IRS weighs inA memo issued by the IRS on Oct. 1, 2008, appears to cast a chill on the ROBS strategy. The 13-page memo concludes that:
ROBS transactions may violate the law in several regards. First this scheme might create a prohibited transaction between the plan and its sponsor. ... Additionally this scheme may not satisfy the benefits, rights and features requirement of the Regulations. ... For this reason employee plans specialists are directed to open ROBS cases as described herein.
Michael D. Julianelle, author of the aforementioned IRS memo and director of employee plans for the IRS, maintains that ROBS plan can be legal -- if you're careful.
"There are so many rules that need to be followed," Julianelle says.
For example, the IRS looks closely to make sure companies that use ROBS funding offer stock ownership to all employees of the business, he says.
"That is one example of what is not happening in many instances, which violate nondiscrimination rules," Julianelle says.
Another red flag is when the rollover amount equals the business' stock value.
"That does raise an eyebrow for us. ... It indicates that this is something we should be looking at," says Julianelle, who says such math usually indicates the rollover's intent is to be used as business seed money only, rather than to be used as a bona fide employee retirement vehicle.
To avoid running afoul of the IRS, prospective business owners should seek the professional advice of a benefits expert, Julianelle says.
Indeed, ROBS proponents such as Guidant's Nilssen insist that rollovers performed by reputable companies operate under IRS guidelines and will not raise agency suspicions.
"I've heard of people using a rollover for business startup to buy a Mercedes-Benz for a company car of a business that is 'to be formed later,'" Nilssen says. "Well, that individual never started a business. ... That's wrong and a transaction we'd never participate in."
Fischer also believes in the ROBS approach. However, he cautions that a ROBS is not a strategy to be taken lightly.
"It does require a lot of thought and scrutiny because you're putting your retirement plan at risk," he says.
Putting retirement at riskThe risk of losing retirement money is the biggest drawback of a ROBS, says Michael Stamler, spokesman for Small Business Administration.
"We do not advise people to use their retirement funds to finance a startup business because there's a great risk that it could consume those retirement funds," says Stamler.
Jaime Raskulinecz, CEO of Entrust Northeast based in Verona, N.J., echoes those concerns.
"What if your business doesn't become profitable and folds? You're out of retirement money," says Raskulinecz, whose firm manages self-directed retirement accounts.
Besides, there are other options to seed a startup business that will not put your retirement money at risk or incite the wrath of the IRS, Raskulinecz says.
- Ask others to invest in your business. Others can legally use their retirement money to invest even if they will not be a principal in the business.
- Ask for a loan. Loans are available from the Small Business Administration. You can also consider a home equity loan or cash loans from friends or family.
- Borrow money from your 401(k). A 401(k) loan is an option, but IRS rules allow you to borrow only up to half of your vested balance, or $50,000, whichever is less. Some plans may even put restrictions on how you can use the money. So check to see if starting up a small business is allowed under your plan.
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