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Subject: |
Using Your 401(K) To Start Or Buy A Business...Revisited |
| Date: |
2009-11-02
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Using Your 401(K) To
Start Or Buy A Business...Revisited
By Cliff Ennico
www.creators.com
"I was laid off from a corporate job a few months ago. I'm
thinking of buying a franchise, but I don't have enough money in my
checking account to pay the franchise fee and other upfront
expenses. I've heard that there's a way I can tap into my old
401(K) plan for the startup capital I need, but I've also heard the IRS
looks at that as an audit trigger. Where's the truth here?"
For some time now, entrepreneurs have been able to tap into their
401(k) plans to start a business using an "Entrepreneur Rollover Stock
Ownership Plan" or ERSOP.
Here's how these work:
- the entrepreneur sets up a C
corporation;
- the corporation then sets up
a profit sharing plan for the entrepreneur;
- the entrepreneur withdraws
funds from his 401(k) plan and rolls them into the profit sharing plan
within 60 days; and
- the profit sharing plan uses
the funds to purchase stock in the entrepreneur's corporation, giving
the corporation the startup capital it needs.
Sounds great, right? There's
only one catch. The IRS doesn't like ERSOPs. It calls them
"Rollovers as Business Start-ups," or ROBS. Now, whenever the IRS
gives a transaction an acronym like that (as in "robs the Treasury of
revenue"), you know a loophole is about to be closed, or at least
tightened.
In November 2008, the IRS released a technical memorandum (the full
text of which can be found at www.irs.gov/pub/irs-tege/rollover_guidelines.pdf),
expressing concern about the proliferation of ROBS transactions and the
possibility that they may not comply with federal pension law.
Specifically, the IRS raised concerns about a number of possible
violations.
Nondiscrimination. Under
federal law, retirement plans must be made available to all employees
of a corporation on a nondiscriminatory basis. Because ROBS
transactions generally benefit only the founding entrepreneur, and do
not enable rank-and-file employees to acquire stock in the corporation,
the IRS believes that some of these plans are
discriminatory. Even if the founding entrepreneur is the
sole employee of the business, a ROBS transaction may still be
discriminatory if it is set up in such a fashion that other employees
would not enjoy the same benefits as the entrepreneur.
Valuation of Corporation's Stock.
In all ROBS arrangements, the corporation uses the proceeds of the
stock sale to acquire assets (such as a franchise). The value of the
stock is set as the value of the assets purchased with the ROBS
proceeds. An appraisal may be created to substantiate this value, but
often it is nothing more than a one-page document furnished by the
promoter who sold the ROBS transaction to the entrepreneur. The
IRS believes this may set an artificially high value on the stock.
Promoter Fees. It may
also be a legal violation if the corporation immediately pays
professional fees to the ROBS transaction promoter out of the proceeds
of the ROBS rollover.
Permanency. Because ROBS
transaction benefits are designed to be used only once, the IRS is
questioning whether they are truly a "permanent" retirement program.
Permanency is a qualification requirement for all retirement plans.
At the time this is being written, the IRS has only begun to scrutinize
the ROBS transaction industry; as yet, there are no set guidelines for
ROBS plans that will withstand that scrutiny. However, since the
IRS' primary concern is that the corporate profit-sharing plan formed
as part of a ROBS transaction be a "real" employee benefit plan rather
than a one-time investment by the company founder, it is likely to look
favorably on ROBS transaction in which:
- an outside accredited
valuation firm (not the ROBS promoter) has established the value of
corporate stock at the outset of the plan and each year thereafter;
- an outside accredited and
licensed money manager (not affiliated with the ROBS promoter) is
appointed and available to render investment advice to the plan
participants as needed;
- the fees for the ROBS
promoter's services in establishing the plan are paid for out of the
entrepreneur's personal funds as a part of his personal investment and
not reimbursed from the corporation at a later time; and
- most importantly, that
"non-highly-compensated-employees" other than the founding entrepreneur
(for example, a person hired by the founder to serve as the General
Manager of a franchised business acquired with ROBS proceeds) be
allowed to participate in the corporation's profit-sharing plan on an
ongoing basis, and are offered the same investment options as the
founder.
If you are planning to do a ROBS,
be sure to work only with a reliable promoter who specializes in these
types of transactions, and offers resources to perform the necessary
legal and tax analysis of each transaction (the industry leaders are
Benetrends Inc., www.benetrends.com,
and Guidant Financial Group Inc., www.guidantfinancial.com).
Insist that the promoter furnish you with a "private letter ruling"
from the IRS or other regulatory determination that the transaction
complies with tax and pension requirements.
And make sure there will be no other nasty surprises for the IRS to
find if and when they audit your ROBS...
Cliff Ennico (cennico@legalcareer.com)
is a syndicated columnist, author and former host of the PBS television
series 'Money Hunt'. This column is no substitute for legal, tax or
financial advice, which can be furnished only by a qualified
professional licensed in your state. To find out more about Cliff
Ennico and other Creators Syndicate writers and cartoonists, visit our
Web page at www.creators.com
or visit succeedinginyourbusiness.com.
COPYRIGHT
2009 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE,
INC. Permission granted for use on DrLaura.com.
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