ROBS Prohibited Transactions
How to Spot Red Flags and Protect Your Tax Benefits
Using a Rollover as Business Startups (ROBS) plan can be a valuable way for small businesses to secure initial funding. It allows entrepreneurs to utilize their retirement accounts to launch or grow a business without incurring income tax or early withdrawal penalties. However, ROBS comes with strict rules under ERISA and IRS laws and regulations. If you engage in a prohibited transaction (unknowingly or not), the benefits of your ROBS can quickly evaporate with tax penalties that negatively impact your bottom line.
This guide will walk you through common prohibited transactions, how to spot them, and why avoiding these missteps is critical for safeguarding your tax benefits and keeping your business operation compliant.
What Are Prohibited Transactions in a ROBS Plan?
A prohibited transaction occurs when actions involving your ROBS plan violate the rules set by the IRS and Department of Labor. These rules are in place to ensure fairness and that all plan participants benefit equally from the arrangement. Actions like improperly using plan funds for personal gain or failing to ensure fair corporate stock valuations can lead to expensive consequences.
Violations can trigger hefty excise taxes and reversal of transactions, which could be a huge drag on your 401(k) plan strategy. It’s essential to involve a trusted tax professional to help you stay within these guardrails.
Common Prohibited Transactions
Understanding the frequent mistakes made by ROBS users can help small business owners avoid costly errors. Below are some typical examples of red flags to watch for in your business operation:
1. Using the Plan NOT as a Retirement Investment but for Your Personal Outside Gain
The investment by the ROBS plan into the corporation must be for business operating expenses. A common Prohibited Transaction (PT) is using corporate money in ways that improperly benefit you personally. Examples include:
Using corporate funds for personal expenses unrelated to the business, e.g. to buy a personal car or house.
Borrowing money (even for a short term!) from your C Corporation for personal use.
2. Incorrect Corporate Stock Valuations
Your C Corporation must value employer stock at fair market value, most effectively by getting a professional third-party appraisal. Neglecting to get valuations for stock transactions opens the door to accusations of abuse and prohibited transactions.
3. Non-Arm’s-Length Transactions
You are permitted to receive W-2 wages from the C corporation. But excessive compensation or using corporate funds to finance an outside investment for yourself or a family member can raise compliance concerns. Consider the following examples:
Joint ownership of real estate that is not used for the operating purpose of the corporation.
Joint ownership of another entity that is not for the operating purposes of the corporation.
These are just a few examples, but the takeaway is clear—any transaction involving your ROBS plan that isn’t impartial and by the book could spell trouble. Want to know more red flags to look out for? Subscribe to our website to learn how to recognize and avoid potential violations that can save your business from penalties, disqualification, and personal financial loss.