Rollover As Business Startup and IRS Prohibited Transactions
In 2010, I wrote an article for the Michigan Business Law Journal called “Using Retirement Plan Assets to Fund a Startup Company.” A copy of the article can be found here, and it discusses many of the potential pitfalls that come with rolling over tax-qualified retirement plan assets to a new startup business that you own (commonly known as a “Rollover As Business Startup” or “ROBS” transaction). The article argues that until the Department of Labor blesses such a transaction, there will always be a large risk that such arrangement runs afoul of the prohibited transaction rules.
While we are still waiting on an official position from the Department of Labor regarding use of a 401(k) plan to fund a startup business, the United States Tax Court recently provided an opinion that clearly shows the federal government and courts will closely scrutinize these rules in the context of self-directed IRAs. In the combined May 9, 2013 opinion of Peek v. Commissioner and Kleck v. Commissioner, the Tax Court agreed with the IRS’ position that because Lawrence Peek and Darrell Fleck had personally guaranteed a portion of the purchase price on a business that also included use of finds from their self-directed IRAs, the IRAs were effectively terminated under the prohibited transaction rules. As a result, income taxes and penalties were owed at the time the IRA assets were pledged as part of the personal guaranty. I am sure Mr. Peek and Mr. Kleck did not think about the impact of the guaranty at the time they signed it, but every action in a ROBS-style transaction can have devastating consequences.
Many companies are still touting ROBS as completely legitimate and risk-free, but the Peek and Kleck decisions clearly show the IRS, DOL and Tax Court will closely scrutinize every aspect of a ROBS-type transaction. If you are thinking about using your tax-qualified assets in a 401(k) plan or self-directed IRA to start a new business, I would be happy to talk to you about the potential pitfalls.