The funding of your own business through the purchase of employer stock (equity investment) using retirement funds is most commonly known as 401k business funding because a 401k/PSP is adopted by the new business that is structured as a C-Corporation (because only stock can purchased not units an LLC does not qualify for the ROBS 401k/PSP business funding structure).
The following facts breakdown the 401k business funding arrangement:
Fact 1: The IRS refers to the use of a 401k for business funding as Rollovers as Business Startups (ROBS)
Fact 2: Retirement funds from the following types of retirement accounts may be used 401k business funding.
SEP IRA; SIMPLE IRA; Traditional IRA; 401k ; PSP; TSP; 457b; 403b; MPP; and DBP.
Fact 3: Roth funds may not be used in the 401k business funding arrangement.
Fact 4: ERISA 408(e), and ERISA Reg. 2550.408 list information regarding the use of 401k funds to invest in employer stock of the employer’s corporation.
Fact 5: Facilitation fees in connection with the setup of the ROBS (401k business funding) arrangement must be paid with outside funds, not retirement account funds (directly or indirectly), in order not to run afoul with IRC 4975(c)(1)(E).
Fact 6: The IRS formally commented on the use of 401k business funds on Oct 1, 2008 by issuing IRS memo commenting that the use of retirement funds is not disallowed but continue to be reviewed by the IRS.
Fact 7: The use of retirement funds for business funding entails the 401k purchasing stock shares in a C-Corporation.
Fact 8: The 401k adopted by the C-Corporation must be offered to all full-time employees during and after the adoption of the 401k plan; therefore, the 401k plan must be communicated to all full-time employees pursuant to Treas. Reg. 1.401-1(a)(2)
Fact 9: A fair market valuation (annual appraisal) must be performed annually on the assets, including the C-Corporation shares, of the c-corporation sponsored 401k.
Fact 10: While additional purchase of stock in the C-Corporation stock is permitted, employees participating in the plan must also be given the option to invest in stock of the employer (the C-Corporation).
Fact 11: Annual non-discrimination testing must be performed on the C-Corporation sponsored 401k.
Fact 12: The 401k adopted by the C-Corporation must be adopted with the intent of being a permanent set-up. Permanency is a qualification requirement for all retirement plans including those used for 401k business funding.
Fact 13: An annual Form 5500 must be filed for the 401k.
Fact 14: Th annual corporation tax return Form 1120 must be filed.
Fact 15: You cannot draw a salary from the 4o1k funded business until income is generated. What is needed is income not necessarily profit (i.e. the C-corporation can be “breaking even”). You should wait to receive w-2 compensation (e.g., salary, bonuses, etc.) until the C-corporation is generating income to justify your salary and then your salary should not be unreasonably high (i.e., no more than what the company would have to pay someone else to do all of the things that you do). Any compensation that you receive should be paid to you as W-2 wages (i.e. not as 1099 income). As such, it will be prudent to coordinate with your business tax adviser.