This blog post discusses the two methods to invest IRA funds in a franchise or business start-up. Both methods fall within the the IRS guidelines; however, each method has a separate set of rules. Thus, it is important to fully understand and analyze both before investing IRA retirement funds in a franchise or business start-up.
- Method one entails passively investing IRA funds in a franchise or business start-up.
- Method two involves actively investing IRA funds in the franchise or business start-up (whether an existing or a new franchise ) by transferring the IRA proceeds to a roll over as business start-up 401k profit sharing plan (ROBS 401k).
Complete breakdown of both Methods–IRA franchise and business start-up financing
Method 1: The process of a actively investing IRA funds in an active franchise or business start-up.
- A new C-corporation is established.
- Corporation sponsors a new 401k/PSP.
- The IRA funds are transferred to a new brokerage account opened for the 401k/PSP.
- The new franchise corporation issues stock shares to the 401k/PSP for the benefit of the franchisee.
- The franchisee must be an employee of the franchise business and he or she may take a reasonable salary.
- The franchisee’s family members may be employees of the franchise business and receive reasonable compensation for their services.
- To the extent that the corporation generates profits and elects to distribute those profits to the owners of the business, the percentage of the profits associated with the shares held in the 401k/PSP will flow back to the 401k/PSP brokerage account.
Method 2: Passively investing IRA funds in a new franchise or business start-up:
- Here is what transpires when passively investing IRA funds in a franchise or business star-up.
- The IRA owner/participant may not personally benefit from his or her IRA’s investment in the franchise business; as such, the IRA owner is prohibited from taking a salary.
- The IRA owner is prohibited from working for the franchise or business start-up.
- It is prohibited for IRA owner to serve as a director, officer or in any position having powers or responsibilities similar to those of officers or directors.
- Most family members are prohibited from working for IRA funded franchise or business start-up. For example, the following family members are restricted from working or providing services to the business (whether for enumeration or not).
- The IRA owner’s parents
- The IRA owner’s grandparents
- The IRA owner’s children
- The IRA owner’s spouse
- Passively investing IRA funds in a franchise or business start-up entails taking title either in the name of the IRA custodian f/b/o the IRA, or a single member IRA LLC is setup (after the IRA has been transferred to a self-directed IRA custodian such as IRA Services Trust Company); the IRA LLC is then funded with self-directed IRA funds, and the IRA LLC purchases stock shares in the case of C-Corporation, or units in the case of an LLC in the franchise business.
- Compliance Note 1: The S-Corporation rules restrict an IRA or any type of retirement account from owning stock shares in an S-Corporation.
After the IRA or IRA LLC buys stock or units in the franchise business, the franchise business issues a stock certificate in the name of the IRA, or in the name of the IRA LLC.
Profits resulting from the IRA’s ownership percentage in the franchise flow back to the IRA or IRA LLC.
Compliance Note 2. When an IRA or an IRA LLC invests passively in an operating business, gains in excess of $1,000 will be subject to unrelated business income tax and must file Form 990-T.