September 30, 2022
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Self-Directed IRA (“SDIRA”) vs. Rollover as Business Start-Ups (“ROBS”)

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Are you looking for ways to employ your retirement assets in a start-up business? There are two options: a self-directed individual retirement arrangement (“SDIRA”) and a rollover as business start-ups (“ROBS”). Both options allow you to put 100% of your retirement assets to work. In other words, for those with deferred tax accounts, there is no dilution from early withdrawal penalties or taxes that need to be paid upon a distribution. The investment strategy used in these two options does not involve distributions that would require a tax being paid. However, the circumstances in which each of these two options can be used are very different.

Those of you who’ve read my previous blogs and articles know that SDIRAs are an investment vehicle that is more passive in nature. So, if you are investing in a privately held existing or start-up business, you’re prohibited from being active in the business. You cannot draw a salary. In fact, the IRS lists several prohibited transactions that you and certain related persons or entities cannot participate in with respect to the business in which your SDIRA invests. For those looking for that type of investment, these circumstances might be right for you.

On the other hand, if being active and in control of a small business start-up is something that is of interest to you, the ROBS option may appeal to you. In fact, for the ROBS option to work, you must be involved as a bona fide employee and be paid a reasonable salary once the business starts generating revenue. The primary guidance listed by the IRS on its website is a memorandum issued in October 2008 by Michael D. Julianelle, Director of Employee Plans at the IRS. Simply stated, ROBS work like this:

  1. Establish a C corporation. This entity cannot be an S corporation or Limited Liability Company.
  2. The shell C corporation sets up a qualified retirement account, usually a 401(k), that can invest in private stock.
  3. Rollover an existing retirement account—401(k), IRA, 403(b), etc.—into the new retirement plan. Roth and inherited IRAs do not qualify for this use. Under IRC Code Sec. 408(d)(3)(C)(ii), an IRA acquired by a beneficiary upon the death of someone other than a spouse is called an “inherited IRA” and requires the beneficiary to take mandatory distributions over a certain period.
  4. Have the new retirement plan invest in the stock of the C corporation.
  5. The C corporation can then use the newly acquired capital to start the business.

A few caveats when contemplating using a ROBS strategy:

  • Though the ROBS strategy is not classified as abusive, the IRS will review the initial setup and ongoing actions of the entity very closely. For this reason, it is highly recommended to consult with an experienced tax professional.
  • Make sure Form 1120 is filed for the entity and Form 5500 is filed for the retirement plan. The one-participant plan exception does not apply to the Form 5500 in this instance.
  • The new business should be careful to use capital only to start and maintain the business and should not purchase any assets that could be construed as non-business personal assets for the business owner.

From a practical standpoint, using retirement funds without the discount of taxes can be a viable alternative for those looking for capital to start a business. However, under the watchful eyes of the IRS, compliance is the key to ensuring success with this funding source.



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