How to Terminate a ROBS 401(k) Plan

Terminating a Rollover for Business Startups (ROBS) 401(k) plan can lead to hefty fines and penalties from the IRS if done incorrectly. These types of plans are heavily regulated, so it’s important that you understand the steps involved to ensure you don’t incur unnecessary fines or other expenses.

If you have a ROBS provider or administrator, you’ll need to work with them to inform them of your intent to close the plan. A ROBS exit strategy requires a business valuation to be completed, and certain paperwork must be filed depending on the reason for the termination. As part of this process, you may also need to satisfy notice requirements to existing plan holders.

Due to the potentially complex nature of this and the possibility of getting fined, we recommend working with a reputable ROBS provider to walk you through the process. Guidant Financial is our top recommendation as it offers one of the industry’s best legal support services and audit protection.

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Step 1: Determine Who You’ll Work With for Your ROBS Exit Strategy

As a business owner, you should first consider whether your ROBS 401(k) exit strategy involves doing this on your own or enlisting the assistance of a ROBS provider, administrator, or other outside counsel.

ROBS Provider or Administrator

If your ROBS 401(k) plan is currently being managed by a ROBS provider or other administrator, you should contact them first. This is because they may have procedures and paperwork specific to their company.

If your plan is not currently being managed by an administrator, you may still be able to hire the services of a ROBS provider to walk you through the process of terminating your plan. Exact paperwork requirements may vary depending on your specific circumstances, such as the state you’re located in. However, common items that you can get assistance with include:

• Drafting a resolution for your board of directors
• Providing required notices to plan participants
• Determining compliance with applicable state, federal, and other regulatory requirements
• Completing required paperwork, such as applicable IRS forms

Third-party Counsel

Hiring the services of an attorney, law firm, or other outside counsel can be a useful option if you do not have a ROBS administrator or find that your ROBS provider does not offer the services you want. Even if you are working with a good ROBS provider, hiring outside counsel can be beneficial as they can serve as a second set of eyes to ensure nothing is overlooked.

Solo Approach

We don’t recommend terminating a ROBS 401(k) plan without any outside assistance. However, if you have a strong legal background or understanding of the regulatory requirements involved, this can be a great way to save money.

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.

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 (cash flow, return on investment)
• 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 (C-corp). There may also be additional nuances depending on the state you’re located in and the details of your business.

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 questions to ask when 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-corp for tax purposes. Business owners wanting to change this must first terminate, or unwind, the ROBS. The following outlines the typical process 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 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

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 it 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.

For guidance on completing the form, see our guide on IRS Form 5500 or get in touch with your ROBS provider or outside counsel.

Frequently Asked Questions (FAQs)

Why should I use outside counsel or third-party services to help me close a ROBS?

How are funds handled when a ROBS is terminated?

Is closing my ROBS plan a good idea?

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.