Rollover As Business Startup – How Does Double Taxation Apply to a ROBS C-Corp?

One of the fundamental requirements of a Rollover as Business Startup (ROBS) transaction is that your business must be organized as a C-corporation.

This requirement will often elicit a negative reaction from an aspiring entrepreneur who is considering using our 401k Business Financing plan to fund his or her business startup.  Many people believe that the best legal entity for a small business is an LLC or perhaps an S-corporation with the primary reason being the dreaded “Double Tax” that applies to C-corporations.

While this belief is debatable and certainly depends on the particular business circumstances, it is clear that if you are seeking to fund your business with 401k/IRA funds without paying taxes or penalties via a Rollover as Business Startup (ROBS) transaction, the business that is funded with your retirement funds must be set up as a C-corporation.  This requirement will often prompt an aspiring business to ask “What about Double Taxation?! How will this apply to my business?”

For a business owner who uses a ROBS transaction for business financing, the “double tax” will not apply in the same manner that it will apply to another business that is organized as a C-corporation and funded with personal non-retirement funds.   To understand the difference, it is useful to first understand how “double taxation” applies to C-corporations generally.

What is Double Taxation?

  • Consider a C-corporation that is generating income of $100k.
    • First Tax: This C-corporation must pay income tax at the corporate rate before distributing any profits to the owners (i.e. dividends to the shareholders of the C-corporation).
    • Second Tax: Any after-tax profits that are provided to the owners of the C-corporation (i.e. shareholder dividends) are subject to income tax again at the owner’s individual rate.
  • In this manner, the income generated by the corporation is taxed twice (i.e. once at the corporate level and then again at the owner level).

How Does Double Taxation Apply to a Rollover As Business Startup (ROBS C-Corp)?

A C-corporation that is funded via a ROBS 401k Business Financing plan must pay income tax on the income that it generates.  Thus, the first tax will apply to a ROBS C-corporation.  The second tax will apply differently, however, because one of the shareholders of the C-corporation is the 401k plan.  Specifically, the “double tax” on any profits distributed to the owners of the C-corporation will be mitigated to the extent that any profits paid with respect to the shares held in the 401k are tax-deferred.  The profits distributed to the ROBS 401k are just like any other gain in a traditional 401k or IRA retirement account in that the gains grow on a tax-deferred basis until they are distributed (e.g., withdrawn for retirement).

Of course, in setting up your business you should consult with a tax professional to consider your unique situation.

To learn more about a Rollover as Business Startup, click HERE or schedule a call HERE.

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About George Blower

I have the privilege of educating our clients about our products and services so that they can make informed and confident decisions about their financial future. Prior to joining My Solo 401k Financial, I served as the general counsel for a subsidiary of a Fortune 500 financial services company. Learn more about George Blower and My Solo 401k Financial >>

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