ROBS: Starting a Business With Your 401(k) Money
How a rollover for business startups lets retirement funds buy a new company without tax or penalty, the structure it requires, and the ongoing obligations that make it fragile.
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
A rollover for business startups (ROBS) uses retirement savings to fund a new business without a taxable distribution: you form a C corporation, it adopts a 401(k) plan, you roll your retirement account into that plan, and the plan buys the corporation's stock. The structure is legal but demanding, and errors turn the whole rollover into a taxable distribution.
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How is it structured?
| Step | Requirement |
|---|---|
| 1. Form a C corporation | Must be a C corporation in practice; a 401(k) plan can legally own S corporation stock, but the S corporation's income would then be taxable to the plan as unrelated business income |
| 2. Adopt a 401(k) plan | A plan that allows investment in employer stock, offered to all eligible employees |
| 3. Roll over existing funds | From an IRA or former employer plan into the new plan — a direct rollover, not a distribution |
| 4. Plan buys stock | The plan purchases newly issued shares at fair value; the corporation receives the cash |
| 5. Operate | The owner works for the corporation and draws a reasonable salary; the plan is a shareholder |
What are the ongoing obligations?
- Employee coverage. Every eligible employee must be able to participate in the plan and invest in company stock on the same terms, subject to nondiscrimination testing.
- Annual Form 5500 filing for the plan — the IRS says the one-participant filing exception for plans under $250,000 does not apply to a ROBS plan, because the plan, not you, owns the business.
- A supportable valuation of the stock at every purchase or sale and each year for the plan's annual return; the IRS has flagged appraisals that simply match the rollover amount as a possible prohibited transaction.
- No personal use of plan assets. Using the funds for personal expenses, paying promoter fees out of plan money, or having the plan buy the stock for more than it is worth can be a prohibited transaction, with an excise tax of 15 percent, rising to 100 percent if not corrected.
- Stay a C corporation for as long as the plan holds stock, with the double taxation that implies.
- Salary must be reasonable — the IRS watches for owners who pay themselves generously from plan-funded capital.
What are the risks?
The IRS opened a ROBS compliance project in 2009 and calls these arrangements questionable, though not abusive tax avoidance transactions; it found most ROBS businesses either failed or were on the road to failure. Operational failures can disqualify the plan, with adverse tax consequences for the company and for you as a participant — potentially including tax on the rolled-over savings and, before 59½, the 10 percent additional tax — and prohibited transactions carry their own excise taxes. Promoters charge setup and annual fees. And if the business fails, the retirement savings are gone — the structure removes the protection a retirement account would otherwise have from business creditors.
When does it make sense?
For an owner with substantial retirement savings, a business that needs capital it cannot borrow, and the discipline to run a corporation with a plan sponsor's obligations. For smaller needs, a 401(k) loan, if the plan offers one (generally the lesser of $50,000 or half the vested balance, repaid within five years) is simpler and keeps the account intact.
Frequently asked questions
Can I use an IRA directly to buy my company?
Not in a workable way. When an IRA-owned company pays the IRA owner a salary, that is a prohibited transaction (Ellis v. Commissioner, 787 F.3d 1213 (8th Cir. 2015)); a 401(k) plan's exemption for buying employer stock for adequate consideration is what makes a ROBS possible.
Can the company be an LLC?
Only if it elects to be taxed as a C corporation and issues stock-like interests the plan can hold; in practice, ROBS arrangements are generally set up with a C corporation.
What happens when I sell the business?
The plan sells its shares and receives its share of the proceeds, tax-deferred; the owner's personal shares are taxed normally.
Can I take a salary from day one?
A reasonable salary for services actually performed is fine; paying yourself out of the rollover capital without work is the problem.
Official sources
The IRS explains: “Results from the ROBS Project indicated that, although there were some success stories, most ROBS businesses either failed or were on the road to failure with high rates of bankruptcy (business and personal), liens (business and personal), and corporate dissolutions by individual Secretaries of State.” — Internal Revenue Service, Rollovers as business start-ups compliance project, https://www.irs.gov/retirement-plans/rollovers-as-business-start-ups-compliance-project
The IRS explains: “The individual then executes either a rollover or direct trustee-to-trustee transfer of the proceeds from the available tax-deferred investment account into this newly created plan.” — Internal Revenue Service, Guidelines regarding rollovers as business start-ups, https://www.irs.gov/pub/irs-tege/robs_guidelines.pdf
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. Our U.S. Tax Desk reviews the plan documents and valuation before retirement money is committed. See pricing or book a free fit call.
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