The Business Acquisition & Compliance Solution Structure (BACSS) is an IRS and ERISA approved structure. It allows individuals to use retirement funds, such as IRA or 401(k) to purchase a new or existing business or franchise tax/penalty-free. You may also know of it as the “Rollover Business Start-Up” or “ROBS” Solution.
The ROBS arrangement typically involves rolling over a prior IRA or 401(k) plan account into a brand new 401(k) plan. A start-up C Corporation business sponsors it. It then invests in the rollover funds in the stock of the new C Corporation.
The Difference between a Self-Directed IRA Vs. Rollover Business Start-up structure to buy a business
At first glance, using a Self-Directed IRA LLC to purchase stock in a corporation should share many similarities with the ROBS structure.
With IRA Financial Group’s Rollover Business Start-Up or ROBS transactions, the structure typically involves the following sequential steps:
- An entrepreneur or existing business owner establishes a new C Corporation.
- The C Corporation adopts a prototype 401(k) plan. This specifically permits plan participants to direct the investment of their plan accounts into a selection of investment options. This includes employer stock, also known as “qualifying employer securities.”
- The entrepreneur elects to participate in the new 401(k) plan. As the plan permits, he directs a rollover or trustee-to-trustee transfer of retirement funds from another retirement plan. This goes into the newly adopted 401(k) plan.
- The entrepreneur then directs the investment of his or her 401(k) plan account to purchase the C Corporation’s newly issued stock at fair market value. In other words, the amount that the entrepreneur wishes to invest in the new business).
- Finally (v) the C Corporation utilizes the proceeds from the sale of stock. Then it purchases an existing business or begins a new venture.
With IRA Financial group’s ROBS strategy, the new business will also be able to borrow from third parties. They will be able to pay salaries to employees (including shareholders/plan participants), and engage in other routine business transactions with disqualified persons. Commonly, a corporate officer or shareholder will make or guarantee loans to the business.
With a Self-Directed IRA LLC, an entrepreneur uses retirement funds to purchase business assets like with the ROBS strategy. However, that individual is not able actively involve themselves in the business. They cannot earn a salary, or even personally guarantee a business loan.
The recent U.S. Tax Court case Ellis v. Commissioner of Internal Revenue, No. 14-1310 (8th Cir. 2015) highlights the risk and limitations when using a Self-Directed IRA to purchase business assets. In the Ellis case, the taxpayers used IRA funds to invest in a corporation that ultimately purchased business assets. Because Mr. Ellis used an IRA and not a 401(k) Plan to purchase the C Corporation stock, Mr. Ellis was not able to earn a salary or personally guarantee a business loan. Ultimately, this was the cause of the IRS prohibited transaction rule violation.
If Mr. Ellis used IRA Financial Group’s ROBS strategy, he would have been able to purchase business assets with retirement funds and earn a salary from the business. Furthermore, he personally guarantees the business loan without triggering the IRS prohibited transaction rules.
Legal Foundation for the ROBS Solution
An individual retirement account investor is able to use retirement funds to invest in an active trade or business without tax or penalty. This is because the ROBS solution qualifies for a special exemption set forth under IRC 4975(d) to certain prohibited transaction rules. The exemption to the prohibited transaction rules under IRC 4975(d) centers around ERISA Section 408(e).
It is IRC Section 4975(d) and ERISA Section 408(e) that shields employers from scrutiny of routine (non-abusive) corporate transactions by the plan sponsor. Additionally, it will shield other “disqualified persons,” which may otherwise constitute technical violations of the prohibited transaction rules (due to the employer-sponsored retirement plan’s ownership of employer securities).
If the plan sponsor and other fiduciaries’ routine corporate transactions do not fall within the purview of ERISA Section 408(e), the prohibited transaction rules will needlessly prohibit a myriad of legitimate business transactions and ultimately nullify the exemption that Congress intended to provide.
To accomplish its intended effect, ERISA Section 408(e) is read to exempt the natural and necessary commercial consequences of owning corporate stock rather than just the stock purchase or divestiture.
Important tax and economic policy considerations also compel a different result for 401(k) plans than IRAs. Congress specifically intends to encourage 401(k) plans to invest in employer securities, within certain limits. The opportunity to invest in employer securities through retirement plans benefit employers and employees alike by aligning their economic interests.
Outside the context of Rollover Business Start-Up arrangements, many 401(k) plans permit participants to invest in employer stock. A number of large 401(k) plans, including plans Apple and Pepsi sponsor, include substantial allocations of employer stock.
Did you know?
The Rollover Business Start-Up solution might allow you to use your 401(k) funds to buy a franchise and earn a salary from the franchise.