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Saturday, December 06, 2008


Many taxpayers have funds in IRA accounts. If they want to use the funds for a business venture, a distribution of the funds is needed. Such distributions are generally taxable, and if the owner is not old enough, a 10% penalty tax to boot is imposed.

Some taxpayers have been using a special route to accessing these funds without current income taxes. It generally involves forming a new business corporation, establishing a 401(k) plan for the business that allows for investment in employer securities, rolling over the IRA funds (or other funds from a prior employer qualified plan) to the new 401(k) plan, and then using the funds to acquire stock in the new business. By transferring cash for stock in the new business, the corporation receives capital it can use for its business.

On its face, there is nothing illegitimate about such an arrangement – it makes use of legitimate provisions of the tax laws, including the roll-over rules and the ability of certain plans to own employer securities. In practice, some of those that have used such arrangements may not have been strictly following all required retirement plan rules and regulations, so those taxpayers who have not done so may be vulnerable to attack. From an overall policy standpoint, one can speculate that such use of IRA funds is beneficial, since the funds are being put to use in job creation business development activities.

Of course, since it has the “appearance” of use of IRA funds that circumvents the taxable distribution rules, one would expect the government to be bothered by such use. Such expectations have been borne out – the IRS has issued a Memorandum for the directors  of the Employee Plans Examinations division and the Employee Plans Rulings & Agreements division expressing hostility to these arrangements and areas for attack. Indeed, the IRS has adopted the acronym “ROBS” for these rollover to business start-up arrangements. This acronym speaks volumes about the IRS’ attitude towards them.

Possible lines of attack described in the Memorandum include purported violation of antidiscrimination provisions and prohibited transactions relating to deficient valuation of the stock received in the transaction by the plan and payment of promoter fees. The Memorandum also addresses statute of limitations issues since many of these transactions done in the past are close to the expiration of the applicable limitations periods.

There are several promoters out there that seek to educate and assist taxpayers with these types of transactions. Before undertaking them, taxpayers or their advisors should familiarize themselves with the issues raised by the Memorandum.

Memorandum of Michael D. Julianelle, October 1, 2008 (

1 comment:

Anonymous said...

Thank you for your analysis. The recent Business Week article that validated this type of set-up and their promoters was single sided and lacking in any real thought or insight. I go so far as saying that the author was even reckless in his disregard of basic fact-checking. Not once did he mention or allude to any potential pitfalls of this type of arrangement. I am sure many people will jump on this band wagon because they read about it in Business Week. I am glad to have your analysis for balance.