Benefits & ERISA Law

IRS Debunks Another 401(k) Urban Myth in New Guidance on Rollovers as Business Startups

By Suzanne Wynn

ROBS, or Rollovers as Business Startups, have been bouncing around the employee plans arena for a couple of years. I first hear an IRS official mention ROBS during the 2006 Cincinnati Benefit Conference as part of the presentation on tax avoidance transactions. This week, the IRS finally released a Memorandum of Understanding, or MOU, addressing ROBS.

In a nutshell, ROBS are plans designed to permit an individual to buy a business, such as a fast food franchise, using their retirement account from a previous employer without taking a distribution from their retirement account so they do not pay tax on the distribution. The individual sets up a corporation, that corporation adopts a qualified plan, the individual rolls their retirement account from a previous employer into the new qualified plan (hence the “Rollover”), and the qualified plan does some one-time-only stock transactions which result in the corporation owning a business, normally a fast food franchise or a frozen yogurt shop (this is the “Business Startup” part).

The MOU on ROBS provides some interesting discussion on some of the theories and concepts which are the underpinnings of employee plans, such as prohibited transactions, the permanency requirement, benefits, rights, and features, exclusive benefit, and promoter fees. One urban myth of qualified plans that this MOU may finally put to rest is the myth of the “inactive CODA”. CODAs, or cash or deferred arrangements, are commonly known as the elective deferrals in 401(k) plans. The Myth of the Inactive CODA is invoked to explain why a 401(k) has an unusually low number of participants actually chosing to make elective deferrals into the plan. When asked why so few employees are availing themselves of the 401(k) plans, the plan sponsor will provide say that the plan’s CODA provision is “inactive”.

In unequivocal terms, the IRS states:

“There being no such thing as an “inactive” CODA, examiners should consider whether all the procedures for allowing employees to participate in the CODA were followed, whether new employees just chose not to defer, or whether employees were not even offered salary reduction elections. If it is established that employees were not permitted to make elective deferrals, the plan would violate IRC section 401(k)(2)(D) in that it did not permit eligible employees to elect salary deferral contributions.”

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Full post as published by Pension Protection Act Blog on November 12, 2008 (boomark / email).