Rollovers as Business Start-Ups

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Rollovers as Business Start-Ups (ROBS) are arrangements based off an exception in the Internal Revenue Code which allows current or prospective business owners to use their 401(k), IRA or other retirement funds to fund a 401(k) qualified retirement plan adopted by a “C” Corporation and pay for new business start-up costs, for business acquisition costs or to refinance an existing business[1] by the 401(k) plan buying “C” Corporation stock (“Qualifying Employer Securities”).[2] ROBS is an acronym from the United States Internal Revenue Service for the IRS ROBS Rollovers as Business Start-Ups Compliance Project.[3]


ROBS plans, while not considered an abusive tax avoidance transaction, are, according to the IRS, "questionable"[4] because they may solely benefit one individual – the individual who rolls over his or her existing retirement 401k withdrawal funds to the ROBS plan in a tax-free transaction. Nevertheless the IRS has repeatedly stated that the ROBS solution is not an abusive tax shelter or an IRS prohibited transaction pursuant to Internal Revenue Code Section 4975.[5]

On October 1, 2008, Michael Julianelle, Director, Employee Plans, signed a “Memorandum” approving IRS ROBS Examination Guidelines. The IRS stated that while this type of structure is legal and not considered an abusive tax avoidance transaction, the execution of these types of transactions, in many cases, have not been found to be in full compliance with IRS and ERISA rules and procedures. The “Memorandum” states, “Although we do not believe that the form of all of these transactions may be challenged as non-compliant per se, issues such as those described within this memorandum should be developed on a case-by-case basis.” In the “Memorandum”, the IRS highlighted two compliance areas that they felt were not being adequately followed by the promoters implementing the structure during this time period.

The first non-compliance area of concern the IRS highlighted in the “Memorandum” was the lack of disclosure of the adopted 401(k) Plan to the company’s employees. The IRS believed that in too many instances the promoter was establishing a 401(k) Plan that was not adequately disclosed to all employees. Internal Revenue Code Section 401(a)(4) provides that under a qualified retirement plan, contributions or benefits provided under the plan must not discriminate in favor of highly compensated employees. In addition, the promoters were encouraging the business owner who had used their retirement funds to purchase company stock to not provide the same benefit to their employees.

The second non-compliance area of concern the IRS highlighted in the “Memorandum” was establishing an independent appraisal to determine the fair market value of the business being purchased. Internal Revenue Code Section 4975(c)(1 )(A) defines a prohibited transaction as a sale, exchange or lease of any property between a plan and a disqualified person. Internal Revenue Code Section 4975(d)(13) provides an exemption from prohibited transaction consideration for any transaction that is exempt from ERISA Section 406, by reason of ERISA Section 408(e), which addresses certain transactions involving employer stock. ERISA Section 408(e), and ERISA Regulation Section 2550,408e promulgated thereunder, provides an exemption from ERISA Section 406 for acquisitions or sales of qualifying employer securities, subject to a requirement that the acquisition or sale must be for "adequate consideration." Except in the case of a "marketable obligation", adequate consideration for this purpose means a price not less favorable than the price determined under ERISA Section 3(18). ERISA Section 3(18) provides in relevant part that, in the case of an asset other than a security for which there is no generally recognized market, adequate consideration means the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations.

An exchange of company stock between the plan and its employer-sponsor would be a prohibited transaction, unless the requirements of ERISA Section 408(e) are met (the acquisition or sale of the qualifying employer securities must be for adequate consideration).

Therefore, valuation of the shares of the newly-formed corporation is a relevant issue. Since, in some cases, the company may be newly established, there could be a question of whether the stock is indeed worth the value of the purchase price exchanged. If the transaction has not been for adequate consideration, it would have to be corrected, for example, by the corporation's redemption of the stock from the plan and replacing it with cash equal to its fair market value, plus an additional interest factor for lost plan earnings. In addition, the IRS asserts that a valuation-related prohibited transaction issue may arise where the start-up enterprise does not actually "start-up."

On August 27, 2010, almost two years after publishing the “Memorandum”, the IRS held a public phone forum open to the public titled “Employee Plan (“EP”) Phone Forum”, which covered transactions involving using retirement funds to purchase a business. Monika Templeman, Director of Employee Plans Examinations and Colleen Patton, Area Manager of Employee Plans Examinations for the Pacific Coast spent considerable time discussing the IRS’s position on this subject. Monika Templeman began the presentation reaffirming the IRS’s position that a transaction involving the use of retirement funds to purchase a new business is legal and not an abusive tax-avoidance transaction as long as the transaction complies with IRS and ERISA rules and procedures. The concern the IRS has had with these types of transactions is that the promoters who have been offering these transactions have not had the expertise to develop structures that are fully compliant with IRS and ERISA rules and regulations. The IRS added that a large percentage of the transactions they reviewed were in non-compliance largely due to the following non-compliance issues: (i) failure by the promoters to develop a structure that requires the new company to disclose the new 401(k) Plan to the company’s employees and, (ii) the failure to require the client to secure an independent appraisal to determine the fair market value of the company stock being purchased by the 401(k) Plan. The IRS concluded by stating that a transaction using retirement funds to acquire a business is legal and not prohibited so long as the transaction is structured correctly to comply with IRS and ERISA rules and procedures.[6]

Promoters, such as an IRA broker of a self-directed IRA LLC or small business financing, aggressively market IRS ROBS arrangements to prospective entrepreneurs and business owners for funding for a business as small business financing. In the case of most ROBS facilitators, there is often a very close relationship between the promoter/facilitator and the franchise industry, seeking to sell and promote business "opportunities" and seeking funding sources for these sales and promotions. Most ROBS "promoters" and facilitators pay substantial referral fees to the franchise brokers who refer business to the promoters. Rarely are these fees disclosed to the entrepreneur. It should be noted that some companies offering ROBS plans do not pay referral fees to brokers, and charge lower fees as a result.[7] There remains a substantial question whether such referral fees are illegal under ERISA and the U.S. Criminal Code: Offer, Acceptance, or Solicitation to Influence Operations of Employee Benefit Plan (18 U.S.C. Section 1954).

In many cases, the broker will apply to IRS for a favorable determination letter (DL) as a way to assure their clients that IRS approves the ROBS arrangement. The IRS issues a DL based on the plan’s terms meeting Internal Revenue Code requirements. DLs do not give plan sponsors protection from incorrectly applying the plan’s terms or from operating the plan in a discriminatory manner. When a plan sponsor administers a plan in a way that results in prohibited discrimination or engages in prohibited transactions, it can result in plan disqualification and adverse tax consequences to the plan’s sponsor and its participants. Accordingly, promoters who emphasize or "promote" base on a favorable determination letter are, at a minimum, engaging in deceptive trade practices.

How it Works According to the IRS[edit]

A ROBS transaction therefore takes the form of the following sequential steps:

An individual establishes a shell corporation sponsoring an associated and purportedly qualified retirement plan. At this point, the corporation has no employees, assets or business operations, and may not even have a contribution to capital to create shareholder equity.

The plan document provides that all participants may invest the entirety of their account balances in employer stock.

The individual becomes the only employee of the shell corporation and the only participant in the plan. Note that at this point, there is still no ownership or shareholder equity interest.

The individual then executes a rollover or direct trustee-to-trustee transfer of available funds from a prior qualified plan or personal IRA into the newly created qualified plan. These available funds might be any assets previously accumulated under the individual's prior employer's qualified plan, or under a conduit IRA which itself was created from these amounts. Note that at this point, because assets have been moved from one tax-exempt accumulation vehicle to another, all assessable income or excise taxes otherwise applicable to the distribution have been avoided.

The sole participant in the plan then directs investment of his or her account balance into a purchase of employer stock. The employer stock is valued to reflect the amount of plan assets that the taxpayer wishes to access.

The individual then uses the transferred funds to purchase a franchise or begin some other form of business enterprise. Note that all otherwise assessable taxes on a distribution from the prior tax-deferred accumulation account are avoided.

After the business is established, the plan may be amended to prohibit further investments in employer stock. This amendment may be unnecessary, because all stock is fully allocated. As a result, only the original individual benefits from this investment option. Future employees and plan participants will not be entitled to invest in employer stock. This is not advisable as all eligible employees should be offered benefits to participate in the 401(k) plan.[8]

A portion of the proceeds of the stock transaction may be remitted back to the promoter, in the form of a professional fee. This may be either a direct payment from plan to promoter, or an indirect payment, where gross proceeds are transferred to the individual and some amount of his gross wealth is then returned to promoter.

ROBS Project Findings[edit]

New Business Failures

Preliminary results from the ROBS Project indicate that, although there were a few success stories, most ROBS businesses either failed or were on the road to failure with high rates of bankruptcy (business and personal), liens (business and personal), and corporate dissolutions by individual Secretaries of State. Some of the individuals who started ROBS plans lost not only the retirement assets they accumulated over many years, but also their dream of owning a business. As a result, much of the retirement savings invested in their unsuccessful ROBS plan was depleted or ‘lost,’ in many cases even before they had begun to offer their product or service to the public. These findings are questionable since there are many ROBS arrangements in which the businesses are quite successful and represent very prudent alternatives to more traditional investments.[9]

Specific Problems with ROBS

Some other areas the ROBS plan could run into trouble:

  • After the ROBS plan sponsor purchases the new company’s employer stock with the rollover funds, the sponsor amends the plan to prevent other participants from purchasing stock. Since the 2008 announcement from the IRS such amendments are rare.
  • If the sponsor amends the plan to prevent other employees from participating after the DL is issued, this may violate the Code qualification requirements. These types of amendments tend to result in problems with coverage, discrimination and potentially result in violations of benefits, rights and features requirements.
  • Promoter fees
  • Valuation of assets
  • Failure to issue a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., when the assets are rolled over into the ROBS plan.

Because the IRS has stressed the importance of compliance when using retirement funds to purchase a business, it is crucial to work with tax professionals who can navigate all the IRS and ERISA rules and make sure your ROBS solutions does not violate any of the rules outlined by the IRS and Department of Labor.[10]

See also[edit]


  1. ^ "ROBS 401k Small Business Financing Explained". Retrieved 18 January 2013. 
  2. ^ Bergman, Adam. / "Business Funding Law". Adam Bergman, Esq. Retrieved 11 December 2014. 
  3. ^ "2008 IRS ROBS Memorandum" (PDF). Retrieved 15 November 2013. 
  4. ^
  5. ^ Bergman, Adam. / "The Law". Adam Bergman, Esq. Retrieved 11 December 2014. 
  6. ^ Bergman, Adam. "The IRS Position". Adam Bergman, Esq. Retrieved 11 December 2014. 
  7. ^ "Referral Fees Paid to Franchise Promoters?". Retrieved 21 February 2013. 
  8. ^ Bergman, Adam. "How It Works". Adam Bergman, Esq., Bergman Law Group, LLC. Retrieved 11 December 2014. 
  9. ^ "Best Small Business Start-Up Loan Alternative – Rollover as Business Startup (ROBS)". Retrieved 18 January 2013. 
  10. ^ Bergman, Adam. "IRS Rules". Adam Bergman, Esq., Bergman Law Group, LLC. Retrieved 11 December 2014.