Rollovers as Business Start-Ups (ROBS) are financing mechanisms in which current or prospective business owners use their 401(k), IRA or other retirement funds to pay for new business start-up costs, for business acquisition costs or to refinance an existing business. ROBS is an acronym from the United States Internal Revenue Service for the IRS ROBS Rollovers as Business Start-Ups Compliance Project.
As Fit Small Business notes, a ROBS is a way to invest funds from your retirement account, like a 401k or IRA, into your startup business without paying early withdrawal penalties or taxes. A ROBS isn’t a business loan, or even a 401k loan, so there’s no paying back debt or interest. Business owners who use a ROBS often see higher success rates than those who rely on traditional business financing. According to a study by Guidant, 81% of small businesses funded with a ROBS were still operating after 4 years. Only 39% of businesses funded with a traditional business loan fared that well.
A ROBS transaction takes the form of the following sequential steps, as listed by the IRS:
- 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.
- 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 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.
- A portion of the proceeds of the stock transaction may be remitted back to the promoter, in the form of a professional fee.
As seen above, a ROBS is a mechanism that can provide funds for investment in start-up business without incurring a tax liability. It isn’t a simple mechanism to implement, however. Our advice is that you engage the services of a tax attorney to assist you during every step of the ROBS implementation process.
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