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Tax Strategies for ROBS Business Financing

December 03, 2019

Most entrepreneurs that engage in the Rollovers as Business Start Ups (ROBS) financing strategy want to operate the C Corporation and ROBS strategy in the most tax effective manner. There are a number of strategies that can be implemented to reduce taxes for these companies and for their business owners. Leading Retirement Solutions is equipped to lead these discussions with business owners, their attorneys, and CPAs.

Common examples of how an entrepreneur can reduce taxes with the ROBS business financing strategy:

Retain C Corporation status: A C Corporation status is the most beneficial tax status for you and your company! It can be helpful from a Corporate tax perspective to keep the bulk of ownership in the hands of the 401(k) Plan rather than individual/personal ownership. The company would want to consider paying out dividends and/or making company contributions (match & profit share) to the plan. The 401(k) Plan gets its rightful portion of a dividend and corporate taxation is reduced as a result.

In Plan Roth Rollover: A designated Roth account is a separate account in a 401(k), 403(b) or governmental 457(b) plan that holds designated Roth contributions. The amount contributed to a designated Roth account is includible in gross income in the year of the contribution, but eligible distributions from the account (including earnings) are generally tax-free. The employer must separately account for all contributions, gains and losses to this designated Roth account until this account balance is completely distributed.

An in-plan Roth rollover is a rollover from your 401(k) pre-tax account, into your own designated Roth account in the same 401(k) Plan. You generally include the taxable amount (fair market value minus your basis in the distribution) of an in-plan Roth rollover in your gross income for the tax year in which you receive it. In-plan Roth rollovers are not subject to the 10% additional tax on early distributions.

If you engage in the Roth conversion strategy and you have Roth monies invested in the C Corporation stock, then any gain thereafter on the growth of the stock is tax-free. For a business owner who invested pre-tax 401(k) monies into the C Corporation stock, this means that if those same monies are converted to designated Roth contributions, the value of the C Corporation stock and earnings generated by the C Corporation stock must be separately tracked.

A 401(k) Roth Conversion maximizes capital returned to a participant’s retirement account for its investment. A Roth conversion – where pre-tax monies to be converted to Roth monies are invested in the C Corporation stock – should happen prior to the buyback of C Corporation stock, assuming the value of the stock will continue to increase and ultimately generate earnings. If you do not convert prior to a buyback of stock by the C Corporation, from the 401(k) Plan, you lose the benefit of claiming tax free earnings, assuming the value of the C Corporation stock has increased. 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.

For more on redeeming stock and exiting a ROBS setup, see our guide on How to Exit the ROBS Business Financing Strategy.

Make company contributions to the retirement plan: Companies and company owners can make and receive tax reducing contributions up to $57,000 - $63,500* in a Defined Contribution Plan (e.g. 401(k)) and up to $230,000* and more in a Defined Benefit Plan. Any matching or profit share contributions the company makes to a retirement plan reduces the company’s taxable revenue. If your company makes an employer contribution, the contributions (up to 25% of gross compensation) generally reduce the company’s taxable revenue by the amount of contribution made to the plan.

Any contributions the business owner makes to their own retirement account reduces the business owner’s taxable income even further. Company owners may contribute up to $19,500* (+$6,500* if age 50 and older), annually. Company owners may contribute their earned income, which can include W-2 compensation, K-1 draws, etc., to their company retirement plan each year, thereby reducing the owner’s personal, taxable compensation.

*Contribution and tax deduction rates are generally adjusted upward each year. Current rates can be found here

Reinvest your 401(k) money into another business venture: There are ways to further invest the redeemed amounts in your 401(k) Plan. We work with clients who sell all or part of their business and rather than returning the sale proceeds back to the 401(k) Plan immediately, they will use the money to finance another business venture. 

Leading Retirement Solutions regularly assists businesses and entrepreneurs who have engaged in the ROBS business financing strategy, with tax reduction strategies. If you have questions you can get in contact with us here.

For more tips and information regarding retirement plans, contact us.

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