ROBS transactions or “Rollover As Business Start-ups” transactions

Brian S. Weinstock

By Brian S. Weinstock

Over the last two years, lending institutions have changed internal policies and procedures with regard to loan approval as a result of the global financial crisis. Most domestic lenders require anywhere from forty percent equity to one hundred percent collateralization in order to begin the discussion of obtaining a loan. This has caused many business deals to stall or vanish. These circumstances have given rise to alternative sources of financing for start-up business, franchise purchases and purchases of existing business or assets. One such way is through a Rollovers As Business Start-ups or known by the Internal Revenue Service (IRS) as a ROBS transactions.

From 1992 – 2007, many employees built up their retirement funds through qualified 401k plans. As a result of the global economic and financial crisis, typical losses in a 401k plan ranged from thirty percent to forty percent of retirement assets. Despite these losses, these individuals still have significant sums of money in these accounts which have been assisted by an increase, from the DOW’s low of about 6,547 in 2009, in the United States securities exchanges. Many United States employees have a substantial percentage of their entire savings locked up in a 401k account which cannot be touched unless the taxpayer is willing to pay a penalty for an early withdrawal before 59 and one-half years old. Over the last several few years, the IRS has seen an increase in ROBS transactions which are being promoted by various entities across the United States as a significant method to capitalize a start-up business, to buy a franchise, capitalize an existing business or buy the assets of an existing business. Essentially, a promoter is a company or individual who markets and sells a tax shelter. A tax shelter is an investment, agreement or plan that is established for the purpose of avoiding or evading federal income taxes.

A ROBS transaction is a tax shelter whereby an individual uses pre-tax passive retirement assets, such as funds in a 401k, to capitalize new or existing businesses without paying taxes on the retirement assets. Typically, the promoter assists the individual through the process by initially incorporating a C-corporation for the taxpayer. The same corporation adopts a qualified 401k profit sharing plan which the promoter markets. The newly established 401k is a plan which includes an uncommon plan election allowing 401k participants to invest their entire account balance in the employer’s stock. At this point, the promoter typically then executes a rollover of retirement money into the new 401k plan. The promoter then directs the 401k to purchase employer stock in the C-corporation. The promoter’s client then transfers existing 401k funds to the C-corporation in order to capitalize the C corporation. The promoter’s client does not pay any taxes or penalties for this distribution or early withdrawal of the existing 401k funds.

Throughout the process, the promoter advises their client that the ROBS transaction meets the requirements of federal law under an ERISA exemption. The promoter typical informs their client that the client will receive a (advisory) letter from the IRS indicating that the ROBS transaction with withstand an IRS review. In addition, the promoter may advise the client that any outside attorney will not be able to advise them that the ROBS transaction is illegal or unable to withstand an IRS review. Given the circumstances surrounding a ROBS transaction, we are not aware of any official opinion letter from the IRS which addresses the issue of whether there is a violation of federal law under ERISA or the prohibited transaction rules with regard to the form or structure and operation or administration of a business, such as a C-corporation, under a ROBS transaction.

While the IRS has not officially deemed the ROBS transactions illegal, they have coined the term “ROBS” for these transactions, are vigorously investigation these transactions with the Department of Labor, have only stated the form may not be a violation “per se” of federal law but at no time has the Department of Labor or the IRS ever stated that these transactions from the structure through the operations will withstand an IRS review. In fact, the answer is that nobody knows whether the ROBS transaction is legal. The fact that the federal government is running massive deficits as well as the IRS :

  1. calling these transactions ROBS, 
  2. having targeted these transactions, and
  3. having issued a stern memorandum for these transactions, should raise red flags with regard to how the Department of Labor and the IRS will treat ROBS transactions in the future.

On October 1, 2008, the Director of Employee Plans for the United State Department of the Treasury issued a Memorandum with regard to guidelines regarding Rollovers As Business Start-ups. The Memorandum reveals that the IRS does not believe that the form of all of these transactions may be challenged by the IRS as being non-compliant “per se” but each case is to be considered on a case by case basis. The problem with a ROBS transaction might not be so much with the form or the structure of the deal but more so with operating and administering the deal after the transaction is completed. Two primary issues raised by the IRS are:

  1. violations of the nondiscrimination requirements, in that benefits shall not satisfy the benefits, rights and features test of Treasury Regulations,
  2. prohibited transactions as a result of deficient valuations of stock,
  3. promoter fees,
  4. “permanent” retirement program,
  5. exclusive benefit of the retirement plan,
  6. the retirement plan not communicated to the employees, and 
  7. inactivity in cash or deferred arrangement.

The United States government encourages the use of retirement plans. In order for an employer to take advantage of these legal tax shelters for their employees, the employer shall adopt the retirement plan for the exclusive benefit of its employees. A lawful use of a 401k is to provide a way for employees to save funds for their retirement. After the plan is adopted, the administrator chooses investments which the employees can choose to invest their savings. With regard to a ROBS transaction, the 401k is being used to shelter income for taxpayers who want to start a business or capitalize an existing business. In this scenario, the 401k is not being used as a way for employees to save money for retirement but as means to capitalize a business.

The Department of Labor and the IRS are currently examining ROBS transactions and have targeted these transactions for review. The IRS Memorandum referenced-above has declared that ROBS transactions “may violate law in several regards.” The IRS has noted that each transaction will be reviewed on a case by case basis as opposed to issuing a blanket letter indicating that all of these transactions are legal. If you have engaged in a ROBS transaction, time is of the essence to contact an experienced attorney to have the transaction reviewed to determine if there have been any violations of federal law. If so, these violations can typically be corrected. If you take steps to correct any violations before the Department of Labor and the IRS begin to investigate your transaction, you can take advantage of the Department of Labor and IRS correction programs.

Once an investigation into your ROBS transaction has begun, you cannot take advantage of their correction programs. If an investigation begins and violations of federal law have been found, the taxpayer can be subject to their entire 401k being taxed, excise taxes, back taxes, penalties, and any other taxes that your ROBS transaction incurred. Moreover, the taxpayer may have a civil lawsuit against any individual or firm who assisted and counseled the taxpayer with regard to the ROBS transaction.


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