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Rollover as Business Startup (ROBS)/401k Business Financing - Reasonable Compensation Factors: How much salary can I make?

10/10/2014

Rollover as Business Startup (ROBS)

Tens of thousands of small business owners have used their retirement funds to finance their business without paying taxes or penalties. The IRS refers to this strategy as a rollover as business startup (ROBS) transaction. The transaction entails using 401k funds to purchase stock issued by the company that operates the business. Since the funds are not withdrawn from the 401k, the transaction does not trigger taxes and penalties.

While the IRS has consistently acknowledged that a ROBS transaction is legitimate it has also highlighted compliance violations that it has found with respect to ROBS transactions. One compliance concern is whether the ROBS transaction violates the Exclusive Benefit Rule which requires that all plan assets are used for the exclusive benefit of employees and their beneficiaries. It is possible that a violation of this rule could be found if the business owner receives salary or other compensation for the services he or she performs for the business that is unreasonably high. As such, it is prudent for the business owner to understand the factors that may be employed in evaluating the reasonableness of such compensation.

Evaluating the reasonableness of the business owner’s compensation is not a “black and white” exercise (e.g., the IRS does not maintain a schedule of reasonable salaries). Instead, the evaluation is based on the specific facts and circumstances in consideration of several factors. In a 2013 case the Tax Court considered the following factors in evaluating the reasonableness of compensation paid to the sole shareholder of a C-corporation in his role as president:
1. Employee’s Role in the Company - Relevant considerations include:

The position held by the employee;
Hours worked;
Duties performed; and
General importance of the employee to the success of the company.

2. Comparison With Similar Companies’ Salaries

3. Character and Condition of the Company - Relevant considerations include the company’s:

Size;
Complexity;
Net income; and
General economic condition.

4. Potential Conflicts of Interest – The Court is concerned with whether a relationship exists between the employee and the company that may permit the disguise of nondeductible corporate distributions as salary expenditures.

5. Internal Consistency – This factor considers whether there is an internal inconsistency in a company’s treatment of payments to employees that may indicate that the payments go beyond reasonable compensation.

6. The Independent Investor Test: This factor considers whether an independent investor would approve of owner’s compensation package that depleted the business’s assets without appropriately paying the investor.

Takeaways:

A business owner who finances his business via a ROBS transaction should not receive salary or other employee compensation that is unreasonably high.
Evaluating the reasonableness of a salary is not a “black & white” exercise but rather requires considering the relevant facts and circumstances in light of several factors.
For any entrepreneur looking to finance his or her business with 401k, IRA or other retirement funds, it is imperative to work with professionals that specialize in rollover as business startup (ROBS) transactions.

Additional resources:

ROBS FAQS

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Solo 401k Deep-Dive: Contributions

10/10/2014

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Solo 401k contribution types, Solo 401k contribution limits, Solo 401k contribution deadlines, Solo 401k multiple plans, Solo 401k Roth contributions, Solo 401k Contribution Calculator

Solo 401k Contributions

This post provides an in-depth review of contributing to a Solo 401k retirement plan including covering the following topics: contribution types, contribution limits, contribution deadlines, multiple plans, Roth contributions, and an online calculator for determining how much you can contribute (Solo 401k Contribution Calculator).

Solo 401k Contribution Types:

In the words of the IRS, a self-employed individual wears two “hats” in a Solo 401k plan: employee and employer. As such, the self-employed individual may make both “employee” and “employer” contributions to a Solo 401k. The practical result is that the individual may contribute more to his or her retirement plan than may be contributed under other types of retirement plans for self-employed individuals such as SEP and SIMPLE IRA accounts. In fact, the ability to make both employer and employee contributions to a Solo 401k is one of the primary reasons that Solo 401k plans have dramatically increased in popularity relative to SEP and SIMPLE IRA accounts.

Solo 401k Contribution Limits:

Total Contribution Limit: For 2014, the total contribution limit for Solo 401k accounts (including both employee and employer contributions) is $52,000 or $57,500 for those age 50 or older.

Employee Contribution Limit: In terms of employee contributions for 2014, a self-employed individual may contribute up to $17,500 of “earned income” (or $23,000 if age 50 or older).

o For purposes of the employee contribution limit, “earned income” is defined as net earnings from self- employment after deducting both one-half of your self-employment tax and contributions for yourself.

o Self-employed persons age 50 or older may make an additional contribution of $5,500 of “earned income” for a total employee contribution limit of $23,000. This additional contribution is referred to as a “catch-up” contribution and must be specifically permitted by the retirement plan. Catch-up contributions provide an additional opportunity to save for those who are nearing retirement age.

Employer Contribution Limit: The employer contribution limit is (i) 25% of your W-2 income if your business is organized as a corporation; and (ii) 20% of net income if your business is a sole proprietorship or partnership.

Example: Mary, age 51, earned $50,000 in W-2 wages from her S Corporation in 2014. She deferred $17,500 in regular elective deferrals plus $5,500 in catch-up contributions to the 401(k) plan. Her business contributed 25% of her compensation to the plan, $12,500. Total contributions to the plan for 2014 were $35,500. This is the maximum that can be contributed to the plan for Mary for 2014.

Rollover Contributions and Direct Transfer: With the exception of amounts in a Roth IRA, you may "roll over" or transfer to your Solo 401(k) amounts you have in virtually any other retirement plan (including funds in a former employer 401(k), a governmental 457(b) plan, a 403(b) plan, etc.).   There are no limits on the amount that you can rollover or transfer from another retirement account.

Solo 401k Contribution Deadlines: Per IRS Publication 560, contributions may be made for a tax year up to the due date of your return (plus extensions) for that year.

Employer Type* Tax Return Filing Deadline Extended Deadline

Corporation Form 1120 March 15 September 15

LLC Taxed as Corp. Form 1120 March 15   September 15

Partnership Form 1065 April 15   October 15

LLC Taxed as Part. Form 1065 April 15   October 15

Sole Proprietorship   Form 1040 April 15   October 15

*Calendar year tax filer

Contributions to Multiple Retirement Plans:

If you are participating in another retirement plan in addition to your Solo 401k, you may be able to make contributions in excess of $52,000 for 2014. This is because employer contributions are not aggregated across all plans in which you participate (in contrast, employee contributions are aggregated across all plans). For example, consider a self-employed individual who also has W-2 position where the person is participating in the employer-sponsored 401k plan (e.g., an IT professional for a Fortune 500 who also has her own web-hosting company). For 2014, this person may contribute $52,000 ($57,500 if age 50 or older) to her Solo 401k and another $52,000 may be contributed as an employer profit sharing contribution to the employer-sponsored 401k plan. As a result, a total of $104,000 may be contributed in 2014 to both plans combined.

Solo 401k Roth Contributions:

A self-employed individual may make post-tax (Roth) contributions to his or her Solo 401k. As these amounts must be segregated from those amounts contributed to the Solo 401k on a pre-tax basis, they must be deposited into a Roth sub-account (or designated account). When a self-employed individual makes Roth contributions, such amounts are contributed as elective deferrals and as such are subject to the limitations that apply to employee contributions: for 2014, $17,500 of “earned income” or $23,000 if age 50 or older provided that the no employee contributions are made on a pre-tax basis since both pre-tax and Roth employee contributions count towards the limit.

Solo 401k Contribution Calculator

To calculate how much you can contribute to your Solo 401k plan, use this online Solo 401k contribution calculator.

Sources: IRS.gov & Publication 560

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Author

George Blower is a principal of My Solo 401k Financial LLC and also serves as the General Counsel with responsibility for providing all legal services to the organization.

Prior to joining My Solo 401k Financial, he served as general counsel for a subsidiary of a Fortune 500 financial services company.

He received his bachelor’s degree in economics at the University of Michigan in 1998 with honors. He received his juris doctorate from Harvard Law School in 2001. He is a member of the Michigan and Ohio bar associations.

Rollover as Business Startup (ROBS)/401k Business Financing - Reasonable Compensation Factors: How much salary can I make?

Solo 401k Deep-Dive: Contributions

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