Oct 13

Some Disadvantages of Using ROBS to Start Your Business

When it comes to using retirement funds to buy or finance a business that you or another “disqualified person” will be involved in personally, there is only one legal way to do it and that is through the Business Acquisition Solution, also known as a Rollover Business Start-Up solution (ROBS). The ROBS solution takes advantage of an exception in the tax code under Internal Revenue Code (“IRC”) Section 4975(d) that allows one to use 401(k) plan funds to buy stock in a “C” Corporation, which is known as “qualifying employer securities”. The exception to the IRS prohibited transaction rules found in IRC 4975(d) requires that a 401(k) plan buy “qualifying employer securities”, which is defined as stock of a “C” Corporation. This is the reason why one cannot use a self-directed IRA LLC to invest in a business the IRA holder or a disqualified person will be personally involved in or why a 401(k) plan cannot invest in an LLC in which the plan participant or disqualified person will be involved in without triggering the prohibited transaction rules. Hence, in order to use retirement funds to invest in a business in which a disqualified person will be personally involve one needs a “C” Corporation to operate a business and adopt a 401(k) Plan

So How Does the ROBS Solution Work?

The structure typically involves the following sequential steps:

1.An entrepreneur or existing business owner establishes a new C Corporation;

2.The C Corporation adopts a prototype 401(k) plan that specifically permits plan participants to direct the investment of their plan accounts into a selection of investment options, including employer stock, also known as “qualifying employer securities.”

3.The entrepreneur elects to participate in the new 401(k) plan and, as permitted by the plan, directs a rollover or trustee-to-trustee transfer of retirement funds from another qualified retirement plan into the newly adopted 401(k) plan;

4.The entrepreneur then directs the investment of his or her 401(k) plan account to purchase the C Corporation’s newly issued stock at fair market value ( i.e., the amount that the entrepreneur wishes to invest in the new business); and finally

5.The C Corporation utilizes the proceeds from the sale of stock to purchase an existing business or to begin a new venture.

Four Disadvantages of Establishing a ROBS

1. The “C” Corporation Requirement: Although there are advantages to establishing a “C” corporation, such as owner’s liability protection from the actions of the company, there are several disadvantages as well.

2. Double Taxation: Corporations, unlike other companies that are considered sole proprietorships and partnerships, file their own taxes separately from their owners at their own tax rates. After the company’s profits are taxed at the corporate level, they are then distributed to the shareholders who have to report the amount received on their individual tax returns. The corporate tax rate is generally 15% for corporate profits under $50,000 and 35% for profits above $50,000. This isn’t the case for Sub-chapter S corporations or LLC, where the profits bypass being taxed at the corporate level and are distributed and taxed at the shareholder’s level. That is called pass-through taxation. For example, if we assume a 20% income tax rate for both corporation and individuals and a “C” Corporation earned $100 of profits, the “C” Corporation would be required to pay tax of $20 (20% of $100) and then the shareholder would be required to pay tax of $16 (20% of $80) on any dividend issued by the “C” Corporation to the shareholder. Whereas, in the case of an LLC or “S” Corporation, there is no entity level tax so the $100 would flow directly to the shareholder or LLC member and a tax of only $20% would be imposed at the shareholder level. Comparing this with the “C” Corporation example, by using a passthrough entity such as an “S” Corporation or LLC, the individual would save $16 in our example (total tax of $36 with a “C” Corporation versus $20 in the case of an LLC or “S” Corporation.

Some Disadvantages of Using ROBS to Start Your BusinessIt is important to note that it can be argued that the disadvantage of double taxation bite does not impact retirement accounts (i.e. 401(k) plans) as much as individuals, since the dividend from the “C” Corporation to the 401(k) plan shareholder would be exempt from tax since a 401(k) plan is a tax-exempt retirement account. However, the double taxation is not eliminated but simply deferred until the 401(k) plan participant elects to take a 401(k) plan distribution, which would generally be subject to a second tax (the first tax would be applied at the “C” Corporation level). In contrast, if a 401(k) plan invested in an LLC, a passthrough entity for taxation, the income or gains from the LLC would generally flow back to the 401(k) plan without tax and the 401(k) plan participant would only be required to pay one tax when a distribution is taken.

Unfortunately, the IRS rules require a “C” Corporation be used when a retirement account holder wishes to use retirement funds to invest in a business they or another disqualified person will be involved in. The issue of double taxation is certainly one disadvantage of the ROBS solution, but it is generally perceived as better than paying tax and potentially a 10% early distribution penalty on a distribution from your retirement account.

Regulations and Formalities

Sub-chapter C corporations generally involve more corporate formalities than LLCs, for example. In general, “C” Corporations have to report annually to the states in which they’re incorporated, and the states in which they do a lot of business, on an annual basis. Also, “C” Corporations must observe certain formalities to be considered corporations. This includes holding regular board and shareholder meetings and issuing stock. Also, the names of corporate officers are made public, which is not required by businesses formed under different organizational structures.

401(k) Plan Administration

Even though 401(k) plan administration costs have come down significantly over the years, there is still a cost of offering a 401(k) plan to employees. In addition to having to make a 3% safe harbor contribution, which will be discussed below, 401(k) plans cost money to administer because there are many compliance issues that have to be monitored, there are many ongoing service and administration functions that have to be provided, and there are a host of education and communication services that are required to be offered to plan participants. It is not uncommon for a small business 401(k) Plan to cost anywhere from $750-$1500 annually for a third-party administration company to administer as well as file the annual IRS Form 5500 .

3. Matching Contributions: A safe harbor 401(k) Plan, which is a popular type of 401(k) plan for small businesses, offer employees who participate in the plan a 3% matching contribution made by the employer. Thus, for example, if the employee earns $40,000 in salary during the year and contributes 3% of the salary or $1200 to the 401(k) plan, the employer would contribute an additional $1200 (3% of the salary) to the individual 401(k) plan account. Taking this a step further, if the business has 5 employees and each employee makes $40,000 a year, the employer now has to make $6000 in employer matching contributions. Although the contributions are tax deductible to the employer, it is still additional funds that are being removed from the company and could impact the cash flow of a new small business.

4. Potential IRS Audit: Dating back to the 2005 or so, the IRS started focusing some attention on the ROBS solutions and some of the abuses they perceived were occurring.

To this end, on October 31, 2008, Michael Julianelle, Director, Employee Plans, signed a “Memorandum” approving IRS ROBS Examination Guidelines. The IRS stated that while this type of structure is legal and not considered an abusive tax avoidance transaction, the execution of these types of transactions, in many cases, have not been found to be in full compliance with IRS and ERISA rules and procedures. In the “Memorandum”, the IRS highlighted two compliance areas that they felt were not being adequately followed by the promoters implementing the structure during this time period. The first non-compliance area of concern the IRS highlighted in the “Memorandum” was the lack of disclosure of the adopted 401(k) Plan to the company’s employees and the second non-compliance area was establishing an independent appraisal to determine the fair market value of the business being purchased. In sum, the IRS was concerned that people were using their retirement funds to buy a business and either the business was not being purchased and the individual then used the funds for personal purposes, thus avoiding tax and potential penalties, or the business that was purchased closed, and the retirement account liquidated, thus, leaving the IRS without the potential to tax the retirement account in the future.

The IRS did not publicly comment on the ROBS solution again until August 27, 2010, almost two years after publishing the “Memorandum”, the IRS held a public phone forum open to the public which covered transactions involving using retirement funds to purchase a business. Monika Templeman, Director of Employee Plans Examinations and Colleen Patton, Area Manager of Employee Plans Examinations for the Pacific Coast spent considerable time discussing the IRS’s position on this subject. Monika Templeman began the presentation reaffirming the IRS’s position that a transaction involving the use of retirement funds to purchase a new business is legal and not an abusive tax-avoidance transaction as long as the transaction complies with IRS and ERISA rules and procedures. The concern the IRS has had with these types of transactions is that the promoters who have been offering these transactions have not had the expertise to develop structures that are fully compliant with IRS and ERISA rules and regulations. The IRS added that a large percentage of the transactions they reviewed were in non-compliance largely due to the following non-compliance issues: (i) failure by the promoters to develop a structure that requires the new company to disclose the new 401(k) Plan to the company’s employees and, (ii) the failure to require the client to secure an independent appraisal to determine the fair market value of the company stock being purchased by the 401(k) Plan. The IRS concluded by stating that a transaction using retirement funds to acquire a business is legal and not prohibited so long as the transaction is structured correctly to comply with IRS and ERISA rules and procedures.

So does the ROBS solution trigger an audit? No one knows what factors trigger an IRS audit, but although legal, the ROBS solution is something the IRS and Department of Labor is looking at. Again, if your structure is set-up properly and the funds are used to buy a business, the 401k plan is being offered to all eligible employees, a valuation of the stock purchased is performed, and the plan is compliant with all annual testing and IRS filing requirement, there is nothing to be concerned with if your plan was audited by the IRS or DOL.

To learn more about the benefits of the ROBS strategy, please contact a retirement tax expert at 800-472-0646.

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Jul 26

The Business Acquisition Compliance and Support Structure

With IRA Financial Group’s Business Acquisition & Compliance Solution Structure (BACSS) – you now can:

  • Use your retirement funds to invest in a new business tax-free!
  • Use your retirement funds to purchase a business or franchise tax-free!
  • Use your retirement funds to finance a new or existing business tax-free!
  • Earn a reasonable salary from your new or existing business.
  • Help grow your business.
  • Recapitalize and/or expand your business.
  • Maintain a qualified retirement plan and help save for the future.
  • Diversify your retirement investment portfolio by investing in your own business as well as stocks and mutual funds.
  • Attract and retain quality employees by offering a benefit not commonly found in small business.
  • Take advantage of high contribution limits under a 401(k) Plan.
  • Enjoy tax benefits generated by using a 401(k) Plan.
  • Work directly with our tax and ERISA professionals to establish an IRS and ERISA compliant structure that works best for you and your business.

Business Acquisition Solution

Invest in your future while gaining financial independence tax-free!

Use your retirement funds to start a new business and earn a salary.

We have developed a process that ensures speed and compliance, by using standardized procedures that work via phone, e-mail, fax, and mail. Your funds will be ready for investment into your new or existing business within 14-21 days.

Call us today at 800-472-0646 to learn more about how you can use your retirement funds to start a new business or grow an existing business tax-free, in full IRS compliance, and without penalties!

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Mar 31

IRA Financial Group Services When Using Your 401k to Start a Business

The IRA Financial Group was founded by a group of top law firm tax and ERISA professionals who have worked at some of the largest law firms in the country, including White & Case LLP and Dewey & LeBoeuf LLP.

In developing our Business Acquisition & Compliance Solution Structure (“BACSS”), similar to the IRS-approved ROBS solution, our in-house retirement tax professionals have carefully examined and researched IRS and Department of Labor guidance to design a structure that is fully compliant with IRS and ERISA rules. Each client of the IRA Financial Group is assigned an individual retirement tax professional who will help customize a structure that satisfies his or her financial and retirement needs while ensuring the structure is developed in full compliance with IRS and ERISA rules and requirements. Our services include:

  • Establishment of “C” Corporation including Filing Fees;
  • Filing LLC Articles of Incorporation with the state;
  • Application for Corporation EIN;
  • Drafting all required initial corporate resolutions and minutes;
  • Drafting of customized Stock Purchase Agreement;
  • Drafting of customized Employee Stock Purchase Agreement;
  • Free consultation with in-house retirement tax professional on the BACSS structure;
  • Adoption of 401(k) Plan;
  • Basic Plan Document;
  • EGTRRA Amendment;
  • Summary Plan Description;
  • Trust Agreement;
  • Appointment of Trustee;
  • Beneficiary Designation;
  • Application for Plan trust EIN;
  • Assistance in the establishment of business and 401(k) Plan bank accounts;
  • Assistance with the transfer of funds to your new 401(k) Plan bank account;
  • Assistance in coordinating the completion of all IRS required information returns
  • Assistance in coordinating the acquisition of an independent business appraisal;
  • Free consultation with in-house retirement tax professional on the BACSS structure;
  • Tax support on the BACSS and the 401(K) Plan; and
  • Annual compliance review

We have developed a process that ensures speed and compliance, by using standardized procedures that work via phone, e-mail, fax, and mail. Your funds will typically be ready for investment into your new or existing business within 14-21 days.

Please contact one of our Retirement Experts at 800-472-0646 for more information.

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Aug 24

Using Your 401(k) to Start a Business

The Business Acquisition Compliance & Support Solution (BACSS)

Are you an entrepreneur having trouble getting financing for a new business?

The IRA Financial Group’s Business Acquisition Structure is your solution!

Use your retirement funds to purchase a new business or franchise tax-free and without penalty!

It’s 100% IRS compliant.

The Employee Retirement Income Security Act of 1974 (otherwise known as ERISA) and the Internal Revenue Code firmly establish that retirement funds may be used to acquire or invest in a new or existing business as long as the transaction complies with IRS and ERISA rules and regulations. Because the IRS has stressed the importance of one-hundred percent compliance with these rules, it is Business Acquisition Solutioncrucial to work with a company that is operated by a team of in-house tax and ERISA professionals who have worked at some of the largest law firms in the United States, including White & Case LLP and Dewey & LeBoeuf LLP to ensure the structure is fully compliant with IRS and ERISA rules. While our competitors were promoting this type of structure, which in many cases failed from a compliance standpoint, the IRA Financial Group’s in-house retirement tax professionals spent the last two years reviewing IRS materials in order to develop the Business Acquisition Compliance and Support Structure (“BACSS”). BACSS was designed as an IRS and ERISA compliant structure for using retirement funds to acquire or invest in a business tax-free!

The IRA Financial Group’s retirement tax professionals will work with you directly to develop an IRS and ERISA fully compliant business acquisition or funding solution customized to your individual business, financial, and retirement needs.

Take control of your future now!

Use your retirement funds to buy a new business or franchise tax-free!

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