How to Exit a ROBS Strategy | Frank Selden Law

How to Exit a ROBS Strategy

This is a reprint from an article posted by Leading Retirement Solutions. Their article can be found here.

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Before a 401(k) plan can be terminated, the assets need to be removed.  In the case of a ROBS plan, that means having the corporation buy back the qualified employer securities (QES) from the plan at fair market value.

The decision to have a corporation buy the stock back from a 401(k) plan, in order to terminate a ROBS strategy, is often a very calculated one. The decision is made based on several factors including 1) priorities of the business, 2) priorities of the business owner(s), 3) retirement savings needs, 4) tax deduction needs, and 5) business expansion/financing needs. Given the tricky nature of this strategy, it’s best to work with a Third Party Administrator (such as LRS), an ERISA attorney, and a tax advisor when exiting a ROBS Plan.

Why exit?

Typically, those partaking in the ROBS strategy that wish to exit it, do so to defer taxation on their company shares or to change their corporate entity to something other than a C-Corporation. If their company stock is valued at more than they want to pay to buy it back, there is a set of provisions in the Internal Revenue Code that permit tax deferral and capital gains tax treatment when utilizing certain methods of exiting a ROBS plan.

Are there certain conditions that must be met in order complete a NUA transaction?

When it comes to methods for exiting a ROBS plan, such as a Net Unrealized Appreciation (NUA) transaction, there are certain conditions that must be met. In order to initiate an NUA Transaction specifically, these 5 conditions need to be fulfilled:

  1. The ROBS participant needs to be at least 59½ years old.*
  2. All other retirement plan accounts (sponsored by the employer) of the ROBS participant are also distributed/rolled out of the plan in the same tax year.
  3. Employer securities must be distributed in-kind.
  4. Employer securities must be distributed in the same tax year.
  5. The shares need to be valued by a third-party appraiser prior to distribution.

*While it’s possible to do for those under 59.5, it would be complicated and expensive to do.

Once the above conditions have been met a ROBS participant exit can be initiated. In the case of an NUA, the participant will only owe ordinary income tax in the year of distribution on the original rollover value of the shares, at the date the original ROBS transaction (as opposed to the current value of the shares).

What would the tax impact look like if they sold the company with the shares still owned by the 401(k) plan?

If the ROBS participant decided to sell the company with their shares still in it instead (as opposed to utilizing the NUA Method), proceeds go into the plan, and when they take the distribution it will be taxed like normal (income tax and capital gains), at the ordinary rate. Leading to much higher costs for the ROBS participant.

Are there other strategies for exiting a ROBS plan?

Aside from the NUA method, there are three other valuation and exit strategies that can be utilized. These include:

  • 401(k) Roth Conversion

A 401(k) Roth Conversion maximizes capital returned to a participant’s retirement account for its investment. Conversion should happen prior to the buyback, which results in no personal taxation on ROI from the initial investment. This method extends the amount of time that the business remains a C-Corporation, since the company can’t convert until all stock is redeemed.

  • Early Buyback

The Early Buyback method allows for a quick exit and S-Corporation Election, but the amount returned to the 401(k) account of the participant may be less than that originally deposited. An Early Buyback can be combined with accelerated contributions to get company profits into the plan.

  • Partial Buyback

For a Partial Buyback, if the company valuation is higher than cash on hand, the 401(k) and Corporation can enter into an amortized payment schedule to settle the buyout. This allows for controlled distribution of the profits to the 401(k) plan. It also mitigates the impact of being taxed as a C-Corporation. This method also extends the amount of time that the business remains a C-Corporation.

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Thus ends the reprint.

If you are looking to exit your ROBS strategy, your plan administrator (TPA) plays a significant role. Hopefully, you have a good TPA like Leading Retirement. Your TPA is not likely to offer legal advice. It also helps to have an attorney who understands how to set up and reverse a ROBS arrangement. That's where we can help. Send an email, call us or book an appointment here to find out what we can do for you.

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