Using funds to start firm brings look

January 7, 2011
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Companies that promote the use of IRA or qualified retirement plan money to start a business may lead you to believe they’ve come up with a novel and safe way to do so at a favorable price. However, all they’ve really done is develop an enticing method of marketing a legal strategy that’s been around for a long time but now carries more risk than ever because of increasing scrutiny from the IRS.

There are still situations in which using qualified money to start a business makes sense, but you must pay close attention to the rules and be aware of the drawbacks of using one of the companies promoting these arrangements on the Internet.

There are a few situations in which you may be permitted to invest your IRA in a business in which you have some interest as an owner or employee, but they’re rare. A qualified retirement plan, on the other hand, may invest in the stock of a C corporation (not an S corporation, partnership or limited liability company), even if one or more participants in the plan is also an owner and/or employee of the C corporation (including management employees).

Consequently, if you’re in a qualified plan or have an IRA with a significant balance, you may be able to incorporate a new business as a C corporation, establish a new plan for the employees of the new business, roll your IRA or qualified plan money into the new plan, and use the rollover money to purchase stock in the new business.  The corporation can then use the money to operate the business.

The laws permitting these arrangements have been in effect for more than 15 years. However, the economic downturn, coupled with the tight lending restrictions being imposed by most financial institutions, have generated a surge of interest in them. As might be expected, this has in turn spurred the IRS to issue a memorandum raising concerns with the way a number of the arrangements have been promoted and structured. The IRS now refers to them as ROBS, or Rollovers for Business Startups.

The IRS has raised two main concerns. The first is whether the purchase of stock by the plan is a prohibited transaction under the Internal Revenue code because the stock was not properly valued before the sale. If the IRS successfully asserts this against an employer, a significant excise tax will apply. The second, which comes into play if the business owner is the only participant whose account is invested in employer stock, is whether the plan violates the nondiscrimination requirements of the code.

Although the concerns are valid, the purchase of employer stock by a qualified plan can usually be structured so as to comply with the requirements of the code. Further, although the IRS seems to be biased against the creation of retirement plans to allow business start-ups (because it does not believe the tax break for retirement savings was intended to be used for this purpose), considering the current unemployment rate and the need for start-up capital to create jobs, any IRS challenge to a properly designed arrangement would not be a good use of limited government resources.

If you’re interested in pursuing this option, be aware that the companies promoting these arrangements on the Internet may not be the best providers of the advice and documents you’ll need to establish the corporation and plan and complete the rollover and stock purchase. Many of these promoters guarantee they’ll defend their clients from attack by the IRS, but the fine print of the guarantee will be riddled with loopholes, generally leaving you and the plan participants unprotected. In addition, the promoters will likely charge you as much as or more than you’d pay an experienced employee benefits attorney, along with your corporate attorney, to do the job better. 

Frank E. Berrodin is an employee benefits and executive compensation attorney in Miller Johnson’s Grand Rapids office. He can be reached at or (616) 831-1769.

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