Hi, let’s talk about ROBS plans and what they are, what the pros and cons are. First ROBS, some people think ROBS means you are robbing your 401k to produce an investment into a business. However, that’s not really what ROBS stands for.
ROBS stands for a Rollover Business Startup. Now, this is a way of taking money out of a 401k plan and investing it into the purchase of a business. Now that may sound like a great thing, but you need to be aware of all of the pros and cons and how this will work. So in buying a business, rather than using traditional financing, a ROBS plan is about taking the money out of a 401k plan and investing it into that business.
To do this it’s not just a matter of writing a check or pulling money out of a 401k. You’ll need to have a third-party administrator help you with this. It is by far not a do-it-yourself project. We work with a lot of companies that utilize ROBS plans. The most popular third-party administrator is Guidant financial. They help a lot of people in and structuring businesses and business purchases using 401k and retirement dollars.
With a 401k administrator like this, you will need to have some extra reporting and extra guidelines that you wouldn’t normally have. The extra reporting is the annual form 5500 for a retirement plan that is produced through the guidelines of ERISA and sent in to the department of labor each year. That is not a function of the IRS. So this is not inclusive of any of the accounting and tax work that would normally need to be done. Guidant will help you file that form 5500 each year. You’ll also have a strict set of rules that you’ll need to follow in your investments.
There are things that you cannot do with a ROBS plan, however, you can’t break off arms of the business and operate it separately, and it must be operated as a C-Corp structure. Now, as a C-Corp, you’ll have a whole different set of tax consequences than most small businesses. Most small businesses operate under a flow-through structure that takes the income of the business and passes it through to appear and be taxed as personal income.
You would be filing a C-Corp, which is means you’d pay under corporate tax rates. Currently, those aren’t that bad, but there are talks in the works of moving those rates up. So that would definitely have a drastic effect on the C-corporation structure. You’ll also need to be very careful about how you take money out of that business. You must be an employee of the business and receive a W-2 and a paycheck.
Now, the timing of that can be a little more flexible to help you with the ownership of the business and the cash flow needs of the business. However, it must be on payroll. If you take out funds in any other way, shape, or form, they’re going to go through the process of double taxation. So dividends, for example, are not tax deductions. When a C-Corp pays those out and the owner must pay taxes on receiving them. So there are a lot of things you’ll need to watch for and plan for. So working with a solid accountant is a must when dealing with a ROBS plan. You’ll also need to be very aware of how this structure works from a cost perspective. It is definitely more costly to do the ROBS plan. Initially, it will take about $5,000 to $8,000 for Guidant to get all of this setup.
You’ll also have ongoing monthly fees of about $150 a month in perpetuity until the entity does not exist any longer under a ROBS plan, you’ll have those fees. So it is a very costly way to operate, but many, many people have said, if that’s the only way I can do it, it’s still worth it. And that’s okay. We just need to know what the risks are and what the pros and cons are.
Now, there is a way to exit ROBS structure, but there are quite a few hopes to jump through. We have successfully helped people, exit ROBS structures to get out from under all of the requirements, but it takes a lot of planning also. So in order to utilize a ROBS plan to purchase a business, you need to be aware of the extra hoops you’ll need to jump through. Again, it is not a process where you kind of throw a business together and hope it all works. There are a lot of rules you must follow, and you may not leave that to chance. Your worst-case scenario is that the IRS says you did something wrong and that the entire amount of money that you took out for the ROBS plan to fund the business is taxable, with a penalty and early penalty for early distributions.
So it’s not so the thing you wanna mess around with, if you were considering purchasing a business with a ROBS plan, I’d love to have the chance to talk with you before you make that final decision. We can also help with a financial analysis to look at traditional financing or other arrangements, including distribution from the 401k or IRA, and help you decide what the long-term of the business looks like and what’s best for your future.
I’m Donna Bordeaux with PYOPAccounting.com. Please follow us on Facebook and Instagram. Make sure you check out our blog and our website from the link below. Subscribe to our YouTube channel and hit the bell to be notified when we post. To contact me, email me at email@example.com.
Donna Bordeaux, CPA with PYOPAccounting.com
Creativity and CPAs don’t generally go together. Most people think of CPAs as nerdy accountants who can’t talk with people. Well, it’s time to break that stereotype. Lively, friendly, and knowledgeable can be a part of your relationship with your CPA as demonstrated by Donna and Chad Bordeaux. They have over 50 years of combined experience as entrepreneurial CPAs. They’ve owned businesses and helped business owners exceed their wildest dreams. They have been able to help businesses earn many times more profit than the average business in the same industry and are passionate about helping industries that help families build great memories.