
401k Options QUESTION :
Do you provide options for 401K plans? If yes, please elaborate.
For our 401(k) Business Financing Plan (ROBS 401k) we offer the Traditional 401(k) Profit Sharing Plan. You are not obligated to make contributions with this plan but could if you so choose. Also, we can provide a Safe Harbor Plan. Employers that sponsor a ROBS 401(k) can avoid the potential ADP or ACP testing failures by converting their 401(k) plan to a traditional safe harbor 401(k) plan. If operated properly, the safe harbor design would exempt the 401(k) plan from having to perform ADP/ACP tests. ADP and ACP tests are used to determine the maximum amount that plan participants may receive as contributions, including pretax and Roth deferrals, matching contributions, and employee after-tax (nondeductible) contributions. For future years, you may wish to amend the plan to make it a safe harbor plan for the reasons described below. The top-heavy testing rules are backward-looking rules that look back at the 401K plan to assess whether the plan only benefited the key employees. If you start making contributions to the 401 k plan (e.g., deferrals from your salary), the plan will become top-heavy. It would be considered top heavy because you are the only person contributing to the 401 k plan and you are a key employee. In that case, the corporation will have to make top-heavy corrective contributions for all employees employed on the last day of the plan year regardless of whether those employees met the eligibility requirements. For that reason, it would likely make sense to set the plan up as a safe harbor plan (starting with the next plan year) because Safe Harbor plans are not subject to the top-heavy rules.