You have worked for a few years and now have a sizeable 401(k) account. You have moved on from your former employer and might be thinking about starting an independent business, perhaps a franchise business. That can take a hefty personal investment. How about using your 401(k) retirement funds to start the new business?
You can peruse any number of websites, and they all advise how to do this so you can start your business “tax-free” and “debt-free”! And that sounds perfect – almost too good to be true. Is it?
The bottom line is that you can use your retirement assets from a prior employer or prior business to fund a new business venture. Here’s how: you first rollover retirement funds from an existing 401(k) account to a 401(k) plan that you set up in a new shell corporation (which should be a C corporation). Your rollover funds can then be used by the new 401(k) plan to purchase the stock of the shell corporation. Once the funds are paid to the corporation for its stock, the corporation can then use those funds to pay start-up expenses for the new business venture.
Whether you call this an “ERSOP” (not an IRS sanctioned arrangement) or something else, just bear in mind that the IRS calls it “ROBS” for “Rollovers as Business Start-ups.”
The IRS zeros in on two primary concerns it has with ROBS transactions. First, if the ROBS 401(k) plan is set up in a way that permits only the business owner to invest his 401(k) plan account in company stock, it may discriminate against any rank and file employees who qualify to participate in the plan. Second, the new 401(k) plan is prohibited by law from paying more for the shell corporation’s stock than the fair value of its business. Is a start-up franchise business, for example, really equal in initial value to the amount of its substantial up front franchise fee and other start-up costs – before it has generated even one dollar of revenue? Questionable, and remember it’s your burden to establish that value in the unfortunate event the IRS comes calling.
First, despite the blandishments of the many websites that promote ROBS transactions, it is advisable to establish the value of company stock through an independent appraisal before you sell it to your shell corporation. Remember, your plan is prohibited from paying even one cent more than what the business is worth.