MBR Financial, Inc.
2000 West Loop South
Ste. 1510
Houston, TX 77027

Rollover as Business Start-Up (ROBS)

What is it?

A rollover as business start-up, or ROBS, is an aggressively marketed technique for using qualified retirement assets to purchase a business. The following is intended only as an introductory overview of this interesting but extremely complicated topic.

How does it work?

In the typical iteration, you, as prospective business owner, set up a new C corporation. The new corporation then hires you as an employee and adopts a 401(k) plan. You become a participant in the plan and initiate a tax-free direct rollover of assets from an IRA (or a qualified employer plan from which you're entitled to receive a distribution) to your new 401(k) plan account.

The new 401(k) plan is structured to allow participants to invest in employer stock. You direct the plan administrator to invest your rollover contributions in stock of the new C corporation. Now the corporation has assets with which it can purchase a business, and your 401(k) assets consist of stock in the new corporation.

Are ROBS legal?

There is no specific provision of the Internal Revenue Code that permits or prohibits ROBS. The IRS has expressed concern that ROBS allow taxpayers to use retirement funds for their own benefit without having to pay any income taxes and penalties. The IRS has not, however, stated that ROBS are illegal per se, and ROBS are not on any list of tax shelters or tax avoidance schemes.

In 2008, the IRS issued a detailed guide on ROBS for its examiners (www.irs.gov /pub/irs-tege/robs_guidelines.pdf).

What kind of business can the plan purchase?

There are generally no restrictions. It can be a new business or an existing business. ROBS are often used to purchase a franchise. Keep in mind, however, that if the business has other employees, another layer of complexity is added.

Can I get a salary from the business?

In general, you can receive a salary if the funds come from the business's operating revenues, not from the cash the corporation received from the 401(k) plan's purchase of stock.

What happens when I want to retire?

Typically, the business would be appraised and a value assigned to the stock held by the plan. If the business will be ongoing, the plan would sell the stock to an unrelated third party and distribute the proceeds to you; they are taxed the same as any other distribution from a 401(k) plan. Otherwise, the business would be liquidated, the plan terminated, and again you would receive a distribution of any proceeds from the plan.

Why would I want to use a ROBS to start a business?

In many cases, it's difficult for individuals to find affordable financing to purchase a small business. Retirement assets provide a ready source of funds, and because you're not borrowing money, there's no interest or any loan repayments.

What's the downside?

There are many potential pitfalls:

  • New businesses are risky, and many fail. You're risking your retirement nest egg, assets that you may not have time to rebuild. You need to consider what your retirement would be like if you lost all or part of these assets.
  • ROBS are complicated structures involving corporations, trusts, and qualified retirement plans, and compliance with state and federal laws. Qualified plans like 401(k)s are complicated in and of themselves and are generally subject to rules issued by the IRS and the Department of Labor. Failure to comply with these rules can lead to disqualification of the 401(k) plan, which in turn could result in its assets being treated as an immediate taxable distribution to you and any other plan participants.
  • If you are named as the plan's trustee and/or administrator, you would generally have fiduciary obligations to the plan and to any other employees covered under the plan. You could incur penalties--and personal liability to other participants--if you fail to satisfy those fiduciary duties.
  • While the IRS has not declared ROBS to be illegal, they are clearly on the Service's radar, and you can expect close scrutiny for your plan and business.

Promoters of these plans are not all equal and there are associated costs. Some claim to have helped hundreds of business owners establish ROBS successfully, without a single plan being disqualified. Use due diligence when choosing a firm to help you with your ROBS.

When considering this technique, keep in mind that tax laws are subject to change.

IMPORTANT DISCLOSURES Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2020.