Terminating a rollovers as business startups (ROBS) plan is a complex process that can result in fines and penalties from the IRS if done incorrectly. ROBS plans are heavily regulated and managing one often involves a large amount of paperwork to remain compliant.
If you need a ROBS exit strategy, you should contact your ROBS provider, determine your company’s value, take action based on the termination reason, complete final paperwork and notice requirements, and then file IRS Form 5500. We also recommend using the services of a ROBS provider, if you’re not currently working with one so that you can receive additional guidance for properly closing out your plan.
Guidant Financial is a good provider to consider as it has one of the industry’s most comprehensive support teams. It offers legal counsel, audit support, and a satisfaction guarantee. It also provides other services that you may need as part of terminating a ROBS plan, such as business valuation services.
Step 1: Contact Your ROBS Provider or Plan Administrator
If your current plan is being managed by a ROBS provider, you should first reach out and inform it that you intend on terminating the ROBS 401(k) plan. Your provider or plan administrator may have specific policies, procedures, or paperwork that it will require you to complete.
ROBS plans are complex, and you should utilize the expertise available to you. Additionally, some ROBS providers offer a satisfaction guarantee and audit and legal services. You can view our list of the best ROBS providers for more help.
Specific requirements may vary depending on the state you’re located in as well as the details of your business. However, common items that your ROBS provider may be able to assist with as part of the requirements to terminate a plan include:
- Drafting a resolution for your board of directors
- Providing required notices to plan participants
- Determination of compliance with applicable state, federal, and other regulatory requirements
- Guidance or assistance with the completion of any paperwork, such as any applicable IRS forms
Benefits of Utilizing Outside Counsel
Some ROBS providers will give a higher level of service when it comes to managing your ROBS plan. For example, some charge fewer fees to manage your plan but offer little in terms of audit support, legal counsel, or guidance for managing aspects of your plan.
If you find that your provider does not provide the services you need, you may have to hire outside counsel for additional support. Hiring outside counsel can also give you the added perk of having a second set of eyes to ensure that your plan remains compliant throughout the termination process. Doing so can help speed up the process and help avoid any costly mistakes.
Step 2: Determine Your Company’s Value
A common next step in terminating your ROBS 401(k) plan is determining your company’s value. This is needed as you’ll later be required to complete a stock buyback, and an amount must be assigned to determine the value of the shares being repurchased.
Your ROBS provider may provide a business valuation as part of its services. If not, you may need to have an independent appraisal valuation completed. Before paying for any valuation, consult with your ROBS provider or outside counsel to ensure it will be sufficient for purposes of a ROBS termination.
Guidant Financial, for instance, offers services for both a certified business appraisal and an estimated business valuation. It’s transparent with the intended use of each, stating that certified business appraisals, although more expensive, are a good fit for legal purposes, such as taxable events and the repurchase of corporate stock.
Items Factored Into a Business Valuation
Different methods exist for determining how much a business is worth. Business valuations can also be a complex process and vary slightly depending on the unique circumstances of a company. You can view our guide on how to value a business for more details.
As part of the business valuation process, you may be required to provide a range of financial documents. However, the following items commonly impact how your business is assessed:
- Historical sales and income, such as cash flow or return on investment (ROI)
- Growth projections
- Tangible and intangible assets owned
- Loans, liens, and other business debts
- Sales performance of companies in the same industry
Step 3: Take Appropriate Action Based on the Reason for the ROBS Termination
The next steps will depend on the reason you’re terminating the ROBS plan. Common reasons include business failure, sale of the business, or conversion of the business structure away from a C Corporation. There may also be additional nuances depending on the state you’re located in and the details of your business. We recommend working with outside counsel or your ROBS provider for guidance on your unique situation.
Business Failure or Closure
If you are closing your business, the company must repurchase shares from the 401(k) plan. Since part of setting up the ROBS required the 401(k) plan to purchase stock in the business, this is essentially reversing the process.
The business valuation completed in the prior step of this guide will determine the fair market value of the stock. When the shares are repurchased, the proceeds are then distributed to all eligible employees’ 401(k) plans based on each individual’s ownership percentage.
Sale of the Business
You should check out our list of what to consider before selling your business. If you’ve decided it’s the right move for you, you can then decide whether you want the sale to be done as either a stock sale or an asset sale:
- Stock sale: Here, you as the business owner are selling the shares you hold in the company. In exchange, the buyer receives equity as a new owner. Sales proceeds are used to first pay back creditors. Any remaining funds are then distributed to shareholders based on individual ownership percentages. Since the 401(k) plan is also considered a shareholder, it will also receive a portion of the sales proceeds, after which you can then roll it into an IRA once the sale is completed.
- Asset sale: This usually involves the sale of a company’s tangible physical assets. In some cases, it may also involve intangible assets such as copyrights, patents, customer lists, and more. Sales proceeds are used to pay off the company’s debts, after which the remaining funds are distributed to shareholders based on each individual’s ownership percentage.
Conversion of Business Tax Structure
A ROBS requires your company to be structured as a C corporation (C-corp) for tax purposes. Business owners wanting to change this must first terminate, or unwind, the ROBS. The following steps outline a typical timeline for this:
- A corporate resolution from the board of directors is created to outline the stock purchase from the 401(k) plan
- The stock buyback can then occur in a single transaction, or over a period of time in multiple transactions
- Proceeds from this buyback are returned to the 401(k) plan, essentially reversing the process that occurred when you initially set up the ROBS
Due to the potential tax implications of switching to a different tax structure, we highly recommend finding a certified public accountant (CPA) and outside counsel to advise you on how this may impact your cash flow.
Step 4: Complete Final Paperwork and Notice Requirements
Now that the movement of funds has been completed as part of the buyback process, you’ll need to prepare and file certain paperwork. You should work closely with your ROBS provider or outside counsel to ensure that nothing is overlooked as there may be requirements specific to your state, industry, or business circumstances. Missing any such requirements can lead to hefty fines from the IRS.
Common requirements may include the following:
- Preparing and filing the board resolution in which the board of directors outlined the termination of the plan
- Gathering documents showing that plan assets have been distributed appropriately
- Verification that the 401(k) plan has no further assets
- Preparation of 1099 distribution forms showing details on who received funds from the plan termination and for how much
- Issuing documentation showing your corporate ledger, census form with employee information, and a year-end summary for the plan
Step 5: File IRS Form 5500
The final step in properly closing out your ROBS plan is to file IRS form 5500. This notifies the IRS that your 401(k) loan is formally closed and must be done if you want to avoid penalties. If this form is not filed, the IRS will still consider your plan to be active, even if there are no plan participants or assets. This will also apply even if your company is no longer actively operating.
Much of the information required to complete this form should have been obtained in the previous step. Form 5500 will require you to provide information about the plan’s type, number of plan participants, asset information, and more. You can view our guide on what IRS Form 5500 is, which includes instructions on how to complete this form. Alternatively, you can get guidance from your ROBS provider or outside counsel.
Frequently Asked Questions (FAQs)
A ROBS is a complex transaction that requires you to navigate a number of different regulatory requirements, and you can read our ROBS guide for more details. Failure to remain compliant can result in hefty fines or penalties. Using a third-party service, ROBS provider, or outside counsel can reduce the likelihood of this happening.
When a ROBS plan is terminated, the company must repurchase shares from the 401(k) plan. Part of this requires a proper business valuation to determine the fair market value of the company’s stock in the buyback. Proceeds are then used to pay creditors, with the remaining funds redistributed to plan participants based on ownership percentage.
ROBS plans are commonly closed when a business owner wants to sell the company, cease operations completely, or change the tax reporting structure. Since there are potential implications to a company’s taxes and finances, it’s recommended that you consult with a CPA. If you need to replace ROBS funds, consider our recommendations for startup business loans.
Bottom Line
Terminating a ROBS 401(k) plan requires a high level of due diligence to ensure you remain compliant with IRS requirements. Failure to do so can result in penalties being assessed. It’s recommended that you use the services of your ROBS provider, outside counsel, and a CPA to ensure the process is done correctly and that you fully understand the tax implications of doing so. If you decide that terminating a ROBS is the right step but want to get additional funding for your business, check out our tips for how to get a small business loan.