In previous newsletters, we have introduced the concept of Rollovers for Business Startup (ROBS), a strategy whereby existing accumulations in qualified retirement plans or IRAs are used as the source of financing business acquisition and startup. The IRS acknowledges that the ROBS strategy is not an abusive tax avoidance transaction and may work as a legitimate tax planning tactic, but cautions that it is questionable and must be assessed on a case-by-case basis.
The general process involves the creation of a new corporation that implements a qualified profit sharing plan or 401(k) plan that allows participants to direct the investment of their accounts in employer stock. The individual forming the new corporation becomes an employee of that entity and enrolls in the plan. He then rolls to the new plan funds that he has accumulated in his personal IRA or in another employer-sponsored retirement plan and directs that his account balance in the new plan be used to purchase employer stock. Finally, the new corporation uses the proceeds of the stock sale to begin the business enterprise.
Rollover for Business Startup can be used as an effective and highly successful strategy when properly structured and implemented. However, the frequency with which the formalities are disregarded or short-changed only encourages the IRS to view these transactions as suspect. Consider these two recent examples:
In Fleming Cardiovascular, P.A. v. Commissioner, decided November 23, 2015, the United States Tax Court issued a declaratory judgment that the IRS had not abused its discretion in revoking the tax qualified status of an employee stock ownership plan created through a ROBS transaction. In addition to the many problems with the operation of the ESOP itself (including failure to obtain independent certified appraisals of the stock, failure to make recurring and substantial employer contributions and allowing individuals who had not yet satisfied the eligibility requirements to participate), the largest issue was the defective rollover. Dr. Fleming had taken distribution from his IRA and remitted the funds to the new corporation in exchange for employer stock to be held in his account in the ESOP. However, the ESOP never established a bank or brokerage account as the interim depository for those funds, so there was no evidence of the receipt of a valid rollover from the individual or his IRA custodian.
Powell v. U.S., the Court of Federal Claims, a decision issued on March 15, 2016, rejected the taxpayers' argument that withdrawals from their IRAs were nontaxable distributions rolled to another retirement account through a ROBS transaction. The taxpayers conceded that, while they had a business plan concerning the real estate purchased with the IRA distributions, there was no written document evidencing the existence of a plan through which the investment was made. Ultimately, the real estate investments were transferred to a corporation, but because that corporation did not exist when the IRA distributions were taken, few if any of the steps required for a valid ROBS transaction were taken.
ROBS transactions have been used successfully countless times, but they continue to be scrutinized by the IRS. Periodic reports of disqualified plans and denial of rollover treatment serve as a reminder that to be successful, one must carefully observe all formalities and adhere strictly to all technical requirements.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
