Ok, now it’s time to solve the mystery. (Final Post) [see previous here]

In 1978 Jimmy Carter reorganized the government with this order, and this took the issue of retirement account prohibited transactions away from the domain of the IRS and gave it to the Department of Labor (DOL).

This fact was unknown to (or possibly ignored by) the ROBS promoters who claimed the IRS ROBS letter confirmed the validity of the ROBS strategy. The truth is that the IRS letter did not say whether or not the ROBS strategy creates a prohibited transaction because the IRS didn’t have the authority to say it. It was the authority of DOL. Ah, what fun bureaucracy can be.

Speaking with the Proper Authority

Now, I’ve known about this transfer of authority ever since the creator of the IRA LLC (late attorney Debra Buchanan) told me about it back in 2004. So I’ve been in close contact with DOL employees for several years. Here’s where the bureaucracy gets funny (or scary, depending on how you look at it).

A couple of weeks after the IRS ROBS letter came out, I called my friendly DOL contacts to ask, “What do you think of the ROBS strategy that the IRS just wrote a letter about?” They responded with, “What letter? What is ROBS?”

[If my friends at the IRS and DOL are reading this now, don't take offense. Everyone knows that government agency intercommunication is kind of like Big Foot and the Loch Ness Monster. It's not your fault.]

So I faxed the IRS ROBS letter over to DOL. I was happy to do this for the IRS because I know they are really busy.

Finally… the Meeting

My annual trip to Washington, D.C. was scheduled for about six weeks later. So this gave DOL plenty of time to review the letter so we could discuss it at our meeting.

When the meeting came in December, all of the mystery surrounding ROBS collapsed with a couple of straightforward sentences out of the mouths of the decision makers at DOL (paraphrased):

The ‘qualifying employer securities’ exemption means that transaction of the plan acquiring stock from the C corporation is exempt. BUT, this exemption doesn’t throw the rules out the window for looking at the whole strategy. This whole strategy generally provides an ‘outside-of-the-plan’ benefit to the participant, who is a disqualified person. Thus this strategy creates a prohibited transaction.

Bear in mind this unofficial conversation is, well, not official. What would make it official is if I (or anyone else) submitted a written request for a DOL “Advisory Opinion” letter that explains whether the ROBS strategy is a prohibited transaction.

These DOL guys indicated that such a request would be met with an Advisory Opinion declaring ROBS illegal.

Don’t Kill the Messenger

There it is, folks. End of story. ROBS is a prohibited transaction. Many people and attorneys can disagree, but it comes down to 4 guys at this government agency in Washington, D.C. to provide the interpretation of the prohibited transaction law. In other words, it doesn’t matter what anybody thinks except for them. And they think you owe the government a 115% tax (on the amount of money involved in the scheme) if you do a ROBS.

Up until this meeting, I was just as hopeful as anyone that ROBS would come out of the gray area in a favorable conclusion. I don’t want to end this topic on an disappointing note, so I will be throwing out some ROBS alternatives in a future post.

[This is a continuation of a previous post. You should read that one first so this makes sense.]

The IRS Responds

For the first time ever, the IRS actually addressed the “financing a small business with an IRA or 401(k)” strategy. They called it “ROBS” for “roll over business startup,” and issued a letter on October 1, 2008. This letter basically stated:

• We know about the ROBS strategy
• We are concerned about it for several reasons

Celebrate and Ignore

Most ROBS promoters spun the IRS ROBS letter as a long-awaited government blessing for the strategy. They said that the concerns that the IRS listed were administrative errors, such as not filing the plan’s annual valuation report, not telling the corporation’s employees that they can also participate in the plan, and not ever launching a bona fide business in the first place. “These can be avoided. Read between the lines here.”

According to ROBS promoters, what was between the lines is that the IRS implied that the ROBS strategy was legitimate in the first place.

You would think my quest for a final answer to “Is the ROBS strategy legal or illegal?” would lead me to the IRS building in Washington, D.C… Not so. What ROBS promoters were ignoring (or unaware of) is that a strange, mostly unknown Presidential move from the 70s placed this matter outside of the IRS and onto a different government agency. In fact, the IRS letter talked around the core ROBS issue and never faced “Is the ROBS strategy legal or illegal?” head on—because, after the move in the 70s, they actually don’t have the legal authority to comment or decide on the issue.

What Now?

Determined to get to the bottom of this, I went to the other government agency.

Oh yeah, let me tell you why this matter is so important: If the ROBS promoters are wrong, everyone who believed them will be subject to a tax of at least 115% of the amount of funds involved in the strategy. OUCH!

Continue to Final/Part-3 of this post

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:

1. Forms a C corporation.
2. Uses the new C corporation to adopt a 401(k) or profit-sharing plan.
3. Performs a rollover from existing retirement funds (IRA, 401k, etc) into the new 401(k) plan.
4. Directs the new 401(k) plan to invest into the new C corporation by purchasing shares of stock.
5. 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.

Continue to Part 2 of this post

2008 was a very interesting year to say the least. Possibly the most productive outcome of the year was the restless message of “rethink things” coming from the little voice beckoning each of us in our minds.

Myth #1… The SEC keeps investment information honest and accurate

The Securities and Exchange Commission (abbr “SEC”) should be done away with. The Madoff debacle along with the dozens of other securities frauds that draw less (or no) attention every single year should be evidence that the SEC is failing. It is tasked with making investments safe and transparent and is having the opposite effect. When an investor or fund manager is considering a particular investment, they believe that the investment is truthful, transparent, and honest because the SEC is supposed to regulate it into such a position. The result can be decreased due diligence because of reliance on the SEC. This leads to disaster when the SEC ends up not doing its job very well. If we didn’t expect the SEC to be “keeping investing safe and honest” then investors and asset managers would take a closer look at investment opportunities which would result in better thought out decisions. I’m not saying the SEC should be doing a better job – I’m saying we shouldn’t expect regulation to create investment safety in the first place.

I believe the SEC does more harm than good by offering a false sense of security.

Myth #2… Financial planners give good investment advice

Something very interesting happened in the last 15 or so years: Stock brokerages spent millions of dollars convincing the American public that securities salesman had become “financial planners”. That move alone shifted the perception of almost every American and the magnitude of Wall Street’s success (theirs, not yours). A “stock broker” is to securities as a car salesman is to cars… but a financial planner sounds a lot like somebody whose job it is to plan your finances. What actually changed to make stock brokers become financial planners? Nothing more than the name and some whiz-bang software and charts to support the faux expertise. Most financial planners are still technically licensed to sell securities (stocks, bonds, and funds) and still primarily earn their living by selling securities and insurance.

If all cars on the road starting randomly exploding, then we wouldn’t be surprised to hear car salesmen and oil company representatives say “Don’t worry, just keep driving your car. Everything’s going to be okay. In fact you might want to trade your car in for a better one. Don’t worry, we have statistics that show that driving a car regularly is very safe and it’s the best way to get around.” Still, in such a case your logic might say Gee, if I don’t want to explode I should stop driving my car since cars have started regularly exploding.

On the other hand, when our securities holdings start self destructing, we forget to include the grain of salt while listening to the securities salesman (financial planner) say, “Don’t worry, just keep buying securities. Everything’s going to be okay. In fact, you might want to rebalance your portfolio and buy and sell some securities right now for better diversification. Don’t worry, we have statistics that show that the stock market is good investment over the long run.”

The fact is that financial planners, whom are truly securities salesman, have no training in assets or investment strategies outside of securities. There’s a whole world of assets and investments outside of publicly traded securities, and anybody whose training and compensation is solely related to the securities market is, in reality, going to be quite useless when it comes to financial planning.

Myth # 3… Smart people are smart

All kinds of very educated people created CDOs, credit default swaps, and a variety of complex derivatives which severely magnified the bubble economy that has turned the world’s finances upside down. These were people with MBAs and other credentials that suggested that their ideas were good. A farmer could have walked into the board room where CDOs were being invented, and he would have said “I don’t understand this stuff; it’s too complex – smells fishy.” For the small time investor and institutional investor alike, we’ve been reminded that things we don’t understand can have unpredictable and undesirable results.

Myth # 4… Past results predict future performance

Every single investment disclosure document says that past performance is no guarantee of future results. It’s part of how the SEC tries to protect people from misleading marketing. Yet, almost every investment strategy promoted by Wall Street is based on the idea that past results will predict future performance. Right now there’s tons of info floating around relating to the Great Depression as an indicator of what to expect from our current recession/depression. Forget about it – it’s less useful than male nipples. The Great Depression was in the industrial age. We are in the information age now. During the Great Depression our money was on the gold standard. Today, the gold standard is long gone, and measuring anything in dollars is like using a wobbling yardstick.

Past results do not necessarily predict future performance.

Myth # 5… I should do what everyone else is doing

The crowd used to agree that the world is flat. The crowd use to agree that humans can’t fly. The crowd used to consider cocaine and heroin as medical treatments. The crowd used to consider smoking cigarettes as safe and healthy. Need I say more?

Think for yourself. It pays off in spades.

### Recommended reading:

• Bail Yourself Out with an Unlimited 401k
• Turn Doom & Gloom into Personal Boom
• Weak economy strengthens the incentive for a Solo 401k

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