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.
Do you have the support you need to manage your small business bookkeeping?
Contact us to schedule an appointment to speak with a local small business advisor.