In October 2008, the IRS issued and internal memo regarding what they call "rollover business startups" (ROBS). This report was the culmination of 2 years of investigation into the world of self directed 401K plans designed to buy stock in its own sponsoring C-Corp (ESOP types of structures). The ROBS are the same basic design as the NAFEP mySOP.
At first reading of the report, the report comes across as negative and aggressive. However, to those of us in the "biz" the report is actually a very good thing. The IRS is tacitly approving the setup and structure. What they are focusing on and pointing out is that people are not implementing or operating the self directed 401K plans (mySOP) per the DOL guidelines.
The following is a section by section review of the IRS memo and how the NAFEP plan stacks up.
1 Issues raised in the IRS memo
1.1 Identification of 9 promoters of ROBS – NAFEP has not been identified or contacted regarding ROBS transactions as we do not amend or change the plans so as to prevent employee participation. The promoters identified were identified because they do amend and alter the plan after its initial creation in an effort to limit employee participation to some degree.
1.2 Benefits, Rights & Features Discrimination
1.2.1 Our current plans only target Officer/Employee types and/or single participant plans. As a general rule our plans do not have NHCEs (non highly compensated employees).
1.2.2 Our plans do not prohibit or eliminate a employee from participating in the plan, therefore there is no discrimination.
1.3 Prohibited Transactions – Valuation of Stock
1.3.1 All clients are advised verbally and through the mySOP setup guide that they need to seek annual valuations of the company stock.
1.3.2 We do not see any issue with the plan’s initial purchase of company stock being purchased at par value. Clients do need to make sure that the plan receives a fair price. Clients should not skew shares to themselves or others buy offering stock at a lower price than the plan paid.
1.3.2.1 Subsequent plan capitalization of the C-Corp will require a valuation of the stock.
1.3.3 All clients are advised to use proper valuations for their annual 5500/5500EZ reporting.
1.3.4 Any clients concerned about this issue should seek to get a “qualified appraisal”.
1.3.5 NAFEP has never provided any valuation services to any plans. NAFEP has only completed 5500 filings for the plans.
1.4 Prohibited Transaction – Promoter fees
1.4.1 NAFEP gets paid by the client directly prior to setup of their plan and corporation.
1.4.2 NAFEP does not meet the definition of a fiduciary or investment advisor as we only receive fees prior to the plan's existence, the client pays NAFEP directly. In cases where we are consulted after the plan's creation, NAFEP does not charge the plan or receive fees from the plan for advice, consulting or services. NAFEP is never hired or retained to offer advice to the plan. NAFEP has no discretionary authority over the plan and its operation.
1.4.3 There may be issues with the client reimbursing himself for the setup costs of the corporation and the plan. The client needs to have capitalization for the corporation and its hard to argue that they have capitalized when they receive all of their fees back.
1.5 Permanency
1.5.1 The NAFEP plan would not violate any permanency issues as :
1.5.1.1 the plan is designed to allow all employees to participate in all features and aspects of the plan so as not to benefit HCEs at the expense of NHCEs
1.5.1.2 Our plans have a 401(k) component that provides for all employees to make regular contributions to the plan.
1.6 Exclusive Benefit
1.6.1 No plan fees are ever directed to NAFEP. The plan does not exist until after we have received a fee for setup of the plan and the corporation.
1.6.2 We instruct and counsel all clients that they should not use the funds to purchase any personal assets from themselves or for themselves.
1.6.3 The IRS states in the memo that they do not believe that ROBS violate the exclusive benefit rules.
1.7 Plan not communicated to the employees
1.7.1 The NAFEP setup guide and our verbal consulting always informs clients/employers that the plan musts be offered and communicated to employees.
1.7.2 The plan manual provides for setup instructions and all necessary and required documents relating to communicating and setting up of employees.
1.8 Inactivity in cash or deferred arrangement
1.8.1 NAFEP plans do not provide any mechanisms for preventing employees from making contributions.
1.8.2 The NAFEP setup procedures instruct the client/employer on offering the plan and providing open access to all plan features to all employees.
2 Summary
2.1 The IRS is not saying that ROBS are illegal in basic structure.
2.2 The IRS is saying that they find many operational defects in how the plans are actually operated in the following areas:
2.2.1 No notification provided to employees
2.2.2 Employees not able to participate on an equal basis with HCEs
2.2.3 Plan asset valuation are questionable
2.2.4 Failure to file annual reports
2.2.5 The business entity has failed
2.2.6 The client has received personal use or benefit of the asset (prohibited transaction)
Current clients of the NAFEP mySOP can take great comfort in the fact that we provide a very solid, safe, and compliant plan and mySOP structure. For those of you interested in reading more about the mySOP, click here.
