CLICK HERE TO VIEW THE SLIDES R0BS-401K Business Financing Top Franchise Considerations
In the franchise industry, one of the top franchise financing options is a rollover as business startup (ROBS 401K) as this will allow you to use your retirement funds to start or buy a franchise without having to pay taxes or penalties.
Key ROBS 401k requirements
•Use retirement funds in a former employer plan and/or non-Roth IRA
•Use the funds to start or buy an active business (i.e. operating company providing goods and/or services)
•Bona fide employee (e.g. 1000 hours per year)
ROBS 401k Process
Step 1: Incorporate C-corporation
Step 2: C-corporation sponsors 401k plan
Step 3: Rollover funds to 401k
Step 4: Invest 401k funds in the stock of the C-corporation
Step 5: C-corporation may use the funds for legitimate business purposes including to buy or start a business
Top ROBS 401K Franchise Funding Compliance Rules & Considerations
#1 – The ROBS 401K-funded business must be operated as a C-corporation
- No exceptions – S-corporation/partnership is not allowed.
- The C-corporation must be an active operating company.
- The C-corporation may have subsidiaries.
#2 – Roth IRA Funds are not eligible
- Neither nondeductible (after-tax) IRAs nor Roth IRA funds can be transferred to the Business Financing 401k (ROBS 401k).
#3 – Roth 401k Funds must be held in a separate sub-account
- If Roth 401k, Roth 457 and Roth 403b are transferred to the “Roth Designated Account” sub-account of the Business Financing 401k (ROBS 401k), these funds must be held in a separate sub-account of your ROBS 401k.
#4 – Generally, can only use funds in a former employer plan
- While some exceptions apply, you typically can only rollover funds from an employer plan once you are no longer employed (separated from service) or 59 ½ or older.
#5 – The ROBS 401K fee can’t be paid with retirement funds
- The ROBS C-corporation can’t reimburse you and can’t payoff credit card used to pay the fee.
- You may receive stock personally in exchange for incurring this expense & in that case coordinate with your tax advisor to report as a business expense.
#6 –You must be a W-2 employee
- A 401k plan is for w-2 employees (not 1099-MISC independent contractors).
- Any reasonable compensation that you receive for work performed is reported as w-2 wages.
#7 – Income and expenses must flow through ROBS C-corporation
- The C-corporation must file a C-corporation tax return (e.g. 1120 at the federal level).
- Reasonable compensation may be paid to you as w-2 wages and any profits distributed to the owners in accordance with the ownership percentages (e.g. 401k for your benefit & you personally).
#8 – Your compensation must be reasonable
- You must wait to receive compensation until the C-corporation generating income to justify.
- Your compensation must be reported as w-2 wages – coordinate with business tax advisor.
- Your compensation must be reasonable (i.e. no more than what the company would have to pay someone else to do all of the things that you do).
#9 – The ROBS 401K can’t guarantee a loan to the ROBS C-corporation
- A loan to the business must be a commercial loan in the name of the C-corporation.
- You may personally guarantee the loan.
#10 – Your ROBS 401k funded business cannot do business with any other business that you or disqualified persons own.
- •ROBS C-corporation can’t interact directly or indirectly with another business that you own.
More Items to Know
- Funds from Inherited IRAs are NOT eligible to be rolled over to a ROBS 401k (unless inherited from spouse)
- No personal loans to the ROBS C-corporation
- ROBS C-corporation can’t own an S-corporation (consider if buying the stock of a business taxed as an S-corporation)
- Confirm the franchisor naming requirements (e.g. the franchisor may not allow you to register the corporation under a name that is similar to the name of the franchise but instead may require that you use a DBA or simply license the use of the name).
Top ROBS 401K Franchise Funding FAQs
Stock for SBA Loan
- QUESTION: I am using ROBS 401k Business Financing in order to put $200k of my retirement funds as a down-payment on a $400K SBA loan to start a franchise. I understand that stock will be issued to my ROBS 401K in exchange for the 401k funds invested in the business. Will I personally receive stock in exchange for personally guaranteeing the SBA loan?
- RESPONSE: No – shares will be not issued to you on account of the SBA loan since the loan is debt (not equity).
- QUESTION: I am funding a new restaurant franchise via ROBS 401K Business Financing. The restaurant won’t be constructed for six months so I will be working out of my home during that time. Can the C-corporation pay me rent for using my home office?
- RESPONSE: No – the C-corporation that is funded with your retirement funds can’t pay you rent to use part of your home as a home office.
Different Lines of Business
- QUESTION: I am using a ROBS 401K Business Financing plan to fund the purchase of multiple locations of a franchise. Can I operate each location via a separate LLC?
- RESPONSE: Yes – each LLC (i) would be a 100% subsidiary of the ROBS C-corporation and (ii) may not be taxed as an S-corporation (since an S-corporation can’t be owned by a C-corporation).
Business Loan in the Name of the ROBS C-corporation
- QUESTION: I am using a ROBS 401K plan in order to start a fitness franchise with funds in my Rollover IRA. The business will obtain a mortgage to acquire real estate. I have already been pre-approved by my bank – will the loan be in my name or the name of the C-corporation?
- RESPONSE: While you may personally guarantee the loan, the loan needs to be in the name of the C-Corporation
Ownership based on funds invested
- QUESTION: I am starting an eyelash extension franchise with my sister. We always discussed that we would own the business “50/50” but most of the funds invested will come from my retirement account – how will the ownership work?
- RESPONSE: The ownership of the company must be based on the funds invested – so an equal amount of funds would need to be invested by your sister in order for her to receive an equal amount of shares in the company.
Home Equity Line of Credit
- QUESTION: I will use a ROBS 401K to invest $250,000 from my former employer plan to start a medical spa franchise. I need another $100,000 and would like to use funds from a HELOC – can I do that?
- RESPONSE: You can certainly take a personal loan such as HELOC and then invest the proceeds in the C-corporation – in that case, the additional personal funds that you will invest will count as your personal investment for which you will receive stock personally in the C-corporation.
I already formed an LLC – Can I use that?
- QUESTION: I have been researching starting a tree care/lawn service franchise for over 1 year and I just discovered that I can use a ROBS 401k to invest my retirement funds without paying taxes/penalties. I already set up an LLC with a name that is perfect for my business – can I still use that LLC?
- RESPONSE: Yes – the LLC would either need to be converted to a C-corporation or contributed to a new C-corporation. Please note that if the LLC elected to be taxed as an S-corporation the S-corp election would need to be revoked.
Hire my consulting business?
- QUESTION: I have an existing senior care consulting business. I am looking to use funds in Rollover IRA at Vanguard to fund a new senior care franchise. Can the new ROBS-funded C-corporation hire my existing business to provide consulting services?
- RESPONSE: No – the ROBS-funded business is prohibited from hiring another business that you own personally to provide services to the C-corporation that was funded with your retirement funds.
Can my family members also invest?
- QUESTION: I will use a ROBS 401K to invest $150k from my former employer plan to buy a bread/cookie route franchise. I need another $100,000 and my father would like to invest these funds from his personal savings. Can my father also invest?
- RESPONSE: Your father can certainly invest funds in the C-corporation that is funded with your retirement funds. Please note that such investment will be structured as a stock purchase where shares are issued to your father personally in proportion to the cash invested.