401(k) Funds To Fund A New C Corp

[Guest scottyd]

I have a client who has been approached to purchase a franchise, to fund the purchase they want him to open a C Corp and then open a 401(k) for it, then transfer his IRA into the 401(k) and use those funds to fund the business (via a stock sale to the 401(k)).

There are three companies that he is looking at:

www.benetrends.com

www.franchisefund.com

www.guidantfinancial.com

If you could comment on this or refer me to someone who can give me an expert opinion.

ScottyD

[namealreadyinuse]

I thought that everyone was pushing it this way:

Set up an LLC w/ IRA as owner and the invest the cash anyway you want. If these get to the same end result (I won;t mention which end result I believe they get to) then the LLC is cheaper.

Ultimately there is a TON on the interweb on these "deals" and my understanding is that the promotors make all of the money setting up the entities and plans.

Good luck!

[Peter Gulia]

There are some right ways for a retirement plan (IRA or § 401 plan) to buy original-issue shares in a new corporation, or otherwise invest in a start-up business.

The hard bit is doing so without triggering a prohibited transaction, taxable unrelated business income, or other nasty consequences. Moreover, Labor department interpretations (which also are authority concerning tax-Code prohibited-transaction rules) suggest that the Government might challenge transactions that, even if entirely proper in form, seem to involve some “arrangement or understanding” to evade exclusive-benefit, fiduciary-responsibility, or prohibited-transaction rules, or to do indirectly that which could not have been done directly.

So one needs the advice, and usually order-of-transactions hand-holding, of a lawyer who understands this business idea and knows every inch of the prohibited-transactions rules along with the Labor and Treasury departments’ and courts’ interpretations of them.

Sometimes, a service provider suggests that it has or will get an IRS determination that a plan using this investment method is “legitimate”. (Others present an IRS determination truthfully, but without explaining the limits on what it means.) An IRS determination that a document in form states a qualified plan doesn’t consider actual transactions and never opines on prohibited-transaction questions.

To defend an implementation, a smart participant wants the support of his or her expert lawyer’s candid outlook, reputation, quality opinion letter, and malpractice coverage.

[J Simmons]

Step-transaction doctrine might be a problem for achieving a result in two steps (IRA to 401k into stock in IRA owner's company) what would be a prohibited transaction in one (IRA into stock in IRA owner's company) if the IRA owner then operates or is employed by the company.

[Locust]

I think it can be done with the rollover into a corporation plan, but I would be uncomfortable with the IRA/LLC investment suggested. I agree with Fiduciary Guidance that you ought to get a lawyer - someone who'll take responsibility if the thing is ever questioned. My guess is that organizations mentioned will set it up for you, but the main thing they want are the ongoing fees for administration, and they'll probably disclaim any responsibility for the legality of it.

[Guest mjb]

Why do you believe that the Q plan route is better than the IRA route when there is tax ct. precedent for allowing such arrangements in an IRA and an IRS ruling?

I have q: when you are talking about Q plan arrangements are you discussing ERSOPS?

Using tax counsel is a necessity.

[Guest scottyd]

Thank you for your responses. This is a new for me and my client needs independent legal counsel who is competent in this area, any suggestions?

ScottyD

[Locust]

mjb - I don't know about any tax court ruling, but to set up a shell LLC and do whatever you couldn't do in the IRA in the LLC makes a mockery of the rules. Could such an LLC loan its funds to the owner of the IRA? There are lots of concepts in ERISA and the tax law that could be used to attack such a blatant attempt to avoid the restrictions on self-dealing.

On the other hand it is clear that an individual account plan of a company may under ERISA and the Code invest in the sponsoring corporation's common stock (employer securities).

[John Feldt ERPA CPC QPA]

This does look like an ERSOP, which is a qualified plan that is purchasing the employer securities.

Also folks, please check with your tax person too. You will have basis in the company if you buy it without using your IRA or your qualified plan's assets. Later, if and when you sell, you have capital gains/(losses) and pay taxes as a capital gain/(or loss).

However, if you use your IRA or your qualified plan and you sell (or want to retire), now any money paid out is considered a distribution and it is taxed as ordinary income - no basis. I'm pretty sure that should be at least one of the important factors in the decision making process.