Be Careful If ROBS Is Your Business Financing Strategy

by Stinson Leonard Street - Employee Benefits & Compensation

Various promoters have suggested to entrepreneurs that they use the assets in their 401(k) plans or IRAs to finance a new business. These programs are sometimes known by the acronym ROBS, or Rollovers as Business Start-ups. The basic structure involves the entrepreneur’s rollover from a prior employer of the amount in his or her qualified plan to an IRA or a 401(k) plan to be established by the new business. The IRA or qualified plan then uses the rollover money to purchase the business, such as a franchise operation. The IRS has cautioned taxpayers that there are many requirements that must be met for this structure to work and also emphasizes that it is risky for business owners to invest all their retirement savings in a start-up business since new businesses fail at a high rate and any failure will result in the loss of both the business and the employee’s retirement assets.

A recent tax court opinion highlights the importance of meeting all legal requirements with these arrangements. The tax court decision involved two individuals who formed a corporation and directed their IRAs to use amounts rolled over from a prior employer’s plan to purchase 100% of the corporation’s newly issued stock. The cash was then used to purchase the assets of a business. The cash in the IRAs was not sufficient to finance the transaction so the company borrowed money from various sources, one of which was a note to the seller, personally guaranteed by the individuals whose IRAs owned the stock of the company. After the transaction was complete, the individuals owned the IRAs and the IRAs owned 100% of the stock of an employer that was now operating a business. The business owed money to the seller of the assets used in the business and the individual IRA owners had personally guaranteed that debt.

The individuals later converted their IRAs from traditional IRAs to Roth IRAs. The business was sold a few years later and the individuals assumed that the gain on the sale would be tax free when received by the Roth IRAs and tax free when distributed to the individuals who owned the Roth IRAs. (If appropriate holding periods are met, amounts distributed from Roth IRAs are not subject to income tax.)

The IRS challenged the tax treatment, claiming that the personal guarantees by the IRA owners of the note to the seller constituted an indirect loan to the IRA itself. Under the tax code, any extension of credit “directly or indirectly” between an IRA and its owner constitutes what is known as a prohibited transaction. An IRA that engages in a prohibited transaction is treated as having lost its IRA status in the year in which the transaction occurs. The IRS claimed that the IRAs lost their status as tax free IRAs in the year in which the personal guarantees were given and that that status continued for every year in which the personal guarantees remained outstanding. Thus, at the time the business was sold, the IRAs no longer qualified as IRAs and the owners of the IRAs had to recognize the capital gain incurred on the sale.

In addition to having to pay the capital gains taxes, the owners were also hit with penalties for failure to properly report their income. The owners claimed that they relied upon their business advisors regarding the structure of the transaction and the appropriate tax treatment. The IRS noted that the promotional materials from the advisor warned the owners to avoid engaging in prohibited transactions with their IRAs. The tax court noted that the owners did not discuss the personal guarantees with the advisor and in any case the advisor was the promoter of the arrangement so was not an independent advisor upon whose advice the owners could rely to avoid penalties.

ROBS can also be structured using a rollover to the 401(k) plan of the new business. Those arrangements too are subject to the prohibited transaction rules. With 401(k) plans, however, instead of the plan losing its tax exempt status, those responsible for the prohibited transaction are required to pay excise taxes. The amount of the excise tax is 15% of the amount involved for each year or part of a year that a prohibited transaction is not corrected. Ultimately, an uncorrected prohibited transaction can be subject to a 100% excise tax.

Taxpayers wanting to use their qualified plan or IRA assets to fund a new business must be especially careful in arranging financing for that new business. In light of this case, taxpayers may need to avoid personal guarantees of additional funding sources. Taxpayers should work closely with qualified advisors and may find that a different source of financing is ultimately a better choice than a ROBS.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Stinson Leonard Street - Employee Benefits & Compensation | Attorney Advertising

Written by:

Stinson Leonard Street - Employee Benefits & Compensation

Stinson Leonard Street - Employee Benefits & Compensation on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.