Gary Bode, CPA: the ROBS technique deserves due diligence. For a free phone consult call (910) 399-2705.
ROBS CPAs see the long-term consequences of using the Rollovers as Business Startup technique to capitalize a new business venture. The ROBS technique allows your personal, self-directed pension plan to invest in a new business structured as a C Corporation. It’s a way for folks to start their own company with retirement funds that would otherwise incur an immediate (25%+) tax upon distribution. Plus it avoids the infamous 10% additional tax. Potential benefits include the new business providing the new Shareholder(s) with a paycheck. Like most ROBS CPAs, I became cautious of this technique once the IRS published warnings about it.
“The ROBS (Rollovers for Business Startups) works; there are just administrative issues to deal with.”
- Gary Bode, ROBS CPA and C Corporation tax accountant
Disclaimer: I am not endorsing ROBS per se. But sometimes, it’s the only way to start a business. It’s not for everyone. Let’s deal with the negative aspects first. Don’t let the following section immediately sour you on ROBS.
Cons
Potential IRS reclassification of the ROBS transaction
This is the biggest issue ROBS CPAs worry about. If the IRS does re-classify the ROBS setup transaction, the funds becomes immediately taxable. So you pay income tax on the ROBS distribution immediately, plus a 10% early distribution “additional” tax. Some folks don’t run a tight enough business to withstand IRS scrutiny.
Company Failure and Loss of your Pension Funds
The IRS itself states many ROBS companies went bankrupt and folks lost their entire retirement funds. That’s strong wording and an unusual stance from the IRS.
The Rollover as Business Startup technique takes good planning
You don’t have to be a ROBS CPA to understand the difficulties of starting any new business. However some folks casually put their entire life savings on the line without a good business plan. Promoters show you the blue sky side of ROBS, but ROBS CPAs sometimes see the consequences of poor planning.
Pension Plan Administration Issues
Realistically, this means more ongoing fees for specialists and less freedom on your employment policies. The IRS states the ROBS technique is not abusive per se. But they also state a favorable Determination Letter, which approves the initial structure of the pension plan, doesn’t prevent folks from mismanaging it later. Employee discrimination, not filing Form 5500, and failure to provide an annual stock valuation are common issues. If the IRS finds your pension plan improperly administered, it can reverse the transaction later. That would mean retroactive taxation on the distribution, essentially forcing business closure in most cases.
Setup Fees
There are a number of companies specializing in helping you set up the ROBS technique and later administering the retirement plan. The average cost is about $5000-$6500 the first year. So, it doesn’t make sense to use the ROBS technique unless the initial startup capital amount warrants it. Why doesn’t a ROBS CPA offer setup? My best contribution to a potential ROBS client is pre-setup (to help with the decision and business plan) and post setup (C Corporation tax planning).
High Break Even Point
I think most ROBS CPAs run a breakeven analysis of your investment. Here’s a simple rule of thumb for ROBS transactions. You can take early distributions from retirement accounts of about $28,000 and still pay the same startup costs as ROBS. More if you split the distributions over two years. ROBS may not make sense, fee wise, for smaller start up costs.
Operating as a C Corporation
Here’s where your ROBS CPA earns their pay; just by keeping new C Corporation in compliance with the IRS. Because one false move and they could negate the ROBS transaction. As a CPA, I find C Corporations are seldom the preferred type of business entity for a small company, unless you plan to go public. I think most ROBS companies wouldn’t choose to be C Corporations if the IRS didn’t require it. Double taxation is just one issue. Form 1120, the C Corporation’s annual tax return, is complex; there are lots of IRS wrinkles to understand. Typically you need more CPA managerial and tax advice with a C Corporation.
Increased Danger of IRS Audit
The IRS is overtly interested in ROBS funded C Corporations. Seriously, they publish warnings about it. If the pension plan administration is bungled, they can reverse the ROBS transaction and treat it as a retroactive early distribution, subject to immediate and hefty taxes. It’s a given they’ll be looking at you intensely. And while they’re doing that, perhaps your C Corporation gets unwanted scrutiny too.
Non-ROBS Alternatives
For smaller amounts of startup capital, talk to your ROBS CPA about borrowing from your pension plan, and the tax break even point for taking early distributions. Start small and grow your company, as opposed to, say, buying a Franchise.
Pros of the ROBS technique
- It may be the only way for you to start a business.
- In this economy, starting your own business may be the only road to employment.
- With careful planning, the ROBS technique works.
ROBS CPA Advice
- Be aware of ROBS pitfalls. But they’re not insurmountable.
- Don’t let the pressure of unemployment force you into quick decisions.
- Get a CPA involved with your business plan. Even if you have specialized skills for a business, plan carefully. Cash flow, cash flow, cash flow.
- Engage a CPA that handles C Corporations.
- Engage a CPA with ROBS experience.
- Choose your setup provider and pension plan administrators carefully.
- Be aware of C Corporation pitfalls.
- Even though you have specialized folks to administer the pension plan, understand the correct methods to keep ROBS compliant with the IRS.
- Even though you’re working with an experienced ROBS CPA such as myself, ask questions. Spend the time to understand the correct way to administer a C Corporation.
- Proactively pass all non-standard business transactions past your CPA.
- Understand the start-up fees.
I’m a ROBS CPA with a virtual office to accommodate C Corporation clients wherever they’re based. Don’t let distance alone dissuade from using our services. Talk to me, I offer a free phone consult; call (910) 399-2705. Ask to talk with a ROBS client to learn about my proactive attitude and C Corporation abilities.
Anyone know if a C Corp started with ROBS can carry a note?
Hi Rich: A C Corporation that uses ROBS has no restrictions outside of the pension plan specifics. The IRS states they will audit the ROBS aspect of C Corporations. So keep your records in good shape in case they look at other areas of your Form 1120. Hope that helps.
Hi, I used a ROBS transaction to start my business and my promoter helped me set it up. They told me I have to maintain a profit sharing account that is offered to my employees and I have to be a C Corporation. I would like to move to an S Corporation without dis-qualifying the ROBS transaction. Do you have any idea on how I can do that?
Thanks
Mark
OK Mark, I’d rather be an S Corporation. But with a ROBS C Corporation you’d have to buy back all the pension plan’s stock with after tax dollars. There’s also many tax pitfalls for an S Corporation that used to be a C Corporation. So as a practical standpoint you’re probably stuck being a C Corporation. I handle C Corporation and most of inherent problems with them are mitigated through good management. So maybe the problem isn’t as bad as might think. Hope that helps.
I worked with a promoter to execute a ROBS transaction, got the funds to the business checking account, but ended up not buying the existing business I had been pursing. I’m working with the promoter to move the funds back into tax deferred status. Obviously, I did not have any revenue since I did not buy the business, but I did incurr start up costs, which mostly consist of a loan from my own savings to the pay the ROBS promoter, etc. I have a couple of questions -
1) Should/can I go ahead and pay myself back the from the funds distributed to my c corp opearting acccount?
2) even though I didn’t have any revenue, is it possible that I can still get a tax refund, due to the net operating loss I will incur?
3) Given that I did not purchase the business and there is no activity, is there anything I need to still be doing since I won’t be dissovling the C corp until after the funds are put back into my retirement account?
Hi Mike. You’d pay tax, and the additional 10% tax, on any funds you don’t roll back into your retirement account. There’s no way to generate a refund through a Form 1120, sorry. The Corporation paid no tax, so no refund. You may have to file a 1120 anyway, I’d have to do a bit of research to determine that.
Hello Gary,
your information in this page is very helpful.
You mentioned the start up or set up costs to be on average about $5000-$6500 the first year, what would the average costs be to maintain it?
Thanks
Pat
Well Pat after the first year I’m usually on board for consulting, 1120 tax preparation, the stock valuation and Form 5500. Maybe $1000-1500 more than an S Corp, depending. Hope that helps.
Hello Gary,
What happens if you sell your Company that was funded by a ROBS transaction. Do all profits go back to the 401k?
Also to be clear about an answer given above, it sounds like to switch to a S Corp that you would have to buy back the shares with post tax money correct? if you were in your first year of business and have not been profitable, could the shares be worth less money since the company value is less?
Thanks,
Jason
Good question Jason. Maybe my Clients have been lucky. I’ve never shut down a ROBS acquired business. Probably not much different than a non Robs C Corporation’s final IRS Form 1120 though. I’d have to research it, sorry. Switching to an S Corporation poses lots of issues, none good. But yes, it would be post tax money.
Hi Gary:
I’m a pension consultant providing admin/compliance, testing, 5500s, etc - i get requests to help setup/administer the Plan under a ROBS transaction. I agree they are not prohibited per se, but there are pitfalls to watch for. The question I continue to ask but cannot get a clear response is who and how the fair market value of C-Corp stock owned by the Plan is determined. As you probably know, the Plan’s trustee is obligated to obtain a fair market value of plan asset holdings at acquisition and at least annually. In a start-up business with no assets, no sales, no inventory, etc how is the fair value (i.e., price per share) of the C-corp stock calculated. My concern is to avoid the self-dealing/Prohibited Transaction fiduciary issues when valuing the assets. it seems that no one involved really has a clear answer to that issue and I’m wondering what you might know about it.
Hi Joy. This is way too complex for a comment. Sorry.
Hi Gary:
I have a ROBS and as a shareholder, I want to purchase the stock from the 401(k) plan and then transfer to an S-corp. You mention many times above that changing to an S-corp poses lots of issues, none good. Can you elaborate on that, please?
Thank you
That’s too open to address in a post. If you can buy back the shares I’d just close the C Corp, with some planning and then setup a new S Corp. Sorry Donna I hope that helped.