Last December, the IRS issues a report outlining new ROBS warnings. This report, Qualifying Employer Securities Project Summary, details a few key items anyone contemplating a ROBS setup should understand. The Project looked at 32 defined benefit plans (DBPs) and 362 individual account plans (IAPs). ROBS plans are all IAPs and made up approximately 2/3 of the total sample size.
Avoid Prohibited Transactions
The IRS started out looking at prohibited transaction (PT) issues:
- the Employer Securities are acquired for adequate consideration (acquired at fair market value),
- no commissions are paid to plan associates to acquire the Employer Securities, and
- the acquisition is in compliance with ERISA Section 407.
We create a ROBS setup in a way that avoids these issues. Not difficult. In fact, I believe that any ROBS promoter who creates a setup with prohibited transaction issues should not be allowed in business. However, there is not regulatory body governing the industry. I create ROBS as a legal service, not merely a promotion. I am, in some sense, governed or regulated by the bar association standards for competent representation.
The IRS then addressed two issues particular to ROBS plans. These are the same top two issues address by the IRS since its first ROBS project in 2008.
ROBS Warnings – Annual Valuations
The IRS requires that the Form 5500 listing the plan assets list all assets, including the qualified employer stock (QES) at fair market value. The IRS found that, with few exceptions, ROBS plan sponsors did not value their Employer Securities in a systematic way on an annual basis and were not valuing Employer Securities at fair market value. Some plan sponsors were using the book value of the corporate assets as the value of the Employer Securities. Other plan sponsors were using the same value as the initial value year after year.
The typical ROBS promoter record-keeping systems ask for corporate financials to create the year end valuation. They do not ask for an independent valuation. The third party administrator I work with asks clients for the proper documentation. Our clients do not have this issue either.
I recommend clients follow the steps the IRS agents would follow if examining this issue. The IRS examination handbook is public information. Take a look at 220.127.116.11.3 Step 3 here. FMV of closely held stock should include book value, dividend paying capacity and the goodwill value of the company. Do this and you’ll be fine.
Do not to create the valuation yourselves, even though the rules say that a FMV value may be determined in good faith by a plan trustee. Have your CPA create the number for you. Less cost than an appraisal and usually more accurate. If your CPA is not comfortable putting their name on a stock price valuation, then you may need to pay for an independent valuation. Ask your Plan admin for what they will accept.
ROBS Warnings – QES Availability
The summary concludes by asserting that employees not having the opportunity to invest in Employer Securities to benefit from their appreciation along with the highly compensated employee appears to be a 401(a)(4) violation. What does that mean?
This code section requires that “the contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees”.
Nearly all of our client plans close the employer stock after a period of time. During the time the stock is available, all employees with funds in the plan may chose company stock as their investment choice at the same price. The board of directors then closes the stock availability. The board has a right to close benefits of the plan. Must a company make its stock available for the duration of the plan? No, the rules allow a closure.
The main point here, as I instruct my clients, concerns timing. If the stock offering closes after six months, and a dozen people are hired in month 7, the IRS will see that differently than if a dozen people are hired in year two or the company never hires anyone else. We create a time frame that works for our clients rather than hand you a boiler plate framework that might get you in trouble.
Here is the bottom line. If you want a ROBS setup and maintenance plan designed to avoid these issues, talk to us. Our goal is 100% right, 100% of the time. Email, call, or set an appointment.