ROBS and Bankruptcy

[mariemonroe]

I have a client who did a ROBS (rollover business start up). His entire retirement savings is now invested in a company that is on the brink of bankruptcy. 

If the company files for bankruptcy, what happens?

[ETA Consulting LLC]

On the surface, he'd lose all of his retirement savings. 

This could open up and entire world of possibilities.  If I have $1 Million in a company 401(k) plan and wanted to devise a scheme to gain income tax fee access to these funds, then I could start of ROBS and drive the company in the group with high expenses (e.g. lucrative travel for business meetings).  After the company fails from high expenses and zero revenues, I file bankruptcy.  The net effect is that I've exhausted all these funds on my personal spending spree (which could be targeted by the IRS as a tax avoidance scheme).

But, until that happens, he merely lost all his retirement savings on a 'bad' investment.

Good Luck! 

[CuseFan]

Hopefully he had no employees.

I guess if he files bankruptcy the plan assets go to zero - and I would terminate and file a final return.

[Luke Bailey]

Agree with CuseFan and ETA Consulting. I talked several years ago with an EP Agent who reviewed many ROBS bankruptcies during the timeframe of the "Great Recession," as part of a compliance project, and as I understand it, where IRS concluded that the ROBS participant had made a good faith effort to run a real business, they let it go. In an egregious case (e.g., no revenue and lots of salary and bonus, or worse, employee loans), the IRS would likely go after it, e.g., if the ROBS funds had gone through an IRA, which they typically do, they could make the IRC sec. 4975(c)(1)(E) argument footnoted in the Tax Court's Ellis decision and allege that the IRA had engaged in a PT in doing the rollover, triggering income at the time of the rollover. Given the amount of the rollover, you'd likely be looking at the 6-year, not 3-year, statute on the individual's 1040.

[mariemonroe]

Thanks for your replies.