How it Works
How Does the ROBS Structure Work?
The ROBS retirement arrangement typically involves rolling over a prior IRA or 401(k) plan account into a new 401(k) plan. A start-up C Corporation business sponsors the plan. Then you invest the rollover 401(k) Plan funds in the stock of the new C Corporation. The funds are deposited in the C Corporation bank account and are available for use for business purposes.
The following is how a typical ROBS structure works:
- Jim, an entrepreneur or current business owner establishes a new C Corporation in the state the business will be operating. The ROBS structure involves a C Corporation, not an LLC or S Corporation. This is because of the exemption to the IRS prohibited transaction rules which involves the purchase of "qualifying employer securities." This is the stock of a Corporation. Using an LLC does not satisfy this definition. Only individuals can be shareholders of an S Corporation and a 401(k) Plan is a trust.
- The new C Corporation then adopts a prototype 401(k) plan. It specifically permits the plan participants, including Jim, to direct the investment of their plan accounts into a selection of investment options. This includes employer stock or "qualifying employer securities."
- Jim elects to participate in the new 401(k) Plan. He directs a rollover of a prior employer's 401(k) Plan funds into the newly adopted 401(k) Plan.
- He then directs the investment of his 401(k) plan account to purchase the C Corporation's newly issued stock at fair market value. In others words, the amount that Jim wants to invest within the new business.
- Additionally, Jim invests personal funds equal to or more than 1% of the purchase price. As a result, the structure is not considered an Employee Stock Option Plan (ESOP).
- The C Corporation utilizes the proceeds from the sale of stocks to purchase the assets for the new business. The proceeds is the amount of rollover funds and personal funds Jim uses.
- Now Jim can earn a salary from the revenues of the business and personally guarantee any business loan.
At IRA Financial Group, we make it even easier for you to establish your self-directed IRA LLC. You can now download the free IRA Financial app for Android or iOS.
Legal Foundation for the ROBS Solution
You're able to use retirement funds to invest in an active trade or business without tax or penalty with the ROBS solution. Again, this is because the ROBS solution qualifies for a special exemption under IRC 4975(d) to certain prohibited transaction rules. This exemption centers around ERISA Section 408(e).
It is IRC Section 4975(d) and ERISA Section 408(e) which shields employers from scrutiny of routine (non-abusive) corporate transactions by the plan sponsor and other “disqualified persons." This might otherwise constitute technical violations of the prohibited transaction rules. This is due to the employer-sponsored retirement plan’s ownership of employer securities.
If the plan sponsor and other fiduciaries’ routine corporate transactions did not fall within the full scope of ERISA Section 408(e), the prohibited transaction rules then needlessly prohibit a myriad of legitimate business transactions. Ultimately, this nullifies the exemption that Congress intended to provide.
In order to accomplish its purpose, ERISA Section 408(e) must be 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 wants 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 ROBS arrangements, many 401(k) plans permit participants to invest in employer stock. A number of large 401(k) plans, including plans sponsored by Apple and Pepsi, include substantial allocations of employer stock.
Self-Directed IRA vs. ROBS Solution to Buy a Business
Previously known as the Business Acquisition Solution (BACSS) at IRA Financial, the Rollover Business Start-up is a type of self-directed retirement solution. So why not use a Self-Directed IRA?
At first glance, using a Self-Directed IRA LLC to purchase stock in a corporation seems to share many similarities with the ROBS structure.
At IRA Financial Group, our ROBS strategy allows the new business to:
- Borrow from third parties.
- Pay salaries to employees (including shareholders/plan participants).
- Engage in other routine business transactions with disqualified persons.
Commonly, a corporate officer or shareholder will make or guarantee loans to the business.
The limitation of using a Self-Directed IRA LLC to buy a business is that you cannot:
- Actively work in the business.
- Earn a salary.
- Personally guarantee a loan without triggering prohibited transaction rules.
Did You Know?
It's important to choose the right entity for your business when utilizing the ROBS structure. Sole proprietorships are best for smaller, self-employed businesses. LLCs are good for smaller businesses that want more asset protection. C Corporations are attractive for larger businesses and individuals in a higher tax bracket. Finally, S Corporations are for those looking to avoid corporate taxes, however they are heavily scrutinized by the IRS.
We wrote the book on the Rollover Business Start-Up Solution
Turning Retirement Funds into Start-Up Dreams is the next best thing to a private consultation with author and former tax attorney, Adam Bergman. The book details various ways individuals can use their retirement funds to finance a business venture without using personal funds or acquiring a loan.