Using an IRA Rollover as a Business Start Up

Published on September 23, 2014

Entrepreneurs who are seeking to start up a business using funds from an IRA rollover might be familiar with the term ROBS which means Rollovers as Business Startups. At first blush this might sound like a good idea (in spite of a questionable acronym) but there are issues surrounding this particular strategy that are sure to catch the attention of the IRS.

ROBS is a complex strategy some entrepreneurs are implementing, using retirement savings early (before the age of mandatory distributions) to buy or launch a business, and avoid paying taxes and penalties for early withdrawal. It has been around for decades; the IRS launched a compliance unit to study ROBS in 2010, and has issued guidelines about it which you can find at https://www.irs.gov/pub/irs-tege/robs_guidelines.pdf

The IRS ROBS Guidelines

Here are the steps that are generally followed in setting up this type of transaction:

• An individual sets up a shell corporation that would sponsor a qualified retirement plan (such as a 401(k) plan). This corporation typically has no employees, operations or assets at this point.
• The plan document put in place states that all participants in the plan may invest the entire account balance in company stock.
• The individual who set up the plan becomes the only employee and participant. Usually at this point there is no ownership or equity interest in the company.
• The individual either rolls over or transfers current retirement plan funds, either from a previous employer plan or IRA, into the newly created plan. Any taxes that might ordinarily be owed by taking a distribution are avoided as the assets go directly into another tax-deferred vehicle.
• The only participant of the new plan then directs the purchase of his assets into company stock, which is then valued at the amount of the plan assets invested.
• These funds are then used by the individual to purchase a business/franchise or initiate a different type of business.
• Many times after the business is established, the plan is amended to prohibit further investments in the company stock, thereby making it impossible for any other employees to invest in company stock.
• In some cases a portion of the proceeds of the stock transaction are remitted back to the promoter.

IRS Warnings Against Using ROBS

The IRS has issued warnings that these arrangements may put account holders on the wrong side of the law—and that they might be held liable for back taxes and won decisions in 2013 against business owners who misused ROBS: In Peek v. Commissioner, the tax court said two Colorado entrepreneurs owed more than $560,000 after they used their company’s retirement plan to guarantee a loan. In Ellis v. Commissioner, the court ruled against a Missouri man who used a ROBS transaction to rent space for his business and pay himself a salary.

Some IRS and Department of Labor issues to be aware of are 1) violations of the non-discrimination requirements of the regulations of qualified plans and 2) possible prohibited transactions because of stock valuations that have no professional valuations and are set based on the amount of initial assets being invested.

ROBS and Self-Directed IRAs

Although Next Generation Trust Services is a neutral, third-party administrator of self-directed retirement plans and we do not give investment advice, we do have one piece of advice for clients who are considering this complicated and questionable arrangement: contact an independent attorney well-versed in ERISA (Employee Retirement Income Security Act) and in setting up employer-based retirement plans such as 401(k)s. An independent ERISA attorney will have your best interests in mind as you review the various aspects of using an IRA rollover to fund a business startup; in addition, there are many stipulations about setting up qualified plans that an ERISA attorney can counsel you on.

Some other things to consider:

In the world of self-directed IRAs, the Ellis v. Commissioner would be a double-jeopardy case of a prohibited transaction with a disqualified individual. You can read more about these in a previous post.

One question you may also want to pose with your tax professional is whether it makes sense for you to use retirement savings for this purpose, especially if you are approaching retirement age and have fewer years to bounce back from a potentially risky investment.

The other issue—one we guide our clients about every day—is to thoroughly research any alternative investment you plan to make within a self-directed retirement plan and to understand it fully before making that investment. Self-directed IRAs allow for an interesting and diverse array of nontraditional investments and account holders should have a full understanding of them before sending our transaction specialists their instructions to expedite. There are many other ways to use retirement funds to make permitted investments that do not venture into questionable territory, and there are many other ways to fund a new business, especially as crowdfunding becomes more popular.

Contact our Self-Directed IRA Retirement Specialists

To discuss other strategies for funding a business and acceptable investments in self-directed retirement plans, contact our specialists at (888) 857-8058 or Info@NextGenerationTrust.com