ROBS: Rollovers as Business Startups

How it works

A ROBS transaction starts with a new C corporation adopting its own 401(k) or profit-sharing plan, one whose plan document expressly lets participants put their account balance into the employer's own stock, what the Code calls a qualifying employer security. The founder then rolls an existing pre-tax retirement account directly, trustee to trustee, into that new plan. A direct rollover is not a distribution, so nothing is included in income and the 10% early-withdrawal penalty under Section 72(t) never applies. The plan then uses that cash to buy newly issued stock in the C corporation, and the cash moves from the plan trust into the corporation's own operating account, where it funds the business: a franchise fee, equipment, working capital, whatever the venture needs. The founder can also draw a reasonable W-2 salary from the corporation as one of its employees.

None of this money ever leaves the qualified-plan system as a distribution. It moves from a rollover-eligible account into a plan trust, and the plan trust exchanges cash for stock. The tax-deferred wrapper survives the whole trip; the plan simply holds C-corp stock in place of cash. Tax is not avoided, only deferred, until the founder eventually takes distributions from the plan in retirement, or the plan sells the stock back and distributes the proceeds. Whatever this is sold as, it is a deferral technique paired with a way around an early-withdrawal penalty, not a way to make retirement money permanently tax-free.

The single statutory pivot

A qualified plan buying stock from the company that sponsors it is ordinarily exactly what Section 4975 exists to stop: a sale of property between the plan and a disqualified person. A founder directing the plan he controls to buy stock he controls is a disqualified person by the Code's own definition, and that sale sits squarely inside the prohibited-transaction rule at Section 4975(c)(1)(A). ROBS survives only because Section 4975(d)(13), by cross-reference to ERISA Section 408(e), carves out a plan's acquisition of qualifying employer securities as defined in Section 409(l), on the condition that the plan pays adequate consideration and no commission is charged on the purchase. That condition is not a formality sitting off to the side. It is the entire legal basis for why this is not a prohibited transaction, which is why an independent valuation, covered below, is not optional paperwork; it is the fact that keeps the exemption open.

What this costs in Florida

Florida has no individual income tax and does not tax pass-through income at the personal level, so when the founder eventually draws money out of the plan in retirement, Florida adds nothing to the federal bill on that side of the transaction. That much is true of any retirement account. What is different here is the entity sitting in the middle of it. A C corporation is not a pass-through, and Florida taxes it directly: a 5.5% corporate income tax on net income above a $50,000 exemption. An S corporation or an LLC running the identical business would not carry that entity-level tax at all. Choosing ROBS means choosing a C corporation to get access to the mechanism, and the Florida corporate tax is a real, recurring cost that choice imports on top of the federal deferral story, not something to discover later.

Who this applies to

Three separate gates have to clear at once, and missing any one of them ends the analysis.

• The entity has to be a C corporation. A qualifying employer security has to be common stock of the employer corporation: either readily-tradable common stock under Section 409(l)(1), or, for the closely-held startup with no public market that ROBS is actually built around, common stock carrying voting power and dividend rights at least equal to the highest class outstanding, under Section 409(l)(2). An LLC issues membership interests, not stock, so it cannot produce a qualifying employer security at all. An S corporation is limited to one class of stock and a restricted shareholder group, and a qualified-plan trust holding S-corp stock runs into the Section 409(p) anti-abuse regime that Section 409(l)'s exemption was never built to accommodate. Practitioners restrict ROBS to C corporations as a result.
• The plan has to be open to every eligible employee, not just the founder. Once the business hires someone who clears the plan's own eligibility conditions, ordinarily age 21 and one year of service under Section 410(a), that employee has to be allowed into the plan, and the right to invest in employer stock is itself a benefit, right, or feature that cannot be reserved to the owner alone without failing the nondiscrimination rules under Section 401(a)(4) and its regulations. A plan that only ever really worked for one person is not the bona fide qualified plan the exemption assumes.
• The money has to come from an eligible rollover source. A pre-tax 401(k), a 403(b), a governmental 457(b), a traditional IRA, or a SEP IRA, all qualify, and so does a SIMPLE IRA once its own two-year SIMPLE wait has passed, provided the source plan or account actually permits a rollover out. Roth balances and inherited IRAs generally do not roll over into this structure cleanly.

What it requires

Two conditions carry the exemption itself; the rest come from separate authorities. Each is a standing requirement the structure has to keep meeting, not a box checked once at the start.

• Adequate consideration, established by an independent valuation. Section 4975(d)(13)'s exemption only covers a purchase made for adequate consideration with no commission charged. For a brand-new shell corporation the fair value is close to the cash going in, but an independent appraisal is what actually documents that the price was adequate, and it is the first thing an examiner tests.
• A fresh valuation every year after that. The closely-held stock sitting inside the plan has to be revalued at least annually, both for the Form 5500 and for any transaction involving a participant, under ERISA Section 103 and the Department of Labor's adequate-consideration standard. This recurring appraisal is the most-skipped step in the structure and a frequent disqualifier.
• A full Form 5500, every year, with no shortcut. The one-participant exception that lets a small solo plan file the short Form 5500-EZ does not apply here. Because the plan owns the operating business through its stock, it is not a one-participant plan under the IRS's own reading, no matter how few people are on payroll.
• A reasonable W-2 salary for the founder, and nothing that reads as the capital coming back out informally. The founder is expected to be a genuine employee doing real work for real pay. Using the corporation or the plan to move value back to the founder outside of that salary looks like a disguised distribution, and Section 4975(c)(1)(F) separately bars a fiduciary from receiving consideration for his own account from a party dealing with the plan.

What you need to document

An examiner's first three requests are predictable: the plan document, the independent valuation, and every Form 5500. Missing any one of those three is close to a guaranteed finding.

The plan document itself

Showing, in writing, that the plan permits investment in employer stock and that the feature is available to every eligible employee, not carved out for the owner alone.

The independent valuation

Supporting the price paid for the stock at the original purchase, and a fresh one every year after that. This is the document that turns adequate consideration from an assertion into something an examiner can check.

Every Form 5500

Filed on time, every year, without a gap. A missed year is the most common ROBS failure the IRS cites. The Department of Labor's Delinquent Filer Voluntary Compliance Program exists specifically to cure one after the fact, and it is worth using the moment a gap turns up.

The rollover paperwork

Proof the money moved as a genuine direct, trustee-to-trustee transfer. That is not a taxable event, but it is still a reportable one: a direct rollover goes on Form 1099-R with a taxable amount of zero, coded G. Skipping the form because nothing was taxed is exactly the error the 2008 memo lists, failure to issue a Form 1099-R when the assets are rolled into the ROBS plan.

Payroll records for the founder

Contemporaneous evidence of a reasonable W-2 salary tied to work the founder actually performed, so the compensation cannot be read as a channel for pulling the invested capital back out.

Where it goes wrong

ROBS is not a listed or reportable transaction. Nobody has to file a disclosure form for using one. But the IRS singled these arrangements out for a dedicated compliance project, opened in 2009 on the back of an internal memorandum from October 2008 that said plainly that many of these arrangements "may serve solely to enable one individual's exchange of tax-deferred assets for currently available funds." The IRS examines them case by case, and its own sample found high rates of business failure, bankruptcy, liens, and corporate dissolution among the businesses ROBS had funded. That posture, not a listed-transaction label, is why this is a structure to enter with a specialist third-party administrator and an independent appraiser rather than alone.

What actually gets one disqualified

• The stock-investment feature stays owner-only. Whether by original design or by amending the plan after the purchase to exclude later hires, this is a coverage and nondiscrimination failure that can disqualify the plan outright, and it is the compliance review's headline concern.
• The valuation is missing or does not hold up. Without it, the purchase price is not adequate consideration, the Section 4975(d)(13) exemption collapses, and the purchase becomes exactly the prohibited transaction Section 4975(c)(1)(A) describes.
• A Form 5500 is missed. There is no one-participant shortcut here, so a gap draws penalties on its own and raises a red flag against the plan's qualified status.
• Plan or corporate assets flow back to the founder outside his salary. Self-dealing and disguised distributions are barred directly by Section 4975(c)(1)(D) through (F).
• The plan gets wound down shortly after the stock purchase. That timing suggests the plan was never a bona fide plan.

The consequences are not symbolic. A prohibited transaction under Section 4975(a) carries a 15% excise tax on the amount involved, imposed on the disqualified person for every year it remains uncorrected, rising under Section 4975(b) to 100% of the amount involved if it is not corrected within the taxable period. Separately, if the plan itself is disqualified, the entire rolled-over balance can become a taxable distribution in the year of disqualification, and the Section 72(t) penalty applies on top of it: the exact tax and penalty this structure exists to avoid, arriving retroactively and all at once. The structure is legal when it is operated correctly. Every failure mode above is operational, not a defect in the concept itself.

A situation where this comes up

The person I see this from has usually spent a career funding a 401(k) at a previous employer and now wants to put that balance to work in an active business, often a franchise, rather than watch a share of it disappear to ordinary income tax and the 10% penalty on the way out. Framed that way, ROBS looks like the obvious answer: the whole balance reaches the business, no current tax, no penalty. What that framing leaves out is everything this page has spent its time on. The plan the founder adopts to make this work is a real, ongoing qualified plan with its own calendar: an appraisal every year, a Form 5500 every year, and a coverage test the moment the business hires its first eligible employee. None of that goes away because the transaction itself closed cleanly.

A self-directed IRA or solo 401(k) is a separate strategy, and I cover it on its own page.

The version that concerns me is the one the IRS's own review was really describing: a plan and a corporation built only to reach a retirement balance conveniently, wrapped around a business that was never going to hire anyone or run long enough to justify the compliance calendar it took on. If that business does not survive, the retirement savings do not survive with it. There is no soft landing back to a plain IRA once the money has bought stock in a company that failed. That risk sits on top of the audit risk, not instead of it, and both need weighing before the rollover happens, not after.