ROBS transactions: the Department of Labor and IRS Regulation

Brian Weinstock

By Brian Weinstock

Recently, the Department of Labor advised that they are in the process of developing information to provide direction for Rollovers as Business Start-ups known by the IRS as ROBS transactions.

The IRS issued a memorandum on October 1, 2008 warning about potential pitfalls for ROBS transactions particularly related to prohibited transactions. Moreover, the Department of Labor and the IRS have indicated that a large percentage of ROBS transactions do not comply with federal rules and regulations with regard to tax-deferred retirement plans such as qualified 401k plans and IRAs.

According to Louis Campagna, Chief of the Fiduciary Interpretations Division for the Department of Labor’s Employee Benefits Security Administration, the direction being produced by his department shall address the Department of Labor’s apprehension with regard to ROBS transactions initiated with rollovers from employer sponsored qualified plans and individual retirement accounts, such as 401k plans and IRAs, in order to allow a professional to assess whether the ROBS transaction could be a prohibited transaction.

The Department of Labor is concerned with the employer’s intent when the ROBS transaction is initiated.

Specifically, the Department of Labor needs to determine whether the ROBS transaction was initiated to implement a lawful way for employees to save money for retirement or is the ROBS transaction being used to shelter income for taxpayers who want to start a business or capitalize an existing business. The latter would allow for the taxpayer to withdraw funds from the C-corporation with the 401k plan for reasons unrelated to the business. If so, the taxpayer could withdraw funds, which where designated as tax-deferred, before they are allowed to be withdrawn tax free.

The IRS has their own concerns with ROBS transactions such as the valuation of the transaction and their compliance with other rules for qualified retirement plans which invest in employer stock, therefore the IRS may publish their own memorandum with respect to the issues they have concerning ROBS transactions.

Besides the complex rules and regulations governing prohibited transactions, another major concern for the IRS is the ability to “unwind” ROBS transactions which have violated IRS rules and regulations for qualified retirement plans. If a 401k plan participates in a prohibited transaction, the entire 401k plan loses its tax deferred status. Therefore, the entire 401k becomes taxable. Another major issue is deterioration of the initial ROBS valuation. Many small to medium size business holders remove cash from the entity for reasons unrelated to the business. This type of action can cause a decrease in the initial value of the ROBS transaction and violate prohibited transaction rules and regulations.

Time is of the essence with respect to hiring a professional to review your ROBS transaction in order to determine if there have been any violations of federal rules and regulations, such as prohibited transactions. The IRS has a self-correction program for 401ks which taxpayers can take advantage of before an IRS examination.

One Response to “ROBS transactions: the Department of Labor and IRS Regulation”

  1. Ed on July 29, 2010 8:47 pm

    Wouldn’t the assignment of an independent trustee (e.g. instition, bank, etc)of the 401K plan help the employer establish a legitimate investment option for not only the owner’s retirement funds but those of the employees?

    From a public policy perspective – and perhaps national security if we consider more deeply the broader implications – it seems we need the governments’ help in creating a safe, legitimate, and competitive alternative to the existing investment options now available to “employees”.

    The traditional plans and investment options have clearly become highly coveted and guarded options – apparently driven by interests that supersede those of the contributing employees and trust.

    Shouldn’t we consider a fair and reasonable investment options that compete against traditional “legitimate” pre-tax retirement fund options where management costs ultimately source prohibitive bonuses, office furniture, high-cost/rent office locations and leases, ponzi schemes etc.

    I’m truly concerned that the recent backlash against alternative investment options, including ROBS, is more about the redirection of employee wealth and less about employee welfare and security – and national, state, and local welfare for that matter since the public is in fact bailing out the banks and firms that promoted or facilitated the public fraud as opposed to those that fell victim to it. This is leaving governments short of cash with far reaching implications.

    These issues and topics are not incongruent. And my point is we should find a way to clean up the ambiguity and allow investments that benefit the public – even if the initiator is one of them!!!

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