October 28, 2021

You’re the Boss Blog: Using Retirement Money to Start a Business

Creating Value

Are you getting the most out of your business?

You’re thinking about starting a company. You’ve decided that the best bet is to buy a franchise. This will give you a leg up because someone else has done the heavy lifting and can give you a road map for success. You’ve discussed opening the business with your spouse, and your spouse is supportive. The only problem is that you need to raise $300,000 to get the franchise off the ground.

You’ve gone to friends, family and your local bank, and they have all turned down your request for a loan. But you really want to do this, and you happen to have saved $500,000 in your Individual Retirement Account. You tell the franchise people about your dilemma, and they tell you that for about $5,000, there is a way you can tap your I.R.A. savings to get the start-up capital you need.

Your franchise company introduces you to a promoter of a strategy known as ROBS, which stands for Rollover as Business Start-Ups. But before you can complete the retirement plan transaction, your spouse says, “Wait just a minute. You’re not doing anything till we check this out.”

This scenario, or a close approximation, is something I often see with my clients. I’ll hear about an idea and a client will ask me to look into it. In this case I decided to do the research without being asked because of two You’re the Boss posts that have appeared in the past year.

I first read about ROBS transactions last June in a post by Barbara Taylor. Then last week there were some comments left on a post written by Ami Kassar about business owners who pay too much for financing. My interest in the strategy was piqued, and I decided to look into whether a ROBS transaction makes sense.

It’s a complicated strategy. First, you need to establish a company with a qualified retirement plan. You then move your I.R.A. money to the new plan in your “shell” company, which takes the proceeds and uses them to buy company stock. Now, you have cash to start a business or, in the example above, purchase a franchise.

Whenever I run across a new strategy that involves retirement plans, I look for a pension administrator who deals in complicated pension issues. In this case I spoke with Tim Voigt from Pension Works in Colchester, Vt. Mr. Voigt told me he had heard of the strategy and thought it was likely to be prohibited, either by the Internal Revenue Service, which often takes the lead on issues like this, or the Department of Labor, which also has jurisdiction over retirement plans. Often, one will rule and the other will remain silent. It may mean only that one agency has not yet reached a conclusion.

I also spoke with Jeff Nabers, of Nabers Financial, who specializes in alternative investments for I.R.A.’s and has spent a significant amount of time researching ROBS. Like Mr. Voigt, he said he thinks the Labor Department might prohibit ROBS transactions — based on conversations he has had with officials there. If the department does rule against ROBS, there are significant penalties that could be levied against those who used the financing tool to start a business.

In 2008, the I.R.S. released a memo that referred to ROBS plans as “questionable” and suggested that they might be used to avoid paying taxes. In February, the agency released a ruling that suggested there is a proper way to do a ROBS plan but didn’t quite put the issue to bed. It did not issue regulations for doing ROBS properly. Nor has it released private letter rulings, revenue rulings or safe harbor rulings on ROBS that would remove any doubt about its legality. Because of that and because the Department of Labor has not ruled on the issue, there is still enough risk to consider ROBS a gray area.

Under the circumstances, I don’t believe I would recommend ROBS for one of my clients. Generally, I find that unless there is specific authority granted, it’s best to stay away from innovative tax plans even if they appear to be legal. And it’s always a red flag for me when the only people I can find to defend a strategy are those who are actively promoting it. And so far, I haven’t found independent accountants and tax attorneys offering support. (If you know of any, please tell us in the comment section below.)

But I also have another concern about the strategy — and that’s what happens when a business owner attempts to exit from a company formed this way. I believe the tax exposure on the sale of the business will be extreme, and I’ll talk about that in my next post.

Josh Patrick is a founder and principal at Stage 2 Planning Partners, where he works with private business owners on creating personal and business value.

Article source: http://boss.blogs.nytimes.com/2013/04/10/using-retirement-money-to-start-a-business/?partner=rss&emc=rss

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