This is part two of a two part article on ROBS setup issues. Click here for part one.
ROBS Setup Issues – Transaction account for the Plan
This is a promoter specific issue. Some promoters ask clients to set up a bank account in the name of the Plan and the corporation. In this model, the funds are transferred from the current custodian to the client in the form of a check or wire made payable to the Plan. If a check, the client deposits it in the Plan’s bank account. I have numerous clients of promoters who use this model who experience difficulties finding a bank that will create an account for the Plan. The Plan is not a State registered entity and, as such, will not appear in the Secretary of State’s database.
Some banks will not open a business account for an entity that is not listed on a Sec of State website. There is also no box to check on bank software that allows their system to recognize that the entity is a 401K Plan. In this model the client signs on the bank account as the trustee of the plan. Sometimes clients make mistakes, for example, spending funds out of the plan on an expenditure for the corporation which is a prohibited transaction. A few times the banks made a mistake depositing plan funds into the corporation’s account. The client is then responsible for moving the funds from the plan account to the corporate account for the stock investment.
The other model, and one I work with, uses an account set up for the plan with the plan custodian. In this model, the funds go directly from the current custodian to the new custodian. The client is only responsible to set up a transaction account for the corporation. The custodian then wires the qualified funds from the plan account to the corporate account. The issues created in this setup are enough, for some clients, to use our services rather than work with promoters who use the first model.
ROBS Setup Issues – Initiating the roll-over request
Sometimes current custodians move funds in a way that creates a distribution either because the clients do not know how to ask or the custodian screws up the instructions. I have not seen this issue in the 2nd model mentioned above. One the reasons for this issue is that some custodians are reluctant to send a check to the client without coding that transaction as a distribution (from plans) or a 60-day rollover (from IRAs). The client sees a check payable to the plan, and does not understand certain codes on the transmittal that indicate a distribution / 60-day rollover to the IRS.
If you use the first transaction model, make sure you ask your current custodian for a plan to plan transfer (if another plan) or direct rollover (if an IRA).
A few quirks in this process you are not likely to encounter:
- Some custodians have an automated process that requires a PIN number. One of our clients did not know to request a PIN, and then waited unnecessarily for a couple of weeks.
- The occasional custodian will tell you that you need to obtain the roll-over request form from your new plan administrator. In the first account model the promoter will provide it to ou. In the 2nd, your plan admin will take care of this.
- Another client was informed that the request needed to be accompanied by a Medallion Signature Guarantee. This is NOT the same as a notary. A medallion signature guarantee is provided by a financial service officer.
ROBS Setup Issues – Investing your qualified funds
You are not required to invest into your corporation everything that you transfer into the plan. Most of our clients do invest all of their qualified funds into the corporation because their businesses need everything they can get their hands to to properly launch. I have not yet seen any business fail because of over-capitalization.
The owner of the shares issued as a result of the plan’s investment is the 401K plan for the benefit (fbo) the employee whose funds made the investment. The voting rights vest with employee, not the trustee. The corporate stock ledger needs to be updated to reflect the Plan’s ownership.
ROBS Setup Issues – Personal Stock
The Plan is not allowed to own 100% of the corporate stock. There must be a non-diminimus amount of stock owned outside the plan. This rule does not state a percentage. Instead, if this issue is ever scrutinized by the IRS, they look at several factors:
- percentage of non-plan ownership (2-3% minimum)
- the sufficiency of the QES transaction
- whether you follow the formalities of your business entity
- does your corporation meet the definition of an operating company
- whether you are an employee of the company
In addition, this personal stock issuance:
- Must be for value (cash, expenses, hard assets, NO sweat equity)
- Issued at the same price as stock to the plan
- Issued simultaneous to the plan purchase
If you have any questions about these issues please email, call, or set up a no cost phone consult using this link.
A ROBS looks easy on the surface. Hopefully these two posts give you a glimpse of sub-surface issues and why we create ROBS arrangements the way we do.