How to Use a Rollover as Business Startup (ROBS) for Your New Venture

Entrepreneurs often seek innovative ways to fund their ventures, and one such method is the Rollover as Business Startup (ROBS). This financing option allows individuals to access retirement savings without early withdrawal penalties or taxes. Understanding how to utilize a ROBS effectively can help minimize financial strain when launching a business. While it offers tax advantages, setting up and maintaining a ROBS requires strict adherence to legal requirements.

Eligibility Criteria

To implement a Rollover as Business Startup (ROBS), individuals must meet specific eligibility requirements. A qualified retirement account, such as a 401(k) or traditional IRA, is necessary for the rollover. Roth IRAs, due to their tax-free withdrawal structure, are not eligible. The business must be structured as a C Corporation, as this setup allows for the purchase of corporate stock—a key component of the ROBS arrangement. The C Corporation must sponsor a qualified retirement plan, typically a 401(k), that complies with the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code.

Additionally, the individual must be an active employee of the business. This ensures the funds are used for active business purposes rather than passive investments, aligning with IRS regulations.

Setting Up a C Corporation

Establishing a C Corporation is the first step in using a ROBS strategy. This structure is necessary because it can issue stock, which is integral to the ROBS process. Start by selecting a unique business name that complies with state naming conventions and avoids trademark infringement. Then, file the Articles of Incorporation with the state, specifying the corporation’s purpose, the number of authorized shares, and details about the board of directors. Filing fees vary by state, typically ranging from $50 to $500.

After incorporation, obtain an Employer Identification Number (EIN) from the IRS, which is required for tax filings and opening corporate bank accounts. The EIN application can be completed online through the IRS website.

Creating the Retirement Plan

Creating a qualified retirement plan, usually a 401(k), is essential for executing a ROBS strategy. This plan serves as the mechanism through which rollover funds are invested into the business. The retirement plan must comply with ERISA and the Internal Revenue Code. Draft a plan document outlining eligibility criteria, contribution limits, and vesting schedules. Consulting with an ERISA attorney or retirement plan consultant is recommended to navigate regulatory complexities.

Once the plan document is finalized, implement the plan within the corporation. Assign a plan administrator to manage participant accounts, oversee operations, and ensure fiduciary responsibilities are met. Regular compliance testing, such as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, ensures contributions are equitable among employees. File Form 5500 annually with the Department of Labor to report the plan’s financial condition and operations.

Funding the Business

To fund the business using ROBS, roll over eligible retirement funds into the newly established C Corporation’s retirement plan. The corporation then issues shares to the plan, converting retirement savings into business capital. This process avoids the penalties and taxes typically associated with early withdrawals.

The capital infusion from ROBS can strengthen the business’s financial position, potentially making it more attractive to lenders and investors. Maintain a balance sheet that reflects the capital infusion accurately, adhering to GAAP principles for transparency in financial reporting.

Recordkeeping and Compliance

Maintaining rigorous recordkeeping and compliance is critical once the business begins operations. The ROBS structure is closely monitored by the IRS and the Department of Labor, requiring meticulous documentation. Failure to comply with regulations can lead to penalties, disqualification of the retirement plan, and tax liabilities.

Ensure the retirement plan remains qualified under ERISA and the Internal Revenue Code. Conduct regular nondiscrimination testing, such as the Top-Heavy Test, to confirm the plan benefits all eligible employees equitably. If the plan fails, corrective actions, like additional contributions to non-key employees’ accounts, may be necessary. Timely and accurate filing of Form 5500 is mandatory to avoid penalties.

Maintain detailed financial records tracking the use of ROBS funds, including expenses like equipment purchases, lease payments, or payroll. Proper documentation ensures transparency and can serve as evidence during audits. Issue annual reports to plan participants, detailing the plan’s performance and the value of their investments. Engaging a qualified CPA or financial advisor can simplify these processes and ensure compliance with all reporting requirements.