IRS 2008 ROBS Memo Issues

IRS 2008 ROBS Memo

We now turn our attention to the issues mentioned by the IRS in their 2008 ROBS Memo. In our last post, we looked at the steps taken by ROBS promoters at that time as scrutinized by the IRS. What did they not like about what they discovered? The two primary issues raised by the IRS were violations of nondiscrimination requirements, and prohibited transactions due to deficient valuations of stock.

IRS 2008 ROBS Memo Nondiscrimination Violations

401K plans are sponsored by employers for the benefit of all employees. While discriminatory plans do exist, none of those plans contain the qualified employer security exemption that is the legal basis for the ROBS transaction. Employers violate plan discrimination tests when they create benefits available through the plan to some employees and not others.

Two rules germane to this issue:

  • Internal Revenue Code § 401 (a)(4) provides that, under a qualified retirement plan, contributions or benefits provided under the plan must not discriminate in favor of highly compensated employees (HCEs), and
  • Treas. Reg. § 1.401(a)(4)-1(b)(2) provides that in order to satisfy § 401 (a)(4), either the contributions or the benefits under a plan must be nondiscriminatory.

They observed ROBS arrangements designed to take advantage of a one-time only stock offering. The investment feature generally would not satisfy the effectively available benefit requirement. The IRS raised the discrimination issue because promoters designed plans such that the plan benefit of employer stock would not be available to other employees.

IRS 2008 ROBS Memo Stock Valuation Issues

After you sift through the revenue code sections and treasury regulations quoted you get to the real IRS 2008 ROBS Memo issue; businesses that don’t get started.

“A valuation-related prohibited transaction issue may arise where the start-up enterprise does not actually “start-up.” Here, the start-up entity might record “cash” as its only asset, without any real attempt to secure, for example, a franchise license, property, plant and equipment or other assets necessary to start a bona fide business. The valuation ostensibly legitimizing the exchange is unsupported.”

Only execute a ROBS plan when you have a legitimate business readily available. How long to people have to create this business? Essentially, the QES exemption requires the employer to be an operating company at the time of the transaction. The IRS has not held this as a standard. One of my clients discovered, two days before signing the purchase agreement, that the seller carried two sets of books; one for the IRS (low numbers) and one for the sale of the business (high numbers). They wanted nothing to do with that seller. They did not find another suitable business for over a year. Stuff happens outside of our control or intention. We create ROBS arrangements when clients have the intention to create a viable business.

Is a ROBS right for you?

If you have a business idea, and the qualified funds – and, if necessary, other funding sources necessary to create it – then, yes, a ROBS will work well. We offer a no cost or obligation phone consult to discuss your ideas and concerns. You can book that call on-line, here.

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