The implementation of advanced planning strategies is to: (1) reduce or eliminate capital gains tax; (2) reduce future estate tax; and (3) increase asset protection from creditors and lawsuits should be on every founder, owner, and investor’s mind. All strategies revolve around time and the amount of equity ownership an employee or investor has in the company. The most relied upon considerations to keep in mind while envisioning planning strategies— to save money on taxes in the long-run are:
- What stage is the company in its life cycle?
- What is the value of your shares?
- What are your current and future wants and needs?
What is QSBS?
Qualified Small Business Stock (QSBS) provides for up to a 100% exclusion of Capital Gains taxes. The QSBS regulations are located in Internal Revenue Code (IRC) Section 1202 and include criteria for both the corporation to qualify as a Qualified Small Business and criteria for the investor to determine how much of their gain may be eligible for tax exclusion.
What is ROBS?
A Rollover as Business Start-Up (ROBS) allows taxpayers who wish to own a business to wield their retirement savings as funding to start their business and associated start-up costs. The funds rolled over from the retirement fund are used tax-free in order to purchase stock in the newly formed C-Corp. This type of arrangement solely benefits the owner of the retirement fund and the business.
Benefits of ROBS
The primary benefit of a ROBS is that it gives entrepreneurs an alternative avenue to finance their dream business. Often, lenders require founders to have strong personal credit scores and generous cash flow and/or tangible collateral in order to be approved for loans. Additionally, this work around for capital means the business is not in debt to a lender since it is the founder’s own money that is rolled from his or her 401k into shares of the C-Corp.
Typically, when someone withdraws funds from their retirement account prior to turning 59 ½, they will get hit with penalties that can add up. ROBS avoid these penalties with the direct rollover into the business.
Troubles Accompanying ROBS
There has not been a high percentage of successful businesses to come out of the ROBS project which sadly means not only a loss of the business for the individual but also a loss of retirement savings. There are also complicated filing requirements for ROBS which exempt filing for some but require for others who surpass a certain asset threshold.
Other negatives associated with ROBS include promoter fees, valuation of assets, and failure to file correctly or issue correct forms to shareholders.
Are ROBS Risky for QSBS?
Typically, after the sponsor of the ROBS purchases employer stock in the newly-formed C-Corp, they will amend the plan so others aren’t able to purchase stock. If others aren’t able to purchase stock then Section 1202 is irrelevant. The amending of the plan can possibly violate Code qualification requirements and can present problems with coverage, discrimination and ultimately could result in benefit, rights, and requirement violations. Moreover, the individual implementing the ROBS will more than likely not be able to qualify for QSBS, even if the company the investor rolled over into was incorporated as a C-Corp.
Learn more about ways to “rollover” into a business so your QSBS remains satisfied here.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.