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It’s not uncommon for even credible and experienced tax professionals to be unfamiliar with the ROBS structure, so we’ve put together some key points about this funding option to help improve communication with these professionals.

How to Introduce ROBS to CPAs & Tax Attorneys

It’s not uncommon for even credible and experienced tax professionals to be unfamiliar with the Rollover for Business Start-ups structure, so we’ve put together some key points about this funding option to help improve the understanding and communication with these professionals. Please feel free to share this information with your tax professional, business attorney or anyone who helps operate your business:

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For CPAs or Tax Attorneys

A common question we hear from tax professionals regarding 401(k) business funding is, “Is this legal?” The simple answer is yes, and here’s why:

ROBS utilizes two prohibited transaction exemptions: one in the Internal Revenue Code (IRC) and one from the Employee Retirement Income Securities Act of 1974 (ERISA). These exemptions allow entrepreneurs to use their retirement funds as capital to start a new business or franchise without triggering a taxable event (a.k.a. causing a taxable distribution).

The ROBS Structure

The two exemptions that work together are IRC § 4975 (d)(13) and ERISA § 408(e). The IRC exemption states there is no prohibited transaction if the rollover falls within the ERISA exemption. The ERISA exemption is appropriately met if the rollover transaction meets various requirements for the acquisition or sale of Qualified Employer Securities (QES). If the requirements of both are met, the two exemptions work in tandem to make ROBS a legal transaction. Check out Chapter 1 of this guide to learn more.

The Rollover

Companies that specialize in setting up the ROBS structure, like Guidant Financial, assist each client with the setup of their new corporation and 401(k) plan. This ensures the structure is formed correctly and meets the IRC and ERISA exemptions. Although complex, these steps are typically completed in less than three weeks. Here’s how it works:

  1. A new business is established as a C corporation.
  2. The new corporation creates a new 401(k) plan that can purchase private stock.
  3. Funds from an existing retirement account are rolled into the new 401(k) plan without triggering a taxable distribution.
  4. The 401(k) plan purchases stock in the C corp.
  5. The C corp acquires or starts a business using funds from the stock purchase.
  6. The new business is now cash-rich and debt-free.

Ownership Structure

Qualified Employer Securities (a.k.a. stock in the company) are purchased by the new 401(k) plan on behalf of the client, and this is what funds the business. The one-time fee the client pays to Guidant is a start-up cost for the business, and the client receives a percentage of personal ownership in exchange for that start-up cost. The 401(k) plan is typically the majority shareholder, though the client can purchase additional stock with personal, non-retirement funds.

Your client can provide a copy of their stock ledger if you would like to review the ownership structure with them. (They will have completed this stock ledger with their assigned Outside Counsel.)

ROBS Requirements

For an in-depth look at the requirements of the Rollovers for Business Start-ups structure, head to Chapter 1 of this guide. For a quick overview of crucial elements to keep in mind, look no further:

C Corporation Status

Any company funded by ROBS needs to be a C corp – not an S corp. Specifically, your client should not elect to be an S Corp (in short, do not file a Form 2553).

Exclusive Benefit Rule / Bona Fide Employee

The person who rolls their retirement funds into the ROBS structure must be a bona fide employee of the business they’ve funded. The rule is mildly vague, but to be safe, we suggest the owner work at least 1,000 hours per year for their business. These hours can be accomplished through sweat equity (any time spent working for the business, regardless of payment). Occasionally owners will work without pay while they get their company off the ground. This still satisfies the requirement.

Adequate Consideration

This requirement simply states that the 401(k) plan cannot pay more than Fair Market Value for additional stock in the company. This typically becomes an element of consideration when the client invests additional funds into the company beyond what they’re purchased using ROBS. When this occurs, a business appraisal is often required to determine the value of each share.

Bonding Requirement

Your client may have a question of whether they’re required to maintain a Fidelity Bond to protect their 401(k) plan. Though the way this requirement is written leads people to believe a bond is not required if there is only one owner, this is not the case. Any plan that purchases QES must be bonded. The Form 5500, a staple of Plan Administration, specifically asks if a plan has an active bond. Answering ‘no’ to this question can trigger an audit.