How to Later Convert ROBS 401k Funded C-Corporation to S-Corporation

QUESTION:

If it’s possible, how would I later convert the C CORP to an S CORP? What are the implications for me, the business, and other issues?

ANSWER:

You asked whether you can convert the C-corporation in which you have invested your retirement funds(Business Financing 401k / ROBS ) into an LLC/S–corporation.

i) As long as you own part of the C-corporation via your 401k the entity must be Corporation taxed as a C-corporation.

ii) If you wish to have the entity taxed as an S–corporation or convert to an LLC, the company would first need to buy back all of the company stock held by the 401k.

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 fair market value at the time of each buyback. As the value should be supported by a business valuation, it may be most efficient to do so at the end of the year as you will need to obtain a valuation for reporting purposes as of the end of the year (regardless of whether the corporation is buying shares back) and could use the valuation for both purposes. The money would flow from the corporate bank account back to the 401k brokerage account on a tax-deferred basis.

iii) The corporation would continue to sponsor a 401k but you would no longer own shares via the 401k.

Assuming that you are eligible to convert the entity to an S–corporation/LLC (i.e. because the company is no longer owned via the 401k), the decision whether to do so is something that you discussed with your business tax and/or legal adviser(s).

What are the steps for the C-Corporation buyback stock from 401k?

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 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.

What is the impact to the ownership of the C-corporation?

As the 401k sells stock back to the C-corporation, the number of shares held by the 401k will decrease. As a result, the 401k will own a lower percentage of the company.
Conversely, the other owners of the business (i.e. you) will owner a greater percentage of the business.
If the C-corporation buys back all of the stock from the 401k, you will no longer own company stock through the 401k and the other owner(s) will thus own 100% of the business

How do I determine the price per share for the stock buyback?

The C-corporation must buyback the stock at fair market value.
While the IRS doesn’t necessarily specify items that must be in the report, they have issued guidance on valuing a closely-held corporation (e.g., see IRS Revenue Ruling 59-60).
Moreover, it is certainly a best practice if the valuation is prepared by a third party who is a business valuation specialist or someone who has relevant training and experience.

What happens to the 401k plan?

The corporation would continue to sponsor a 401k but you would no longer own shares via the 401k.

What can I do with the funds in the 401k plan?

The proceeds of the stock buyback will be deposited in the 401k brokerage account & you can invest those funds however you see fit (e.g. stocks, bonds, mutual funds, etc.).

Can I rollover the funds to an IRA?

Generally, unless you are age 59 1/2 or over, only amounts that were transferred to your 401k from other IRAs or former employer plans are the only funds that can be transferred to an IRA.