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IRS, Expert Give Warning to Rollover Industry

SAN FRANCISCO – One of the nation's top specialists on using retirement fund rollovers to start small businesses warns that there may only be one party that is helped out with 401k and IRA retirement funds being taken out early without supposed tax penalties to fund start-up businesses. And it's not the franchise or small business buyer. “Ultimately, this might only be a good retirement plan for those that get commissions and fees by promoting these ideas if they get away with it,” Stephen L. Dobrow states. He is the president of the American Society of Pension Professionals & Actuaries (ASPPA), an association of professionals that focuses on retirement issues.

Those that work in such instruments prefer using ERSOP, Entrepreneur Rollover Stock Ownership Plan, or Rainmaker Plans rather than the acronym the Internal Revenue Service unaffectionately has named them, ROBS, Rollover Business Startups.

Last week Dobrow was testifying before Congress and visiting foreign countries about retirement and pension plans. Today he speaks with Blue MauMau's readers about Guidant Financial Group's decision last month to pull out of such instruments. 

On February 18, Guidant's new chief executive officer, Stephan Roche, cited the ASPPA meeting in the decision to pull out of the industry.  Roche states, "There was an ASPPA conference. They had a conference with Michael Julianelle, who authored the IRS memo of October 1 (pdf), and Monika Templeman (IRS Director of Employee Plans and Examinations), and other top-ranked DOL (U.S. Department of Labor) employees. One of our executives was at this conference. At the conference, the IRS expressed frustration to attendees that the field directive went out. They started calling all the companies that sell the product, promoters. And when you call us 'promoters,' that is a specific terminology that is used by the IRS to describe companies or firms that promote certain products that they will then choose to evaluate."

“Guidant is correct,” says Dobrow of the ASPPA.

He continues, "The whole industry is in trouble. While some of the promoters claim to have a secret formula that makes it all work, I don’t think that it is true. These IRS investigations come on the heels of other tax avoidance plans such as Welfare Benefit Plans and 412(i) Defined Benefit Plans where the same kinds of claims got made, and the IRS systematically levied huge fines upon the taxpayers and promoters (and won in court). It may take the IRS a while to get all the investigators up to speed, but when they are ready, they will likely 'throw the book' at the taxpayers and the promoters.”

Benetrends 401k startup funding chart
Rolling over a 401(k) plan to fund a small business/Benetrends Web Site

Dobrow, also president of Primark Benefits, an employee benefits firm based in San Francisco, warns that the guidelines are still vague, a danger sign for franchise buyers who use their retirement funds to start their businesses. “There are not ROBS guidelines, nor is there a recipe as to how to do ROBS correctly. This is a ROBS alarm – warning signs and notice that these are on the 'radar screen' at the IRS. The notice just referred to just a small fraction of what they have run into so far.”

When dealing with qualified plans, or even IRAs, there are hundreds of rules (ERISA and the tax code and related regulations) that must be adhered to in order to maintain the tax qualified status of a plan. Dobrow emphasizes, “All of the ROBS arrangements that I’ve seen, and the marketing literature that was created by the promoters, missed one of the most important things about retirement plans. Retirement plans are meant by the government to be plans of deferred compensation. That is, untaxed until spent in retirement, and then it gets taxed as spent. The plans are not 'save until I want to buy a franchise' plans. They are not 'untaxed investment capital accumulation' plans. When they get treated as such, problems arise.”

“All of the transactions that I’ve heard about so far have impressed me as violating the rules on “self-dealing” and “indirect prohibited transactions,” Dobrow continues.

Companies such as SD Cooper, BeneTrends and others routinely rollover retirement funds to help fund franchises. BeneTrends even states on their web site how safe their ROBS plan is. They write, "Good News from the IRS: Their word - The Plan's OK." They reassure franchise and small business investors, "We'll obtain a letter documenting IRS approval for each individual plan."

Jodie Reynolds of media relations in the Internal Revenue Service's Indiana and Kentucky office stated that the service will not comment on specific companies but shared the agency's most recent guidelines from the November 5 edition of IRS Employee Plans News, in "When Too Good to Be True Very Well May Be: Funding Business Startups with Plan Assets " (pdf). The Internal Revenue Service seems to be getting tougher. Regulators state:

As a tax regulatory agency, our focus is on the conformity of policy consideration with established law. This is especially the case with any transaction, such as this one, that promises a transfer of value without payment of any accompanying tax. From our experience, many ROBS arrangements quite simply do not comply with the law.

ROBS plans are questionable in that they may solely benefit one individual’s exchange of tax-deferred assets for currently available funds. This stock exchange occurs inside what should otherwise be a retirement plan for the benefit of employees. Yet, from our review, few, if any, employees other than the individual who initiates the transaction will actually benefit from the exchange. Furthermore, these arrangements are predicated on stock valuations that are frequently superficial and are administered more as a corporate funding vehicle than a bona fide employee benefit program.

For these reasons, we intend to scrutinize ROBS arrangements. Our guidelines will serve as instructions to our technical specialists to resolve issues they encounter when evaluating these plans. We believe that ROBS arrangements may endanger the qualified status of otherwise tax-qualified employee plans and may be prohibited transactions, requiring complete undoing of the transaction, and imposition of excise taxes.

"Many taxpayers may be of the opinion that it's their money and they should be able to do what they want with it,' says Dobrow. But, he continues, “They fail to realize that the IRA is a combination of 'their money' and unpaid taxes.” He explains that if a small business or franchise buyer wants to convert the full amount of the IRA to "their money," that the IRS would wish them to take a taxable distribution, return the unpaid taxes to the Treasury, and then, he says, “use the remaining 'their money' however they wish.”

Dobrow concludes, “I feel very sorry for the misinformed masses that rely on their advisors in good faith and end up getting burned.”

“As a retirement planner, it is with great distress that I see retirement money being placed in speculative investments by those least able to recover if things don’t work out as hoped,” he states. “ If the investor had other money, then it is likely that the investor wouldn’t be raiding his or her 'nest egg.' How does one recover if one loses both the business and the 'nest egg'?”

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Don Sniegowski is editor of Blue MauMau, the daily news journal for franchise & small business owners. Call him at +1 (270) 321-1268, tweet @bluemaumau or email