ROBS plans (i.e. Rollover Business Start-Up plans) are a popular method for funding new business ventures, especially for franchises. The tax savings enable the entrepreneur to squeeze more capital out of their available start-up funds, making the whole venture possible. What a great idea, right?
At some point, however, the ROBS owner may wish to get out of the ROBS arrangement. How to do so, and when, is worth careful consideration. Understanding the possible exit strategies and related tax implications can help a ROBS owner divest their plan account of company stock as smoothly and cost effectively as possible.
Divestment of company stock turns a ROBS plan into a regular retirement plan.
The ROBS stock (aka Qualifying Employer Securities, or QES) is a special asset held in the ROBS owner’s retirement plan account. The plan should and probably does have other assets besides the company stock. Therefore, taking the QES out of the plan does not necessarily involve terminating the plan itself. If you wish to terminate the plan, additional steps are required.
Three Paths for Divestment
The applicable plan rules provide three general ways to get the stock out of the plan – either:
(1) Reverse the original ROBS investment through a cash redemption;
(2) Distribute the QES directly to the plan participant; or
(3) Sell the entire company to a third-party buyer.
The above paths result in different income tax consequences for the corporation and the ROBS owner. The expense of each path varies as well, depending on the value of the corporation at any given time.
Note that in addition to the business considerations and the particular tax effects, the status of the plan must also be decided in conjunction with the ROBS exit. Even after a plan is de-ROBS-ified, it is a separate legal entity from the company and continues to exist, now as a traditional retirement plan, until it is formally terminated. A corporation may have good business reasons to continue its non-ROBS plan into the future, to continue to provide valuable retirement savings opportunities for its employees.
This is the first part of a two-part post about ROBS exit strategies. Coming soon: Part 2—Tax Effects of Divesting the Plan of Stock Ownership