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ROBS CPA discusses Pros and Cons of the Rollovers as Business Start-Up Technique for 2017

ROBS CPA Wilmington NC

Gary Bode, CPA: the ROBS technique deserves due diligence. For a free phone consult call (910) 399-2705.

ROBS CPAs see the long-term impact of using the Rollovers as Business Startup (ROBS) technique used to capitalize a new business venture. Why? We’re usually engaged as the ongoing C Corporation CPA. 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 (30%+) tax upon distribution. Plus it avoids the infamous 10% additional tax. Like most ROBS CPAs, I became cautious of this technique once the IRS published warnings about it. However the IRS now seems to treat ROBS Corporation the same as a non ROBS Corporations.

“The ROBS (Rollovers for Business Startups) works; there are just administrative issues to deal with.”
– Gary Bode, ROBS setup 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. This post is based on seven years experience as a ROBS CPA and IRS directives,

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 retirement funds become retroactively taxable. So you pay income tax on the ROBS distribution immediately in the tax year of the ROBS transaction, plus a 10% early distribution “additional” tax. Plus penalties and interest of course. Some folks don’t run a tight enough business to withstand IRS scrutiny.

The audit rate for ROBS Corporations is 4%. But that figure doesn’t come from the IRS. None of my Clients have been audited. Using a well established ROBS provider also decreases that risk. I’ve read documentation from maybe nine ROBS providers. Some of them have lots of legal disclaimers. While I can provide most of your due diligence with a free phone consult, remember I don’t do the ROBS setup and my responsibility starts after the setup. Except I sometimes talk over start-up expenses before the setup occurs. A call to Guidant should be part of your due diligence for the actual setup aspects of ROBS. I like them because they cover several hot IRS issues other setup companies don’t. If you mention my name they’ll pre-pay $1,000 of accounting costs. Your ROBS CPA doesn’t have to be me for that to happen, but most of my ROBS callers end up using me as their ROBS CPA.

Company Failure and Loss of your Pension Funds

The IRS itself states some ROBS companies went bankrupt and folks lost their entire retirement funds. That’s strong wording and an unusual stance from the IRS. That’s why I think engaging a ROBS C Corporation CPA is important. Like me. I won’t take you on as a ROBS C Corporation Client if I think you won’t succeed or if I’m not familiar with particular type of business. I don’t know the details or number for this IRS statement, but here are possibilities

  • The IRS shut them down, but not perhaps because of using ROBS.
  • The stockholders violated the pension plan provision of ROBS.
  • The ROBS C Corporation didn’t obtain an annual business valuation. Note the cost of this requirement is something you’ll have to live with.
  • The ROBS Corporation did not file Form 5500 with the Department of Labor.
  • Stockholders took an immediate salary but never purchased the franchise or business as they intended.
  • They used ROBS money to pay their ROBS setup provider.
    • You personally buy shares with the setup fee.
    • So you might have 4% of stock and the ROBS 401(k) trust owns 96%.
    • Some providers adjust the stock ledger, some don’t.
  • The ROBS Corporation invested in some LLC but didn’t have at 51% control of the LLC.
  • The required annual valuation of the company was shoddy.

The Rollover as Business Startup technique takes good planning

You don’t have to be a ROBS CPA to understand the difficulties of starting a new business. However some folks casually put their entire life savings on the line without a good business plan. Cash flow projections are crucial. Promoters may show you the blue sky side of ROBS, but ROBS CPAs sometimes see the consequences of poor planning. That’s why I think it’s important for a ROBS CPA to watch your back the first year or so.

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 mishandling 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. Again Benetrends can be useful to avoid pitfalls of using the ROBS technique since they offer ROBS setup audit insurance.

High Break Even Point

I think most ROBS CPAs run a break even 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. Another CPA says $50,000 is the break even point not my $18,000.

Operating as a C Corporation

Here’s where your ROBS CPA earns their pay; just by keeping new C Corporation in IRS compliance. Because one false move could negate the ROBS transaction. However I sometimes get a ROBS client a few years after the business started. Sometimes the books are awful, they violated some prohibitive transaction, didn’t create corporate minutes, etc. But the IRS didn’t take any interest in them. One such Client didn’t bother to file Form 5500 for two years.

As a ROBS 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. I’ll discuss how to avoid that below. 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 ROBS C Corporation.

Increased Danger of IRS Audit

The IRS is interested in ROBS funded C Corporations. Seriously, they publish warnings about it. But if read why, they say that your can legitimately avoid those issues. Part of prevention is using a well established ROBS setup provider. Part of that would be using a seasoned ROBS CPA. 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. In my opinion, there are now so many ROBS setup transactions that ROBS is almost mainstream in 2017 and probably only plays a part in the IRS audit selection process. Some of that is due to a change in the general type of ROBS client. Most of the ROBS calls I get are from Folks who want to be their own boss and want to control their retirement funds themselves.

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.
  • ROBS corporations stand a better chance of surviving because there isn’t the usual startup loan to service. That’s a big deal
  • You get to be the boss.
  • You get to change careers.
  • You’re in charge of your pension plan instead of letting it sit in a brokerage firm earning a few bucks a year.
  • In this economy, even in 2017, starting your own business may be the only road to employment.
  • Your ROBS Corporation has a better chance of becoming successful.
  • With careful planning and upkeep, the ROBS technique works.

“Learn about IRS ROBS prohibited transactions.”
– Gary Bode, ROBS CPA and C Corporation tax accountant

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.
  • Have a business plan. Even if you have specialized skills for a business, plan carefully. Cash flow, cash flow, cash flow.
  • Engage a CPA that handles ROBS C Corporations.
    • Some CPAs won’t.
  • Engage a CPA with ROBS experience. They’re hard to find.
  • Choose your CPA  provider and pension plan administrators carefully.
    • Again a call to Guidant is prudent. Their process seems tight, they offer a platform of financial services (like coordinating an SBA loan) and prepay $1,000 of accounting fees if you mention my name.
  • 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.
  • Use corporate minutes to back up any major decision in the ROBS company.
  • Proactively pass all non-standard business transactions past your ROBS CPA.
  • Understand the start-up fees.

I’m a ROBS CPA and C Corporation tax accountant.with a virtual office to accommodate C Corporation clients wherever they’re based. Don’t let distance alone dissuade from using our services. There are lots of ROBS posts on this website. Use the search bar above or click on Forms and type in ROBS. Talk to me, I offer a free phone consult. I feel like I can provide 75% – 80% or so of what I consider due diligence when deciding to use ROBS technique. I don’t claim to be be a ROBS expert but I’ve worked with ROBS for maybe seven years now and think I know the technique pretty well. (910) 399-2705.

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32 comments to ROBS CPA discusses Pros and Cons of the Rollovers as Business Start-Up Technique for 2017

  • Rich Faringer Jr.

    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.

  • Mark

    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.

  • Mark

    Gary,

    Thanks for your response. Would you agree that another option is to recognize the ROBS as a distribution, then pay the taxes and 10% penalty? At least in this option, I can then switch to an S Corp and avoid the double taxation issue. What do you think?

  • Mike McWilliams

    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.

  • Pat

    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.

  • Jason

    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.

  • Joy

    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 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

  • justin

    Hello, I have a ROBS C-Corp. After 2 years I have accumulated money through contributions back into my 401k. Can the 401k purchase additional newly issued C-Corp stock if I get the company re-appraised?

  • CW

    Hi Gary,
    Used a ROBS to start my business last year. Hindsight, I should have not done it. Rolled 45K, I should have taken the tax hit instead. I’d like to exit the vehicle now. I understand, and accept, I’ll pay taxes/penalties as a consequence. As with most first year small business, we are finishing in the red. I am getting my annual valuation done now. What are my options?

    Best,
    CW

  • Gary my business I started with a ROBS plan it is now 3 years old and profitable. I am leery of the IRS and making sure all my T’s are crossed and I’s dotted every year properly and would love to close the C-Corp. My original investment was 260K can I return that 260K to the 401K Plan by buying all the shares and close the C-Corp and convert to a new S Corp? The hassles of the keeping all the records is getting to be a pain and I would like to get free and clear of the IRS and all its filing requirements for good!

    Thanks,

    Greg

  • Gary my business I started with a ROBS plan it is now 3 years old and profitable. I am leery of the IRS and making sure all my T’s are crossed and I’s dotted every year properly and would love to close the C-Corp. My original investment was 260K can I return that 260K to the 401K Plan by buying all the shares and close the C-Corp and convert to a new S Corp?

    Thanks,

    Greg

    • Yes, but it may be a little harder than that Greg. Run the numbers. Since you’re not changing to an S Corporation, which has it’s own set of IRS wrinkles, you’d have to sell the company to you. And then setup up an S Corp. Hope that helps. Feel free to call me 910 392 2705

  • Steve O

    Hi Gary,

    Explain to me the $28,000 per year borrowing form my 401k? That is without penalty? And it can be used to start up a business?

    Would I be better off taking a 30% hit to fund my business as opposed to ROBS C-Corp? I would be the only employee of my business at least for the first year, but may hire a worker in the 2nd year most likely if my business grows. And perhaps my income would be low enough that maybe I can get part of the 20% taxes back?

  • Nate

    Hi. What is the process for successfully closing a ROBS relationship?

    Eg, paying back your original, personal 401k amount and ‘separating’ your 401k monies from your business (and rolling the funds back to a traditional brokerage). Can the ROBS 401k decide to sell its holding of company stock back to the company (the company having enough retained earnings to do so); some type of buyback?

    Goal: to legally separate funding with no penalties (because your 401 is full (and normal) and the IRS hasn’t been cheated out of taxes), and you don’t have to manage a 401k for the employees.

  • Scott

    Hi Gary. I rolled $305,000 using the ROBS method 7 years ago to purchase a business. I now have $200,000 in retained earnings. I have been offered $600,000 for our business. $300,000 in cash and a ten year installment plan for the remaining $300,000. How would the IRS view a sale of my ROBS C Corp structured in that fashion?

  • Jeff

    Hi Gary, I have a question about pre-paid expenses. If I need to pay some urgent expenses in the weeks before the C-Corp is actually set up like a prepaid lease payment, insurance fees to get access to building, etc., can I get reimbursed for this once the ROBS funds are transferred and available in the business as operating capital? I realize I will have some paid-in capital up front anyway when the C-Corp is set up, but some of these expenses are very large and I can’t afford to drain my personal accounts for long to cover them. Thanks!

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