Is Peek and Fleck v Commissioner – a ROBS case? This morning I read a recent blog post on an attorney website cautioning people from using a rollover business startup (ROBS) funding in light of Peek v. Commissioner (link removed 10/27/17 as the article has disappeared). This is not the first such post since the 2013 case. However, is Peek v. Commissioner about someone using a rollover business startup? You decide.
In 2001, the Peek and Fleck used their self-directed IRAs to fund the purchase of Abbott Fire & Safety, Inc. from an unrelated third party. At that time, Abbott was a successful business specializing in the sale of fire alarms, sprinklers and other fire suppression equipment. The taxpayers acquired Abbott through a newly formed corporation – FP Company – which the taxpayers capitalized exclusively with their IRA assets. Each of the taxpayers’ IRAs transferred cash to FP Company in exchange for the company’s stock. Following the transaction, the taxpayers’ IRAs collectively owned 100 percent of FP Company. FP Company then acquired Abbott using that cash (i.e., the proceeds from the stock sale to the IRAs), cash from a bank loan and promissory notes. The sellers required the taxpayers to personally guarantee the promissory note FP Company made to them. In subsequent years, the taxpayers rolled over the FP Company stock from traditional IRAs to Roth IRAs, which resulted in income to the taxpayers during those years. In 2006, the taxpayers sold FP Company for a substantial profit, which the taxpayers claimed was permanently shielded from tax on account of the FP Company stock being held by taxpayers’ Roth IRAs.
Is this a ROBS arrangement?
No. It is an IRA investment, and the differences are exactly why the IRS found that Peek and Fleck committed a prohibited transaction when they guaranteed the loans and disqualified their IRAs.
ROBS transactions typically involve the following sequential steps: (i) establish a new corporation; (ii) the corporation adopts a 401(k) plan that specifically permits plan participants to direct the investment of their plan accounts into a selection of investments options, including employer stock; (iii) client elects to participate in the new 401(k) plan and, as permitted by the plan, directs a rollover or trustee-to-trustee transfer of retirement funds from
another qualified retirement plan into the newly established corporate plan; (iv) client then directs the investment of his or her 401(k) plan account to purchase the corporation’s newly issued stock; and finally (v) the company utilizes the proceeds from the sale of stock to purchase an existing business or to begin a new venture.
Had Peek and Fleck used a proper ROBS setup, instead of directly investing into their corporation with their IRAs, they could have guaranteed the loans without creating a prohibited transaction.
If you want to invest retirement funds into a business, understand the differences between investing your IRA versus creating a rollover business startup. Self-directed IRAs have some distinct advantages over ROBS, but are not the proper format for all investments. A ROBS arrangement would not have created the tax free growth that Peek and Fleck wanted. However, their personal guarantee violated the IRA rules. Your best option is to discuss your goals with someone who knows all of the rules for both concepts before you involve your qualified funds. That’s what I offer. Call me. 425.990.1021