An ERSOP® plan is an Internal Revenue Code tax-qualified profit sharing plan that allows for rollover money to be invested into the sponsoring business. It is a true employee benefit plan and must be operated as such. The plan contains a sophisticated profit sharing contribution formula and may contain a 401(k) salary deferral arrangement, but no mandatory match. An ERSOP® plan is an “eligible individual account plan” — specifically a volume submitter profit sharing plan with IRS pre-approved enabling language that allows the plan to invest in “qualifying Employer securities” (stock). The plan is adopted by an Employer (which is a C—Corporation that has not elected S— Corporation status) with a minor amendment stating that only rollover monies shall be used for such investments. The pre-qualified plan, with the minor amendment along with full disclosure of the intended investment, is then submitted to the IRS for an individualized favorable determination letter. The entrepreneur rolls over pre-existing retirement funds into the plan and the money is used to purchase the stock of the adopting employer or an affiliate. The acquisition of “qualifying Employer securities” must be for “adequate consideration”, and no commission may be charged with respect thereto. An ERSOP® Plan would be engaging in a “prohibited transaction” were it not for the statutory exemption IRC§4975(d)(13).
In 2004, after giving “the full disclosure” to a skeptical examiner in the IRS National Office, she responded “well OK; but I still don’t like it.” and then proceeded to issue Favorable Determination Letters to three of our clients whose applications she was reviewing. With that attitude in mind, this is an area of tax law that one would be well advised to tread carefully. Do not be too clever. Observe the black and white letter of the law. Document every related transaction well. Do not give the IRS cause. We fully disclose to the IRS each of our clients’ unique situation so that each will have reliance on their individual IRS Favorable Determination Letter. It is not the IRS favorable determination letter that the IRS would challenge, it is how closely you (the participant, the trustee, the employer) follow the IRS favorably determined plan. That is what it is — a plan. A plan to be followed. SDCooper Company ERSOP® Plans have fared very well during IRS audits. The audit activity culminated in a Memorandum (Memo) dated October 1, 2008. In the Memo the IRS Director stated, though the Rollover for Business Start-up (ROBS, the IRS term) plans were not non-compliant with the Internal Revenue Code “per se”, he did list areas of concern of these plans in operation. These were areas where we were concerned early on. With the publication of the Memo the IRS released pent-up “no change” audit letters to ERSOP® Plan clients. “No change” is a good thing.
Money in most IRAs may be rolled over into an ERSOP® plan and then invested in “qualifying employer securities.” Basically, only an inherited non-spousal accounts may not be rolled over. into an “eligible individual account plan.”
Our clients are, as the name suggests, entrepreneurs. As such, each is “an officer, director (or an individual having powers or responsibilities similar to those of officers or directors)” and therefore a “disqualified person” as defined in Internal Revenue Code. Further, since an IRA is specifically excluded from the definition of an “eligible individual account plan” (as defined in ERISA § 407(d)(3)), any entrepreneurial investment of funds held within “self-directed IRA” would not be exempted from being a prohibited transaction as defined in the Internal Revenue Code. However, once those “self-directed IRA” funds are rolled over into an ERSOP® Plan, those same funds may then be invested in any entrepreneurial way.“Self-directed IRA” investments must be passive or they are a distribution subject to taxes and penalties.
The Plan is the document setting forth rules of eligibility, participation, contributions, benefits, discrimination, vesting, distributions and retirement. The powers and duties of the Trustee may be included in the Plan document but are often in a separate TRUST document. The Trust Fund (or the INVESTMENTS) is (are) the sum of the contributed and rolled over money under the terms of the PLAN held by the Trustee. The TRUST document describes the permitted investments. The ERSOP® plan TRUST document provides for the greatest variety of investments including “qualifying Employer securities.”
Millions of dollars in advertising are spent each year by investment houses to blur the line between the PLAN and the INVESTMENTS. An ERSOP® plan may contain a 401(k). All that is required is that you as TRUSTEE establish individual investment accounts at your favorite bank, mutual fund, or broker. Each pay period your payroll service will calculate the 401(k) contributions of each eligible employee and issue you a report. You will then send a check covering those contributions along with the report to the broker who will happily deposit the correct amounts into each participants account. The ERSOP® plan purposely does not contain mandatory employer match language as a new business seldom has the cash flow. Employer discretionary matching is permitted. The ERSOP® plan provides all of the structure and forms necessary. We at SDCooper Company will coordinate with your investment house in the enrollment of your employees into the plan.
Because ERISA states that the transaction is exempt from being a prohibited transaction “if no commission is charged with respect thereto . . .” If we charged a variable fee instead of a flat fee for service, the IRS could assert that the variable fee was a commission, and therefore the investment of the funds into the stock of your new corporation was a distribution subject to taxes and penalties.
Because ERISA states that the transaction is exempt from being a prohibited transaction “if no commission is charged with respect thereto . . .” to which the IRS adds “to or from a ‘disqualified person’.” We are defined in the Internal Revenue Code as a “disqualified person” because we provide services to the plan. If the IRS found during an examination (IRS audit) of your plan that we had paid or received a commission by any name, the IRS could assert the investment of the funds into the stock of your new corporation was a distribution subject to taxes and penalties. A franchisor must disclose any commissions paid or received in its FDD and if it is so disclosed in the FDD it would thereby be disclosed to the IRS. Therefore, anyone who pays or receives a commission in respect to establishing these plans are putting their clients at risk with the IRS.
First a little history: In 1974 when ERISA was passed, Congress said that if a corporation adopted a plan then an individual could serve as the Trustee of the Plan’s Trust. This was later in 1982 extended to Keogh plans (plans for the self employed and partners.) You should ask yourself “who is the most trustworthy person you know?” Answer: YOU. There is a natural inclination not to incur the fiduciary responsibility of handling and investing the other Plan Participant’s money, especially the rank-and-file-employee Participants. However, each and every Participant will have their own individual investment account. They will be responsible for their own investment return. You as Trustee will need to be bonded against non-investment loss. ERISA bonds cost a couple of hundred dollars per year. An outside Trustee charges annual fees of 1-2% of the whole Trust Fund. You, as Trustee, cannot be paid to serve as Trustee.
We believe that there is an irreconcilable conflict of interest between the design and administration of the PLAN and the sale of investments to the TRUST fund.
If this is a start-up or new territory our best recommendation is for you to call the franchisor’s office and ask them if they are aware of a CPA firm that has a track record with their franchisees. If that does not work, then call some franchisees in your area and ask about their satisfaction with their accountant. Your accountant does not have to be in your city, county, or state. What you want is someone with client base experience in the type of service or business that you are starting. Accountants are often like some law firms who will take on any type of case, you do not want that. You want someone that understands you and your business. You do not just need a “tax guy/gal – preparer”. You need a firm that: (a) will help set up your chart of accounts for the best management information feedback possible, if you will be doing your own bookkeeping, (b) you can network with several times a year review your numbers and goals, (c) will be part of your business planning for the first couple of years, (d) brings experience gained from similar clients, who can reflect on what is happening in your company compared to what they observed from their other clients. It does not have to be a high powered CPA firm. If the franchisor / franchisees can not help you, then please call our nearby clients and inquire into their satisfaction with their accountant. Target a few and interview several. We recommend at least two or three interviews to find someone with which you have chemistry, a professional who seems interested in what you are doing.
From the IRS 2011 Robs Compliance Project: on Not Filing Form 5500 or Form 1120 “Many ROBS sponsors did not understand that a qualified plan is a separate entity with its own set of requirements. Promoters incorrectly advised some sponsors they did not have an annual filing requirement because of a special exception in the Form 5500-EZ instructions. The exception applies when plan assets are less than a specified dollar amount and the plan covers only an individual, or an individual and his or her spouse, who wholly own a trade or business, whether incorporated or unincorporated. In a ROBS arrangement, however, the plan, through its company stock investments, rather than the individual, owns the trade or business. Therefore, this filing exception does not apply to a ROBS plan and the annual Form 5500 or 5500-EZ (5500-SF for filing electronically) is still required.”
Congress never intended plans to be used this way. Copies of the ERISA Congressional Conference Report are all but lost to time, but the Joint Committee staff makes it clear these transactions were expected and encouraged.
It is required? No. ERISA §407(b)(2)(A) states “the portion of such plan which consists of applicable elective deferrals (and earnings allocable thereto) shall be treated as a separate plan” which is not “eligible.” Or at least advisable? Probably not. Please see our presentation on 401(k) vs. ERSOP® Profit Sharing Plans. The IRS insists that you have a 401(k)/Salary Deferral Plan. The October 1, 2008 Memo does not state that you must have a 401(k) plan, only that if you have a 401(k), it cannot be “inactive.” You must pay yourself a salary and make salary deferrals immediately [within days, weeks or a few months] in order for you to be an considered an employee and a plan participant eligible to make a rollover. There are better ways to make you an eligible employee. The c-corporation may only pay you a salary once the c-corporation is profitable or generating cash-flow. There is no such requirement in the Code or ERISA.
These plans may not be used to fund a finance business. Go tell that to Bank of America, Wells Fargo and Goldman Sachs. Check cashing, payday advance stores and factoring operations are common.
An IRS advisory letter issued to the plan document sponsor is equivalent to an individualized Favorable Determination Letter issued after full disclosure to the IRS to you in the name of your company and plan. At every audit the agent requests an individualized FDL if it exists, however, in January 2012 the IRS stated that Service would no longer issue “comfort letters” (i.e. individual Favorable Determination Letters for word-for-word adoption of prototype or volume submitter documents with advisory letters and without amendments.) If there have been amendments to the documents then IRS will continue to issue individual Favorable Determination Letters.
A business valuation is required by the plan as part of due diligence of a business acquisition. ERISA 408(e)(2) requires that the Plan Trust receive “adequate consideration.” Adequate Consideration is defined in ERISA (3)(18) as “Fair Market Value.” Fair Market Value is what you, as a non-coerced buyer, agrees to pay, to an agreeing unrelated unconcerned seller. A third-party valuation is an opinion, that is sometimes helpful. Could it hurt if you have a third-party valuation? No.
From the IRS 2011 Robs Compliance Project: Preliminary results from the ROBS Project indicate that, although there were a few success stories, most ROBS businesses either failed or were on the road to failure with high rates of bankruptcy (business and personal), liens (business and personal), and corporate dissolution’s by individual Secretaries of State. Some of the individuals who started ROBS plans lost not only the retirement assets they accumulated over many years, but also their dream of owning a business. As a result, much of the retirement savings invested in their unsuccessful ROBS plan was depleted or ‘lost,’ in many cases even before they had begun to offer their product or service to the public. In 2010 The Small Business Administration released a study that greater than 90% of SBA guaranteed loans to businesses with the capital injection coming from the retirement fund accounts of the entrepreneur were still performing which was considerably greater than those loans without such retirement funds.