November 19, 2019
Our topic today is the truth about ROBS plans, the good, the bad, and the ugly, and we’re going to dive into that in just a moment.
I’ll start off by telling you about us. I’m Donna Bordeaux. I’m a CPA with CampgroundAccounting. My husband Chad Bordeaux is also a CPA and an OHP, which is the designation that ARVC provides for Outdoor Hospitality Professional. We operate a CPA firm that specializes in working with campground and RV park owners and family-owned businesses. We are also avid campers so we camp across the United States. This gives us a great perspective to see how the industry is operating the current trends. And we’re very interested in those as well as knowing how to help our park owners be even better owners and grow their businesses and maintain good tax filing status and minimize the impact of income taxes. We’ve been around for a good while now and we have a lot of resources that are available. If you’d like to follow us we have a Facebook page for CampgroundAccounting, as well as a YouTube page with a whole bunch of blogs and videos just like this one on different topics of interest to the RV and campground industry.
Let’s get started with what is a ROBS plan. ROBS is an acronym of course. And even I myself forget sometimes what it stands for. It is a Rollover for Business Startups. What this means is that you can use your retirement monies to help purchase the stock or an investment in a business. Keep in mind that you must use a third party like Guidant or Franfund to assist you with establishing and the recordkeeping for the plan. The qualified retirement plans that you can use include IRAs 401 K’s set plans, thrift savings plans for 57 and 43 be plans. These plans all have to be qualified pre-tax retirement plans. Please note that you cannot use Roth IRAs or Roth 401k is in the ROBS plan. Those can be used in other ways, but not within a ROBS plan.
The ROBS plan is a designated process that the IRS maintains and one of the restrictions is that you must be taxed as a C Corp. You don’t have any other choice. You cannot be a sole proprietorship, a partnership, and an S Corp. None of those options are available for you or nonprofit. You must be taxed as a C corporation in this situation. C corporations are not flow-through entities. They pay their own taxes. That tax rate currently is at 21%. It’s a flat rate. So if you earn $1, the tax is 21 cents. If you earn in a million dollars, the tax is 21% of that as well.
Keep in mind that the IRS has its eyes on these plans. The culprit is that many people have been taking advantage of the situation and using ROBS plans, but not following the rules and regulations that the IRS has set forth. The rules are actually set by the IRS and the Department of Labor because this is also dealing with ERISA law, which is what governs 401k and retirement pension plans.
One of the problem areas that we see a lot in dealing with these plans is that you cannot contribute make money or contribute money or make these investments without doing it properly. It has a certain path that it must flow through and boxes must be checked. It’s not a matter of just cashing out your 401k and depositing it into a checking account and making a business purchase. There are processes and procedures that have to be followed that are fairly strict. If you violate these, you could contaminate or disqualify your entire retirement plan. That means that those dollars could be taxable yet again. You want to be very careful.
We also see that the IRS has its eyes on these plans because some people are not using third party plan administrators. If you’re going to do this, you must use a third-party plan administrator. Also, there are some pretty strict rules about who is able to do what. No lending of money can happen between the plan and the business owner. So there may not be any loans to or from a shareholder. So this is not just something you can just throw together and operate a business without really having some pretty deep understanding of what you’re doing. So make sure that if you’re attempting to use ROBS plan, you are aware that you will have kind of one hand tied behind your back when you’re operating a business using this structure.
This must be an active business. You cannot have absentee owners and there cannot be any passive component to the business. It cannot own rental properties or oil royalties, or things that are considered to be passive. This must be an active operating business and anyone who is involved in the business must be involved in it fully. If a buyer has a large retirement plan and would like to buy a campground wants to let his son or daughter operate it, you cannot do that through ROBS plan. The person contributing the money from their retirement plan must be active in the business and that is a requirement, not an option.
Next up, all rollover participants must be employees. So for example, I had a situation last week where a couple said we are husband and wife and we would both like to use our retirement funds to contribute to the business but my husband doesn’t want to work in the business. I will operate it solely. If you’re going to do this through ROBS plan, both the participants who are rolling those dollars into that plan must be active in the business. They will both need to be on payroll and receive a reasonable salary.
What are the filing requirements? What are the specific things that might be a little different than a normal business? First off, the Form 5500 must be filed each year with the Department of Labor. You’ve maybe never seen this form before, but this is what a retirement plan will file each year with the Department of Labor. It kind of looks like an IRS Form as well. But there is actual little separation that goes to the Department of Labor and not the IRS. This form is going to be an informational return that talks about who is in the plan, how much is invested in the plan, what is its value? This is the part that you’re going to want to have that Third Party administrator assist you with. Most third party administrators will have a process where they will actually file this return for you. You will have to give them information and complete some survey information each year, but they will assist you with the filing of this return.
Another issue that always comes up is how do we get money out of the business. Now that the compensation strategy and distribution strategy is very different than it would be in any other type of business. The ROBS plan puts restrictions on how you get money out of the business, and I’ll cut to the chase. The only way to do this is through payroll. You may not take distributions or draws from the C Corp. Those are called dividends and dividends are subject to duplicate taxes. You cannot take dividends because you’re going to have to give your 401k who was also a fictitious owner will call it will have to get equivalent the dividends, You may not take the normal form of distribution or draw that you might be used to if you owned a business before. Every dollar that you take out of that business will also be subject to payroll taxes.
It’s also important to note that there should be no personal commingling of expenses or income and I do mean none. If there’s one or two here or there, I suggest you write a check back to the business to reimburse it if something accidentally happened. The C Corp structure with the ROBS is very specific and you cannot have the normal process of utilizing that if a personal expense comes along here there. You want to be very clear because a lot is at stake if your plan was to be terminated.
Next up is selling the business. This is where the exit strategy comes in with the ROBS plan. The proceeds of selling the business become earnings for your 401k and for the ownership of the company. So a big difference from selling a normal business is that the proceeds are going to be subject to ordinary income and not capital gains. So again, this is ordinary income, not capital gains. Capital gains right now top out at 20% on your federal taxes. That’s under current law today that can always change but under that 20% instead, ordinary income goes up to 36% depending on your income. That difference is very critical when we’re talking about selling the business we’re usually talking about hopefully some large dollar amounts that you’ve built up by then.
If you’re familiar with how a 401k works for the taxation, as the money is put into the 401k, it is invested. And those investment earnings grow tax-free. They grow tax-free until you decide to take a distribution until you decide to take the money out. So in this case, selling the business is no different than owning stock in a major company. If you own some Apple stock with your 401k or Microsoft or Duke Energy, the proceeds of the sale of that will roll back in and become a part of the new balance of that 401k. When you decided to take a distribution out of that 401k, that is considered ordinary income and not capital gains. You will not have the advantage of using capital gains rates in the sale of your business if you’re utilizing a ROBS plan.
Next up is exiting the ROBS plan. There’s obviously the way we just talked about with selling the business. But what if you want to exit the ROBS plan without selling the business? Is this possible? Yes, it is. The process of exiting the ROBS plan without selling the business involves buying the stock from your 401k buying it back. So if you have a low point in the valuation of the business, for example, in that first couple of years, if you’re investing a good bit in maintenance, and you’re really just making a turn with the business or making some big changes to the business, you may see that you don’t earn a lot of money in those first couple of years. And that’s will decrease the valuation of the business. Now, hopefully, that’s just a temporary decline. But this is a way that you can utilize an exit strategy for the ROBS plan.
The ROBS plan may be the only way that you can get that campground purchased. So it may be a one of a kind solution to be able to do this if you can’t obtain other financing. So that is a good solution at the time, but you’re going to have to live with the consequences of what requirements there are operating the business. In some cases, I help my clients choose to exit the ROBS plan at a strategic point within a few years of purchasing. They may at that point also be able to refinance out of the ROBS also if the value is a low enough point. You may have the money to be able to buy it out and that will mean that you would basically buy the stock of the business out at a valuation. Again, a third-party valuation will be required. We can help facilitate that you would buy the stock back from your 401k and from you personally or any other owners, and deposit that money back into the 401k and call it a day.
I will say that if the valuation is at a low point, that will probably mean that your 401k has taken a pretty big loss. But the strategy would then be to get that business back on track so we can start funding that 401k again, and make up for the losses that we had in there and start showing that money away again for your retirement. Another thing that can also alleviate the pain is the monthly maintenance fees that you’re paying on the ROBS. Typically we find that it takes about $5,000 to get that ROBS plan in place. Those are one time fees upfront. Companies like Guidant will charge you $149 a month for each and every month going forward to maintain and administer your plan. So if you own that business for 30 years, you’re going to be paying $150 a month, times 12 months of the year for 30 years. It’s not a cheap way to go.
Utilizing the ROBS plan may be a magical solution to buying that business, but it has some very long term effects. So consider looking at a ROBS analysis before you make a purchase. Or if you’ve already made the purchase. Look at the ROBS plan analysis to determine if there’s an exit point that you should be watching for. The ROBS analysis that we do will look at the differences between the tax rates along the way and the costs that are incurred each month as you maintain that plan. And it will compare to the long term costs of the ROBS plan structure versus facilitating how to exit that structure. Sometimes we find some pretty remarkable cases where it may be an excellent point to exit the ROBS plan well before you ever sell the business.
I see a lot of cases with seller financing and a portion of the down payment is coming from a ROBS plan. If you were looking at ROBS plan with a small dollar amount (less than $300,000 to $400,000) the cost is still the same to maintain that plan every month. It may make it a little less likely that it is a great solution if you’re doing a smaller dollar amount, or it may also make it a better solution to exit that ROBS plan solution faster. The valuation will typically take a dip after you first purchase the business and start doing the changes that you see fit.
We also have a couple of other resources. I mentioned this briefly on the front end, we have a full blog of information that deals with all different things affecting campground owners and common topics, or campers site lock fees, and audits Wi-Fi, all kinds of good stuff. So check out our blog, it’s at CampgroundAccounting.com/blog. And also you can hop on over to YouTube and look up campground accounting on the search there and you will find a bunch of videos we generally try to do two to four videos a month and add those to our library there. Please subscribe to that channel and then we’ll make sure that you see everything new that’s coming out in the industry.
Donna Bordeaux, CPA with CampgroundAccounting.com
What happens when you send two CPAs out into the relaxing outdoors to camp? You get CampgroundAccounting.com. Donna and Chad have over 50 years of combined experience as entrepreneurial CPAs. They’ve owned businesses and helped business owners exceed their wildest dreams. They camp and travel across the country every chance they get, so it’s just a natural fit that they focus their CPA skills on helping campground owners throughout the USA grow their businesses and minimize the impact of taxes. They understand the key performance indicators and specialized issued that face RV park owners every day.