Rollover for Business Startup (ROBS)

The potential benefit of ROBS business funding:

Start a Business Debt-Free

ROBS is an excellent way for entrepreneurs to finance their own business ventures. You don’t have to deplete your personal savings account, borrow from family, or take out a second mortgage on your house. Instead, you’re using money you wouldn’t have touched until retirement as seed money for your business startup.

ROBS is an equity-financing alternative with unique advantages over traditional bank debt or other debt capital. As an ROBS CPA firm, Legacy Tax & Resolution Services can show you how to get the most out of your financing arrangement.

Get on the Fast Track to Profits

When your new business isn’t saddled with a monthly loan payment, there’s less overhead – and no interest expense – so you can turn a profit much quicker. Having less debt also helps increase the business’s cash flow, giving you more resources to succeed.

Avoid Taxes and Penalties on Early Withdrawals

ROBS is a legal, tax-deferring vehicle that allows you to shift money out of your retirement plan and invest it into your new business without wasting money on the penalties paid if you withdraw the funds prematurely.

Attract the Best Employees for Your Business

Not many small businesses offer their own 401(k) plan, but the ROBS structure requires that you provide the plan for your employees. This makes your company an attractive place to work for the best candidates in your industry, so hiring is more straightforward, and your workforce is stronger.

ROBS arrangements also have additional requirements about offering the plan to your team. As a ROBS CPA firm, Legacy Tax & Resolution Services can show you how to navigate these requirements to keep you compliant.

Be in Control of Your Financial Future

ROBS arrangements require the entrepreneur to be a full-time employee of their corporation – so this isn’t how you’ll fund that moonlight side gig you might have been dreaming about. Instead, this is how you can hand-pick the career you want – in the industry or franchise you want – on your terms.

As a shareholder employee, you’ll earn a reasonable salary, as reported on Form W-2. We will explain how to properly report your wages, help you determine a reasonable salary for the work you perform, process payroll for your employees, and work to ensure W-2s and 1099s are issued on time.

By taking advantage of ROBS, you can create the life you want through your small business and achieve the financial freedom you’ve always dreamed about.

Retirement Building Strategy

If done correctly, a ROBS arrangement can send dividends your way and allow you to distribute dividends back into your retirement account. Like owning stock in a publicly traded corporation, your 401(k) investment in the C-Corporation is entitled to dividends by its percentage of corporate stock ownership.

Initially, an ROBS shareholder usually owns 5-25% of their company stock, and their retirement account owns the remainder. Over time, shareholders may buy back some or all of their corporation to meet their financial needs. Others might stay a minority shareholder so they can pay more significant dividends (tax-deferred!) back into their retirement account.

No matter the situation, the decision to buy back stock is complex, requires a formal business valuation, and should be considered solely based on the shareholder’s long-term goals.

Here’s how our in-depth process works.

FUND YOUR BUSINESS IN 4 STEPS AND THEN KEEP YOU OUT OF TROUBLE

ESTABLISH A C CORPORATION

Legacy Tax & Resolution Services will assist you in establishing a relationship with the ROBS facilitator to create a C-Corporation. The C Corporation is an entity that is legally separate from you, the investor, and legally separate from your retirement plan.

We’ll be there to help walk you through the entire process.

CREATE A NEW401K PLAN

Your chosen ROBS facilitator will create a self-directed 401k plan for your C-Corporation. You will be an employee at the highest level of your company.

This vehicle will enable you to call the shots and control your investment.

PERFORM THE ROLLOVER

Funds from your existing retirement plan(s) will need to be transferred by you under the guidance of the ROBS facilitator to your new self-directed 401k plan.

Your ROBS Facilitator will make sure this goes smoothly.

SELF-FUND YOUR BUSINESS

As the trustee of your new 401(k) plan, you will direct the plan to purchase stock in your new corporation, therefore providing your business with the funding it needs.

Now that you have the funding, you can open the doors to your shiny new business!

AVOID COMPLIANCE ISSUES

This is the most important step of them all, making sure you avoid the below compliance issues. It is absolutely critical that you work with an Accounting, Payroll, and Tax Preparation firm that can provide you with the guidance and support to avoid devastating compliance issues.

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Explore the 5 pillars of a properly structured and maintained ROBS

1. Client's Duty of Prudent Investment

You have a fiduciary duty to invest your retirement funds wisely. Since any investment is inherently risky, this generally means “sound and prudent investments.”

2. Adequate Consideration for Fair Market Value

Your plan can’t pay more than market value for stock in your business. Simply put, don’t attempt to scam or rip off the 401(k) plan.

3. Corp Must be an Operating Company

Your business must offer goods or services in exchange for money.

4. Employer Must Not Discriminate Against Non-Highly Compensated Employees (NHCEs)

You must offer all employees the option to participate in the 401(k) plan. Not just highly compensated ones.

5. All Rollover Participants Must Be Bona Fide Employees

You must be an active employee of the business.

The Dos and Don’ts of ROBS

1. Offer Qualified Employee Securities (QES) and the 401(k) Plan to Employees

DO — Offer your employees the opportunity to participate in the 401(k).
DON’T — Create barriers or obstruct employees from participating in the 401(k). The fourth pillar of ROBS says that the employer of a ROBS business must offer the right to purchase stock in the company with their retirement money. As the company owner, you must offer your employees the opportunity to use their retirement funds to buy stock in the company.

You must make the offer when the employee is hired — but the employee probably won’t take it. So, if you hire additional employees, ensure that’s part of your benefits package. Employees are unlikely to remove their money from liquid and more customary investments like a publicly traded company, where they can cash out any time to put it into their privately held business. Still, they can’t cash out until you sell the business.

2. Maintaining Active Business Status

DO — Maintain an active business/operating company.
DON’T —Shift into a passive business model. This stems from the third pillar of ROBS, which requires your business to be an “active operating company.”
Most businesses and franchises meet these operating criteria. Eligible business ventures don’t include lending, investing, or single investments in real estate. Real estate does present a grey area: you can fund a property management or Real Estate Operating Company, but qualifying as “operating” depends on the scale of the venture.

And one more thing: your business must be legal on the federal level. For example, though marijuana is legal in many states, it still hasn’t been legalized by the federal government. Even if you live in a state where pot shops are legal, typically, you can’t use ROBS to fund one. Some of the more risk-tolerant ROBS providers may move forward with a business like this, but note that the Internal Revenue Service (IRS) hasn’t approved ventures that aren’t federally legal.

3. Maintain Active/Actual Employee Status

DO — Maintain your position as an active, bona fide employee with a REASONABLE salary.
DON’T — Become a passive employee. To be an eligible employee, you must pay yourself a salary and can’t be a silent investor. The fifth ROBS pillar states that all business owners with qualified employer stock (QES) must be active employees of the business. This isn’t a requirement for any business partners who use funding other than ROBS. Remember that the active status doesn’t expressly state your work type. You could work the register, manage inventory, or serve on your corporation’s board. But this pillar does mean you CANNOT be a passive investor in your friend’s wine bar or use ROBS to buy a franchise for your spouse or child and not be involved.

4. Corporation Status

DO – Maintain your status as a C CORPORATION for the life of your business under ROBS.
DON’T – Change your entity type, no matter who tells you to. There are horror stories where a CPA or Tax Attorney unfamiliar with ROBS has advised clients to shift to a different kind of corporation or business structure. Common business structures include corporations, partnerships, limited liability companies (LLCs), s-corporations, and sole proprietorships. These professionals who have misled small business owners likely weren’t well versed in ROBS. You should contact your plan administration/plan provider team or outside counsel before making ANY changes. A change to another business entity could result in a taxable distribution on your rolled-over funds. That means all the rollover funds could get hit with an early withdrawal fee – as if you pulled them directly from your 401(k) plan.

5. Avoid Creating a Taxable Distribution

DO – Follow all the rules of ROBS set forth by your provider and the Internal Revenue Service (IRS) and Department of Labor (DOL).
DON’T – Ignore any of the five pillars. If even one of the five pillars is ignored, the whole structure becomes unstable. This can result in heavy penalties from the IRS.

6. Federal Law Governs Your Plan, Not State Law

DO – Follow all federally legal activities in your day-to-day business activities and business in general.

DON’T – Attempt to use state laws when managing and choosing your business. The law that allows ROBS to exist is through the IRS, so it must follow federal law.

7. File Your Documents Every Year – Including Form 5500

DO— Remember to file your business taxes every year – at both the federal and state levels, if applicable. Remember, you must file your corporate taxes on your own.

DON’T — Forget to file your Federal and State Forms 1120 and 5500. Don’t wait until the last minute to complete these essential annual responsibilities. Your plan administration service provider won’t sign and file these documents for you; you can only file them with the IRS. It’s essential to have this ingrained in your annual processes to meet your obligations to the IRS. Your plan administration service provider will walk you through the steps each year. Missing timely filing could result in adverse tax consequences, such as a tax penalty!

8. Always Make Prudent Investment Decisions for Your Business

DO – Make prudent investment decisions related to your business under ROBS.

DON’T – Make poor investment decisions. You’re a trustee of your corporation, and your retirement plan is the beneficiary. This means you have a fiduciary duty to invest your retirement funds wisely. Since any investment carries an inherent risk and may or may not turn out to be beneficial to your retirement plan, it’s essential to make sure you do thorough due diligence

9. Adequate Consideration for Fair Market Value

DON’T – Rip off your plan by paying more than Fair Market Value (FMV) for the stock you buy with the C corporation. Remember the saying, “Thou shalt not rip off the plan.” In other words, the plan can’t pay more than Fair Market Value for the stock it purchases in the C Corp. FMV is a price determined between a willing buyer and a willing seller. Both must be familiar with the essential facts of the deal, be under no “extraordinary compulsion” to buy or sell, and not be related.

If the buyer and seller are related (familial, or the client is refinancing her own business), it’s crucial to have FMV determined by an independent, third-party appraiser. This ensured that a fair price was set for both the buyer and the seller.

10. Termination of the Program – Closing or Sale of Your Business

DO — Remember that if you close or sell your business, you must complete your corporate taxes, Form 5500, and any other state or federal annual requirements. It’s also imperative you consult your plan administration team and outside counsel throughout this process.

DON’T — Think that closing or selling your business is the last step in exiting your ROBS structure. Just because your company’s doors are closed doesn’t mean your 401(k) plan and other aspects of the structure are. As per usual, you’ll need to complete your taxes and Form 5500 for that plan year. The IRS takes these things seriously. They will subject you to penalties if the requirements aren’t appropriately completed.

If you’re already using the ROBS structure and have questions about ongoing compliance or compliance rules, contact our Client Services team, your outside counsel, and your CPA to address any changes you’re considering. This will help ensure a smooth transition and avoid any penalties from the IRS.

For more information, please refer to the IRS guidelines for ROBS programs.

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