Impact of The Trump Tax Plan & The Rollover Business Start-up Plan
The big winner under the 2017 Trump tax plan were “C” Corporations. Prior to the 2017 Trump tax plan, using a “C” Corporation for a small business was considered tax inefficient because of the 35% maximum corporate tax rate. However, the Trump tax plan lowered the corporate tax rate to 21%, which has contributed to the reemergence of the “C” Corporation as a popular business entity choice for some small businesses.
When it comes to using retirement funds to invest in a business involving the retirement account holder or any of his or her lineal descendants (“disqualified persons”) there is generally only one legal way to do it and it involves the purchase of “C” Corporation stock (qualifying employer securities) by a 401(k) Qualified Retirement Plan. The structure is known as a “Rollover Business Start-up” or “ROBS.”
The Internal Revenue Code explicitly permits the purchase of corporate stock by a 401(k) Qualified Plan. Nevertheless, the ROBS structure remains somewhat controversial. Although the Internal Revenue Service (IRS) has repeatedly confirmed its legality, it continues to be on the radar of the IRS and Department of Labor (DOL) due to a lack of compliance in some cases.
The ROBS arrangement typically involves rolling over a pre-tax IRA or 401(k) Plan account into a newly established 401(k) Plan, which is sponsored by a “C” Corporation and then investing the rollover funds in the stock of the “C” Corporation. The individual retirement account holder can then earn a reasonable salary as an employee of the business.
The advantage of the ROBS solution is that it does allow one to use all their pre-tax IRA or 401(k) funds to buy a business that they will be involved in personally as an employee without tax or penalty.
The primary downside of the ROBS structure is the use of a “C” Corporation as the business entity. A corporation (sometimes referred to as a “C” corporation) is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs. Corporations are known to have double tax - first, when the company makes a profit, and then to the shareholder on their personal return when dividends are paid. The highest corporate income tax rate was 35%, but beginning in 2018 will drop to 21%. Whereas, a sole proprietorship, LLC, or “S” Corporation is treated as a passthrough entity for tax purposes. In other words, a “C” Corporation would impose two taxes on corporate earnings: a corporate level tax and a shareholder tax on the dividends received. In comparison, for a passthrough entity, such as an LLC, the profits bypass taxation at the corporate level and are distributed and taxed at the owner’s level. Therefore, clearly the use of a “C” Corporation has been a big reason why many individuals have walked away from using a ROBS solution to buy a business with retirement funds and have instead opted for a taxable distribution. However, that may all change in 2018 and beyond. A reduction in the corporate tax rate from 35% to 21% is expected to make “C” Corporations a more attractive form of doing business from a tax standpoint than before and, thus, should make the ROBS solution a far more appealing option for people looking to use retirement funds to buy a business in 2018 and beyond.
Work one-on-one with our in-house tax professionals who will help customize a “Business Acquisition Solution” that will meet your businesses needs and goals.