What are the true ROBS downsides? Today, I found a 2013 article on the SBA website about using retirement funds to start a business. The article accurately portrays rollover business startups (ROBS), but then mentions IRAs in a way that will get people in trouble.
- Putting retirement savings at risk – A true ROBS downside. I have many clients who firmly believe that investing funds into a business they control is less risky than leaving the funds in a mutual funds controlled by someone else. Most retirement accounts lost 45% of their value in 2008. Still, some of my clients have lost their entire retirement savings when their business failed. It happens. I also know that, because they are putting their retirement savings at risk, ROBS clients are more inclined to invest into less risky business.
- Increased IRS scrutiny – Not a true ROBS downside. 401K Plans are monitored for compliance, although the DOL has that authority, not the IRS. The DOL uses the IRS to enforce tax compliance for plans, but plans are more of an employee rights issue than tax issue. Plans invested into their sponsoring corporation have additional reporting requirements for the qualified employer stock that do not exist for plans without this stock. Does sponsoring a 401K plan with QES stock invite additional IRS scrutiny for corporation? With over 1,500 clients in 12 years, I have not seen ROBS play out this way. The key is to use a good plan admin to get the 550o done right and on time.
- Costs – Not a true ROBS downside today. In 2013, when the article was written, ROBS promotion companies charged about $5k to set up a ROBS arrangement, and an additional $1k per year to administer the plan. ROBS promoters charge about the same today. However, there is now an alternative. I charge a flat fee to create a ROBS arrangement which includes the state filing fee, all phone calls, emails. I also work with a superb plan trustee that creates and administers the plan for about the same annual cost. Better product, attorney-client relationship, at about 1/2 the cost.
Use an IRA Instead?
The author then mentions, “ROBS are not the only way to own stock in a company you control. You can use a self-directed IRA for this purpose.” Dangerous. The author then describes a court case where the taxpayers involved invested funds into a company and then co-signed a loan, which disqualified their IRA. That court case is Peek and Fleck v. Commissioner. The IRS also argued that wages paid to them and rents paid to a company they controlled also constituted prohibited transactions but the court did not opine on those two arguments.
Does investing an IRA into the same business that one might create with a ROBS create a different risk for the retirement funds as an investment? No, same investment risk.
How about IRS scrutiny? Investing an IRA into your corporation, in my experience, greatly increases the risk of IRS scrutiny because of the potential for prohibited transactions (PT). The downside of a PT, as happened to Peek and Fleck, is a complete disqualification of the IRA, retroactive to the PT date, with taxes, penalties and interest immediately due. A company one controls is treated as a disqualified person for prohibited transaction discussions when an IRA invests. However, the corporation plan sponsor in a ROBS arrangement is not a disqualified person.
The cost of a self-directed IRA is less than a ROBS. At Frank Selden Law you will save maybe $500 to create a SDRIA rather than a ROBS. Do NOT invest your IRA into a company you control just to save $500. Use a SDIRA for passive investments only. Use a ROBS for active businesses.
Get it Right
The article is by a guest contributor, not an official SBA post. I am a fan of the SBA. I highly recommend their resources for writing your own business plan. The SBA does not create ROBS or SDIRAs. The article does recommend competent legal advice, and in this regard I fully agree. You can book your own no cost or obligation appointment here. Get it right, right from the start.