The Internal Revenue Code and ERISA law require the use of a “C” Corporation for using retirement funds to acquire stock in a business (ROBS). The reason for this is that Section 407(d)(1) of ERISA defines the term “employer security,” in part, to mean a security issued by an employer of employees by the plan, or by an affiliate of such employer. Under section 407(d)(5) of ERISA, the term “qualifying employer security” includes an employer security, which has been understood to mean stock. The term “stock” is not defined in Title I of ERISA, however, most tax commentators believe this to mean the stock of a corporation and not an interest in a limited liability company or partnership. The use of an S Corporation for this structure is not permitted because a qualified plan cannot be an S Corporation shareholder. Generally, only individuals are permitted to be S Corporation shareholders.
What is a C Corporation?
A C Corporation is a business term that is used to distinguish this type of entity from others, as its profits are taxed separately from its owners under sub-chapter C of the Internal Revenue Code. A C corporation is owned by shareholders who must elect a board of directors to make business decisions and oversee policies. A C Corporation provides its shareholders with limited liability protection. Thus, the C Corporation’s shareholders would not stand personally liable for debts incurred by the C Corporation. They cannot be sued individually for corporate wrongdoings.
Will I pay more tax if my business is set-up as a C Corporation?
In general, a C corporation can be used to split the corporate profits among the owners and the corporation. This can result in overall tax savings. The tax rate for a corporation is usually less than that for an individual, especially for the first $50,000 of taxable income. In addition, a C Corporation can deduct the cost of business expenses, such as salary, thus, further reducing the company’s taxable income. For example, the operators of the corporation may withdraw reasonable salaries, which are deductible by the corporation. These salaries are therefore free from tax at the corporate level (though the recipients will have to pay income tax, and both recipients and the business will have to pay FICA tax, on them). In some cases, the entire net profit of a C Corporation may be offset by salaries to the shareholders, so that no corporate income tax is due.
Do I need an independent appraisal for the purchase of the new corporation stock?
Yes. Pursuant to ERISA rules, a 401(k) Plan is permitted to acquire “qualified employer security” provided that the acquisition or sale is for adequate consideration. In the October 1, 2008 Memorandum, the IRS stated that an exchange of company stock between the plan and the new company sponsor would be a prohibited transaction, unless the requirements of ERISA Section 408(e) are met. Therefore, valuation of the capitalization of the new company is a relevant issue. Since the company is new, there could be a question of whether it is indeed worth the value of the tax-deferred assets for which it was exchanged. If the transaction has not been for adequate consideration, it would have to be corrected. On August 27, 2010, on the public phone forum, the IRS reaffirmed their position on the need for an independent appraisal to value the purchased corporate stock. The IRA Financial Group will assist you in identifying an independent third-party business appraisal or CPA to help value the stock of the new or existing company.
Please contact one of our ROBS Experts at 800-472-0646 for more information.