IRS Compliant ROBS setups | Frank Selden Law

IRS Compliant ROBS setups

The IRS' ROBS Compiance Project details specific concerns with ROBS arrangements. These are the same top two issues address by the IRS since its first ROBS project in 2008.

Fortunately, these issues are easy to avoid if you have a proper ROBS setup.

Prohibited Transactions

Most ROBS promoters instruct their clients to set up a checking account in the name of the plan. Qualified funds are transferred into that account and then invested from that account into the corporation's business account as a stock purchase. Fully compliant so far.

Issues arise when clients (or banks) mistakenly deposit qualified funds into the corporate account, use funds from the plan account directly for corporate or personal expenses, transfer funds from the plan account into the corporate account because the company needs money without going through all of the steps required for a stock purchase, or transfer funds from the corporate account into the plan account without documenting: whether the funds are a stock buyback; salary deferral, matching contributions or profit-sharing; which employees are involved, or any required 1009s. The recordkeeper services offered by most ROBS promoters does not prevent prohibited transactions. Your ROBS experience does not have to be that way.

When we create a ROBS setup under 401K ROBS PROS, all of our clients are set up with a plan account on a financial platform managed by a Third Party Administrator. You work through them to invest funds from the plan into the company. You also work through them for stock buyback, salary deferral, matching contributions and profit-sharing. They create any 1099s required to be issued by the plan. Issues prevented.

Annual Valuations

The IRS requires that the Form 5500 listing the plan assets list all assets, including the qualified employer stock (QES) at fair market value. The IRS found that, with few exceptions, ROBS plan sponsors did not value their Employer Securities in a systematic way on an annual basis and were not valuing Employer Securities at fair market value. Some plan sponsors were using the book value of the corporate assets as the value of the Employer Securities. Other plan sponsors were using the same value as the initial value year after year.

The typical ROBS promoter record-keeping systems ask for corporate financials to create the year-end valuation. They do not ask for an independent valuation. Our third-party administrator asks clients for the proper documentation. Our clients do not have this issue either.

I recommend clients follow the steps the IRS agents would follow if examining this issue. The IRS examination handbook is public information. Take a look at 4.72.8.4.3 Step 3 here. FMV of closely held stock should include book value, dividend-paying capacity and the goodwill value of the company. Do this and you’ll be fine.

Have your CPA create the number for you. Less cost than an appraisal and usually more accurate. If your CPA is not comfortable putting their name on a stock price valuation, then you may need to pay for an independent valuation. Ask your Plan admin for what they will accept.

QES Availability

The summary concludes by asserting that employees not having the opportunity to invest in Employer Securities to benefit from their appreciation along with the highly compensated employee appears to be a 401(a)(4) violation. What does that mean?

This code section requires that “the contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees”.

Nearly all of our client plans close the employer stock after a period of time. During the time the stock is available, all employees with funds in the plan may choose company stock as their investment choice at the same price. The board of directors then closes the stock availability. The board has a right to close the benefits of the plan. Must a company make stock available for the duration of the plan? No, the rules allow a closure.

The main point here, as I instruct my clients, concerns timing. If the stock offering closes after six months, and a dozen people are hired in month 7, the IRS will see that differently than if a dozen people are hired in year two or the company never hires anyone else. We create a time frame that works for our clients rather than thrust upon you a boilerplate framework that might get you in trouble.

Avoid IRS ROBS Issues

Here is the bottom line. If you want a ROBS setup and maintenance plan designed to avoid these issues, talk to us. Our goal is 100% right, 100% of the time. Download the 401K ROBS PROS e-book or schedule a consult directly on my calendar here.

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