Wife is sole mbr LLC and trustee of 401K plan which invests in husbands privately held partnership

[RC50]

A wife has run a company for the past 8 years as a single member LLC. The LLC establishes a qualified 401K plan of which the husband rolled his 401K after becoming an employee. The wife's Plan states if an employee quits or is fired the Trustee ( who is the wife per The Plan) controls the 401K investment decisions. The husband was then let go. The husband then setup his own partnership LLC of which the wife's 401K Plan invested in with "for the benefit of her and for the benefit of the husband's," 401K funds from her qualified Plan. We believe this structure is legal given that the wife's company's 401K Plan is written to allow these types of alternative investments and that there is no attribution between husbands and wives to create a disqualified or prohibited transaction.

The wife's business has no business dealings with the husband's business and the wife is not compensated in any way by the husband's business. The wife has helped in the husband's new business with marketing and the like but this is being done on the side and is separated from her main, profitable business.

The wife's 401K Plan has a TPA who files form 5500 and drafted the Plan documents. All of the funds that were rolled into the wife's 401K Plan are now invested in the husband's business. A valuation of the husband's business is done yearly to establish value of each membership held in the 401K plan of the wife's business.

The operating agreement for the husband's company states how the memberships get sold back to the wife's 401K once the business returns double the original investment.

Can anyone comment on this structure as it relates to being a prohibited transaction?

[BG5150]

My suggestion is to engage an attorney.

[RC50]

My suggestion is to engage an attorney.

Thank you. Yes, we did that and the general consensus is that this all works. However, just because experienced attorneys believe it all works doesn't mean in practice that DOL believes it works. What I know is that interpretation of the code sits in a narrow range. I too have read over the code and believe it all to be permissible.

What would be helpful is to hear from anyone else out there who has structured these types of arrangements and to hear their comments in case our team has missed something.

[david rigby]

...The husband was then let go.

Yeah, that happened to me, sort of.

[Bird]

I'm not going to offer an opinion on this, but I am curious - cutting through the somewhat tortured syntax and terminology used, the gist of this is that the wife's plan owns the husband's business, or at least part of it, is that right?

If so, then what does this sentence mean - "The operating agreement for the husband's company states how the memberships get repurchased by the wife's 401K once the business returns double the original investment" - if the wife's 401k already owns the company? It's not necessarily relevant but just curious.

[jpod]

Please tell us why whoever opined on this feels that it is not a 4975©(1)(E) self-dealing PT?

[ESOP Guy]

Not sure about this but could anyone raise the question if the husband was really "hired" by the wife's company? It looks like there might have been some kind of pro forma hiring for the sole purpose of allowing him to roll the funds into the 401(k).

It has been a long time since I studied the topic but the IRS has the power to challenge otherwise legal transactions on the basis of the Economic Substance Doctrine. (Not sure if this will be worth their time but it looks like a classic example of why this doctrine exists)

https://www.irs.gov/businesses/codification-of-economic-substance-doctrine-and-related-penalties

http://www.journalofaccountancy.com/news/2014/oct/201411106.html

Once again the IRS in the end says ROBS are legal but clearly doesn't like them and appears willing to hit them with technicalities. This comes across as a ROBS on steroids.

https://www.irs.gov/retirement-plans/employee-plans-compliance-unit-epcu-completed-projects-project-with-summary-reports-rollovers-as-business-start-ups-robs

https://www.irs.gov/pub/irs-tege/robs_guidelines.pdf

It sounds like there is a fixed buy/sell agreement where the 401(k) has to sell the asset upon it growing to a fixed sized. Would there be any fiduciary concerns? The plan can lose 100% of its investment but can't gain more then 100%. Most investments are lose 100% in theory unlimited upside.

Besides PT issues which I am not an expert on that topic come to mind quickly. This sound risky at best and trouble at worse. Honestly a simple ROBS seems like it would have been easier and less trouble-- but not liked by the IRS as noted above. That is unless there is an expectation of employees and they simply don't want to share equity in the new business.

[jpod]

ESOP Guy: All good points. As to ERISA fiduciary concerns, it sounds like the wife's plan could be a one-person plan exempt from Title I of ERISA, albeit still subject to the IRC 4975 PT rules.

[RC50]

I'm not going to offer an opinion on this, but I am curious - cutting through the somewhat tortured syntax and terminology used, the gist of this is that the wife's plan owns the husband's business, or at least part of it, is that right?

If so, then what does this sentence mean - "The operating agreement for the husband's company states how the memberships get repurchased by the wife's 401K once the business returns double the original investment" - if the wife's 401k already owns the company? It's not necessarily relevant but just curious.

Yes, that is correct. The wife's plan owns less than 10% of the husband's business.

There is provision in the operating agreement of the husband's company which states the memberships are sold back to the company once each membership is worth double what it was initially purchased at. Effectively, double the money that was put into the husband's business is put back into the 401K plans tax protected.

[RC50]

ESOP Guy: All good points. As to ERISA fiduciary concerns, it sounds like the wife's plan could be a one-person plan exempt from Title I of ERISA, albeit still subject to the IRC 4975 PT rules.

The plan is not a one-person plan but is subject to IRC 4975 PT rules.

[K2retire]

"there is no attribution between husbands and wives"

Are you sure about that detail? Avoiding that attribution is only possible in very limited circumstances.

[RC50]

Not sure about this but could anyone raise the question if the husband was really "hired" by the wife's company? It looks like there might have been some kind of pro forma hiring for the sole purpose of allowing him to roll the funds into the 401(k).

It has been a long time since I studied the topic but the IRS has the power to challenge otherwise legal transactions on the basis of the Economic Substance Doctrine. (Not sure if this will be worth their time but it looks like a classic example of why this doctrine exists)

https://www.irs.gov/businesses/codification-of-economic-substance-doctrine-and-related-penalties

http://www.journalofaccountancy.com/news/2014/oct/201411106.html

Once again the IRS in the end says ROBS are legal but clearly doesn't like them and appears willing to hit them with technicalities. This comes across as a ROBS on steroids.

https://www.irs.gov/retirement-plans/employee-plans-compliance-unit-epcu-completed-projects-project-with-summary-reports-rollovers-as-business-start-ups-robs

https://www.irs.gov/pub/irs-tege/robs_guidelines.pdf

It sounds like there is a fixed buy/sell agreement where the 401(k) has to sell the asset upon it growing to a fixed sized. Would there be any fiduciary concerns? The plan can lose 100% of its investment but can't gain more then 100%. Most investments are lose 100% in theory unlimited upside.

Besides PT issues which I am not an expert on that topic come to mind quickly. This sound risky at best and trouble at worse. Honestly a simple ROBS seems like it would have been easier and less trouble-- but not liked by the IRS as noted above. That is unless there is an expectation of employees and they simply don't want to share equity in the new business.

The husband did perform actual work for the company while hired which created value for the wife's company so although his employment appears to be for 401K rolling the company received benefit.

Thanks for the links above. This mechanism is similar to a ROBS but doesn't meet the exact definition because of the plan of the wife's company owns the membership shares.

The 401K does have to sell the asset at a fixed size. The good news is the husband's company was post revenue in month one and the valuation of the business is already quite high. I believes the IRS takes issue with ROBS because of the inherent risk that many of these deals have in loosing 100% of the value.

Risky, yes.

Thanks for the comments. All are good.

[RC50]

"there is no attribution between husbands and wives"

Are you sure about that detail? Avoiding that attribution is only possible in very limited circumstances.

So we're told by both the TPA and the attorneys.

[jpod]

And what about the PT exposure?

[RC50]

I should note the wife's 401(k) plan owns a minority position in the husband's company, less than 10%. We created two different membership classes within the husband's company, Class A (with one vote per unit) and Class B (with nor voting rights or governance rights whatsoever). The wife's 401K owned Class B membership. This effectively ensures the IRS can’t argue that the wife's plan ever had any control over the husband's business. Much like preferred stock there is some type of return on investment to compensate for the loss of voting privileges.

The husband's company is a partnership so not a ROBS. ROBS require investment in a C Corp.

PT exposure is avoided because there is no attribution between husbands and wives.

[jpod]

You, or the attorney who blessed this, should consider reading the regulation interpreting 4975©(1)(E), if you or he/she hasn't already done this. Attribution is irrelevant. That's not to say there definitely is a PT, but it should be considered.

[RC50]

You, or the attorney who blessed this, should consider reading the regulation interpreting 4975©(1)(E), if you or he/she hasn't already done this. Attribution is irrelevant. That's not to say there definitely is a PT, but it should be considered.

Yes. Agreed. Good point. Thank you. This has been done.

There is no doubt there is some gray here hence my post. I believe this will require a further deep dive to ensure protection.

Lastly, can anyone comment on the percentage of Plans that do get audited? None of this matters if there is never an audit. If audited we will want there to be no gray.

[Belgarath]

What I've generally heard is that for "regular" plans, about 5%. For specialty plans such as ESOP's, it is higher, but some of the ESOP experts here can doubtless give you a better figure. Could be an IRS audit, or a DOL audit.

[UtahCPA-APA]

Are there any UBTI issues?

[shERPA]

Section 4975(e)(2)(F) specifically includes family members in the definition of disqualified persons, and subparagraph (6) specifically names the spouse, so the statement "there is no attribution" doesn't make sense. What attribution rules are you referring to and how do they override 4975(e)(2)(F)?

ROBS rely on a PTE for purchasing "employer securities", which need to be stock or certain debt instruments, I don't think an LLC membership qualifies. Also, it doesn't sound like husband's company is the "employer" so the employer securities exemption doesn't apply anyway.

Might want to get a second (or third opinion). I wouldn't go there nor would I advise my clients to do this.