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Rollovers As Business Startups: 4 Most Common Compliance Issues

July 03, 2018

The Rollovers As Business Startups (ROBS) financing strategy is a resourceful way to use your retirement savings as capital to start a new business or grow an existing one. You will not incur any taxes or early withdrawal penalties or have to pay exorbitant interest rates associated with traditional bank lending.

ROBS is a complex strategy that can be made simple and even easy with the right support and guidance. Though the initial transaction may appear straight forward, as seen in our 8-step guide, what is often overlooked are the nuanced Internal Revenue Service (IRS) and Department of Labor (DOL) requirements that apply not only to the setup of the strategy but also to the ongoing administration of the strategy, including the required Corporation and retirement plan (e.g. 401(k) Plan).

The real challenge that most business owners who engage in the ROBS business financing strategy face is, of course, compliance issues and regulatory requirements. Here we will shed some light on the 4 most common compliance issues that we encounter from those who have engaged in the ROBS business financing strategy.

1) A second/subsequent Retirement Plan is set up for employees (oftentimes with Paychex or ADP)

Setting up a second retirement plan (e.g. 401(k), SEP/Simple IRA) generally results in compliance issues and regulatory violations as well as additional unnecessary costs. We often take on clients who have unwittingly established another retirement plan at the direction of their financial advisor or a payroll company that sells retirement plans, like Paychex or ADP.

This is a situation that we too often see where a business owner established a 401(k) Plan to engage in the ROBS strategy, but then inadvertently sets up a second retirement plan for her/his employees. This results in unnecessary additional fees and can also create compliance issues. We often see the original 401(k) Plan used with the ROBS transaction but not offered to employees of the Corporation (or subsidiaries). Failure to offer the original 401(k) Plan usually results in a prohibited transaction. By not offering the initial 401(k) Plan that provides access to the Qualified Employee Securities (QES/private stock) to employees, the employees are essentially being denied benefits they are entitled to, pursuant to federal regulations.

Furthermore, the business owner also ends up paying for and into multiple retirement plans when they only needed one, not to mention the aggregated testing that may be required between the retirement plans, which would result in additional work and costs for the business

2) The Plan that engaged in the ROBS strategy is not offered to employees of the corporation and the business owner has no support, information, or idea on how to do that.

A 401(k) Plan that has been set up and utilized to engage in the ROBS business financing strategy is subject to an abundance of ongoing compliance and regulatory requirements. These requirements are new for most business owners and can be confusing and hard to understand. Beyond the initial ROBS transaction and business financing, a ROBS business owner typically has little to no support moving forward, and most are unsure of how to manage the benefit that is the retirement plan. Here are some basic questions business owners have had about their ROBS strategy:

Q: Do I have to offer the Plan to my employees and allow them to contribute compensation?

A: Yes, you do. It’s required by federal law. A 401(k) or other type of retirement plan that is used to engage in the ROBS business financing strategy must be offered to all eligible employees of the company, both current and future. One of the more challenging steps for a business/owner is to determine 1) when an employee will be eligible for the plan; and 2) which retirement plan benefits is each employee eligible for.

Q: Do I need to offer my employees a chance to invest their retirement monies into Corporation as well?

A: It depends on timing and how your retirement plan is designed. Again, the ROBS business financing strategy is complex with many moving parts so we recommend discussing your priorities and goals with a ROBS expert and ensuring that the retirement plan is designed to meet your priorities and goals .

Q: When should you offer the Plan to your employees?

A: There is no single answer for this question because of the variables involved. It depends on a number of factors, including:

  • the type of retirement plan,
  • whether your employee(s) have met the service and age requirements detailed in your retirement plan (a legally binding document), and
  • if there is a predetermined waiting period for new employees.

Q: What notice(s) must you provide your employees about the retirement plan?

A: When you hire an employee and as you near the time when the employee would be eligible for the plan, federal regulations require that you provide your employees with certain notices about the retirement plan, including:

  • Participant Notices: which are notices the employee receives letting them know that the retirement plan exists, and they have the right to enroll in it. There may also be other possible notices required as well depending on how the retirement plan is designed.
  • Summary Plan Description: this document communicates to the employee that there is a plan, when they’re entitled to enter the plan and what benefits they’re entitled to.

We have seen it many times where at some point during the initial ROBS transaction, a business owner will come to believe that the retirement plan does not have to be offered to employees beyond the owner. This, of course, is not true and leads to a cascade of compliance issues, which if left uncorrected and discovered by the IRS or the DOL, will likely result in hefty taxes and penalties. The unfortunate thing is that these are issues that can be easily remedied by professionals. However, many business owners try to manage the retirement plan themselves with little understanding how to do so and with no direction at all from the individual/company that set up the ROBS strategy in the first place.

We’ve helped many clients get back on track with our consulting and correction services and even go on to take care of the government reporting for them so they can focus on more important things, like building their business.

See the 4 Most Common ROBS Questions Answered!

3) You did not file the required IRS Form 5500 for your retirement plan with the Department of Labor (DOL) and Internal Revenue Service (IRS)

Many business owners who have engaged in a ROBS strategy are not familiar with the unique requirements of IRS Form 5500 (the information/tax return required of their retirement plan). They don’t have the support or knowledge of how to go about completing and filing it or believe they are exempt from filing it altogether.

ALL business owners who are currently engaged in a ROBS strategy must file IRS Form 5500.

IRS Form 5500 is a single tax form considered an informational return because you’re reporting activities and information about the retirement plan but not submitting a tax payment (since retirement plans are tax deferred/savings plans). CPAs generally do not prepare/file IRS Form 5500 as regulations require additional financial and plan valuation reporting that most CPAs don’t offer.

IRS Form 5500 is also unique because it is initially filed with the Department of Labor (DOL) even though the form is called an “IRS” Form. The DOL will then file it with the IRS on your behalf. Failure to file IRS Form 5500 results in a $750 late penalty per year, immediately due, no excuses, no extensions.

This is a big and surprisingly common compliance violation with the ROBS strategy. Often, we encounter clients that have worked with a ROBS provider or their own CPA and are informed that they are exempt from filing Form 5500, because their company meets the following conditions:

  • If the assets/money in the plan is valued under $250,000; and
  • If the 401(k) Plan has no eligible employees beyond the owner.

However, here’s the big, and I mean BIG, caveat to this exemption that most CPAs and even some ROBS providers are not aware of. If there is an asset in your retirement plan that is hard to value (like the private stock of your C-Corporation) or are not easily tradeable, you are subject to filing IRS Form 5500.

Under current regulations and guidance, privately held stock in a Corporation is considered hard to value or a nontraditional asset. Because all ROBS strategies involve privately held stock in the C-Corporation, the result is that every ROBS client in the country is required to file IRS Form 5500. There is no exception to this requirement! If a ROBS Provider or CPA tells you otherwise, please send them to us.

4) You’ve decided to convert from a C-Corporation to an S-Corporation or you’re restructuring your Corporation because of an acquisition or merger

Conversions: One of the foundational requirements of the ROBS business financing strategy is that if a qualified retirement plan (e.g. 401(k) Plan) invests money into a Corporation, taking stock in return (and becoming a shareholder/owner), that company must report as a C-corporation to the federal government. Once you have engaged in the ROBS business financing strategy, you must maintain your Corporation as a “C-Corporation,” until such time as the Corporation buys all of its stock back from the 401(k) Plan.

Most CPAs, however, are not familiar with the unique regulations related to the ROBS business financing strategy, which requires that the corporation retain its “C” status so long as the 401(k) Plan is a shareholder. We typically have seen the conversion from a C-corp. to an S-corp. as a recommendation that comes directly from the business owner’s CPA. CPAs will say to the business owner that “your business is small, and you don’t want to be subject to double taxation. You need to convert into an S-corp. Immediately!” If you follow the CPA’s recommendation and convert your Corporation from “C” to “S” status you are committing a prohibited transaction, making your entire 401(k) Plan taxable with IRS early withdrawal penalties. Furthermore, the Department of Labor can even pursue a fiduciary breach against you.

However, there is still a way to convert to an S-corporation if you’re inclined to do so. Basically, you will have to exit the ROBS business financing strategy . There are a few common strategies that allow you to exit the ROBS strategy. Regardless of the strategy you select, you will need to accomplish a full buy-back of the corporate stock (also known as a stock redemption) or distribute the stock in-kind to an owner other than the 401(k) Plan.

There are also various ways you can get money into the Corporation to buy back the stock, and once the stock is bought back from the 401(k) Plan you can then convert to S-Corporation status or even an LLC. You can then either terminate the Retirement Plan or maintain the Plan so you can continue to use it for additional business financing, retirement savings or even tax reductions.

Mergers & Acquisitions: If you are contemplating a merger or acquisition it’s important that you coordinate employee benefits, like the 401(k) Plan, between the two (or more) companies. The 401(k) Plan that is engaged in the ROBS business financing strategy must always get the benefit of any bargain, as required by federal regulations. So, before a merger or acquisition can happen there first needs to be a valuation of the C-Corporation stock. The corporate stock must be properly valued and paid for by the incoming company, it cannot just be given away.

The ROBS business financing strategy can be an excellent resource for businesses, however, there are compliance pitfalls that you need to be aware of and unless you wish to negotiate, on your own, the complex and varied governing regulations, it is often preferred to leave ROBS compliance in the hands of a professional. Leading Retirement Solutions and its highly credentialed team are experts in administering 401(k) Plans that are engaged in the ROBS business financing strategy. We take the stress out of employer and employee benefits by taking on the responsibility for you, making sure you stay compliant.

  • Have employees? We can help with traditional investment options (such as mutual funds, target date funds, etc.), enrollment forms, comprehensive enrollment kits, payroll contributions and so much more.
  • Are you a business owner that needs help with tax reduction, retirement savings or employee attraction and retention? Or, do you need help with your exit strategy? We can help with that also!
  • We go above and beyond to engage clients in filing form 5500 to avoid DOL penalties. Beyond talking about it throughout the year and email communications, we also make regular phone calls to our clients as each deadline approaches, all to make sure you remain compliant.

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

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