The End of Small Business Financing with IRA and 401k Funds? (Part 1) October 15, 2009
Posted by Jeff Nabers in : Self Directed IRA Solo 401k , trackback
Guidant calls it Audeo. Benetrends calls it Rainmaker. SDCooper calls it ERSOP. It goes by many names and it’s gotten a lot of attention from the franchise industry and, as of about a year ago, the IRS. The IRS calls it “ROBS” for Roll-Over Business Startup.
What is it?
It’s a strategy where a person with retirement funds:
- Forms a C corporation.
- Uses the new C corporation to adopt a 401(k) or profit-sharing plan.
- Performs a rollover from existing retirement funds (IRA, 401k, etc) into the new 401(k) plan.
- Directs the new 401(k) plan to invest into the new C corporation by purchasing shares of stock.
- Now this person has a C corporation with some or all of their retirement funds in it, and they are told they can use the funds to run the corporation, launch a venture, buy a franchise, and even pay themselves a salary.
Special Powers – For Good or Evil?
This is a tremendously powerful strategy. The problem? Many attorneys think it’s illegal because of the prohibited transaction rules. Those rules say that the accounthoder (a.k.a. plan participant) is classified as a “disqualified person,” meaning that the retirement plan can’t transact with him or do things designed to benefit him outside of growing the plan.
To complicate matters, many other attorneys think it’s legal and on very solid ground. Why the disagreement? The pro-ROBS attorneys say that a special exemption throws the prohibited transaction rules out the window when you classify the transfer of the C corporation stock as “qualifying employer securities.”
A Quest for the Final Answer
About a year ago, my phone was ringing off the hook from people saying, “Some say it’s legal, some say it’s illegal. What’s the truth? I don’t want to risk my retirement fund on something sketchy!”
So I set out to get to the bottom of it, and the outcome will surprise you. Stay tuned for the tale of my trip to Washington, D.C. to meet with the guys with whom the buck stops.
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Comments»
Why is the 401(k) buying an interest in your corporation rather than forming a corporation directly? The latter, as you know, is a very common scheme with LLCs.
Bob,
If a 401k forms its own corporation, then that corporation is considered to be “the plan” itself for purposes of prohibited transaction. This means that it would be obvious that a disqualified person (such as the plan participant or his/her family members) cannot work for or transact with this corporation.
The intent of a ROBS structure is to enable the plan participant to run the business and derive compensation from it.
Jeff
Many people work for their plan-owned companies, in the sense they manage and direct its activities. Are you saying the mere act of management, without a transaction (like being paid a salary or exchanging assets between plan beneficiary and the company), is forbidden? Hundreds if not thousands of people have formed and run plan-owned companies on the assumption this was kosher.
Bob,
Aside from ROBS issues (which are to be explained through this 3-part post) the IRS doesn’t like people to work for free, especially for companies they control or have some other interest in.
– Jeff
Since receiving a salary in those cases would be a clear self-dealing violation, is the IRS really going to put you in a “damned if you do, damned if you don’t” situation?
Hi, Bob.
This is a 3 part post. Make sure you read all 3 parts, as the answers are within them.
Jeff
[...] Authors Jeff Nabers and Phoebe Chongchua (Five Steps to Freedom: How to Cut Your Dependence on Institutions and Escape Financial Slavery) suggest that using an investment structure known as Rollovers As Business Startups (ROBS) to fund a business startup or franchise is an IRA prohibited transaction. [...]