The Complete ROBS Compliance Guide

In 2008, the IRS issued an internal Memorandum providing field agents with technical guidance on ROBS arrangements. The Memorandum is the primary source of current IRS thinking on these plans — and it is often misread by people who assume it casts ROBS in a negative light.

The Memorandum is unambiguous on one point. In Treasury's own words:

“Treasury does not believe that the form of all of these transactions may be challenged as noncompliant per se. There is no inherent violation in the form of a plan containing a ROBS arrangement that would otherwise prevent a favorable determination letter ruling.”

In plain English: the IRS is telling its own agents that ROBS plans are legal, and can receive a favorable determination letter when they're set up correctly. The governing law that allows a 401(k) plan to purchase stock of its plan sponsor was passed in 1974— it's not new, and it's not a loophole.

What the IRS does point out — and what the rest of this guide is about — is that they've seen operational issues in some plans that violate basic qualification rules. Those issues are the target. Not the structure itself.

A core premise of qualified retirement plans is non-discrimination — benefits cannot favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). Under the law, an HCE is anyone who owns 5% or more of the plan sponsor, or receives compensation over a specified threshold (adjusted annually for cost of living).

The IRS applies two tests to Benefits, Rights & Features: current availability and effective availability. In a typical ROBS plan year one, there are no NHCEs — so current availability is satisfied by default. But effective availability requires more: the plan must not be structured in a way that prevents NHCEs from ever benefiting.

Treasury's concern is that a plan design might only allow the HCE (the founder) to invest in employer stock. Since stock in privately held companies is typically only available at inception, the investment option must be available to all plan participants, not restricted to the founder. That availability is documented in the Summary Plan Description and acknowledged on the enrollment form where each employee elects to participate.

When a qualified plan purchases stock from its plan sponsor, it qualifies for a statutory exemption from prohibited transaction penalties only ifthe purchase meets ERISA section 408(e). One of 408(e)'s key requirements: the purchase must be for adequate consideration.

For marketable securities, adequate consideration is the market price. For non-marketable assets — like stock in a privately-held franchise — adequate consideration means fair market value determined in good faith by the trustee. DOL regulations specifically contemplate two acceptable paths: the fiduciary is either independent of all parties to the transaction, or relies on the report of an independent appraiser.

In practice, this means your plan should have an accredited outside valuation firm establish the value of corporate stock at the outset of the plan and annually thereafter for as long as the plan holds the stock. Skipping annual valuations is one of the most common ways ROBS plans quietly drift out of compliance.

Treasury has flagged the potential that fees paid to the “promoter” (the organization that designs and installs the ROBS structure) could constitute a self-dealing prohibited transaction if paid from plan assets. To make that argument stick, Treasury would need to classify the plan provider as an investment advisor under ERISA — a specific legal status with specific criteria.

ERISA regulations define a person as rendering investment advice when they: (1) advise the plan on the value of securities or other property, (2) make recommendations about investment decisions, and (3) have discretionary authority or control over those decisions — with the advice rendered on a regular basis pursuant to an agreement that it will serve as the primary basis for investment decisions.

A compliant TPA avoids this trap through three explicit practices:

• An independent accredited valuation firm — not the TPA — establishes stock value at inception and annually.
• An independent accredited money manager is appointed to render investment advice to plan participants.
• TPA setup fees are paid from the entrepreneur's personal funds as part of their personal investment — never reimbursed from the corporation later.

Treasury's concern here is that a plan could be established solely as a funding vehicle — a one-shot stock purchase — rather than as an actual, ongoing retirement plan. That would violate Treasury regulations requiring that qualified plans be created primarily for the purpose of providing systematic retirement benefits for employees, and that the plan be permanent rather than temporary.

Plans that fail the permanency test typically lack substantial and recurring contributions. They might have exactly one transaction (the initial stock purchase) and then sit dormant.

The practical remedy: the 401(k)/Profit Sharing Plan in a properly-administered ROBS is first a qualified retirement plan, second a plan allowing self-directed investments, and third a plan that offers employer securities as one option among many. A compliant TPA will recommend that the founder contribute a minimum of 1% of their compensation into the plan annually to demonstrate ongoing intent.

A qualified retirement plan must be for the exclusive benefit of its participants and beneficiaries— not for other purposes. Treasury has stated explicitly that a typical ROBS design does not violate this rule. But they have seen plans that misused funds to purchase personal assets from the sponsor, or for personal use by the sponsor, rather than to buy a legitimate trade or business.

The remedy here is common sense applied rigorously. The purpose of the plan is to accumulate assets that will provide retirement benefits for participants. Plan funds are for investing in the future of the business — not for consumption today. A compliant plan documents the business purpose clearly and keeps plan assets strictly separated from personal use.

A qualified plan must be communicated to the employees of the plan sponsor. It's not for the exclusive use of the company founder — it's a benefit for all eligible employees of the sponsoring company. That communication happens in three specific, documented ways:

The signed enrollment form is the key artifact. It provides clear, dated documentation that the plan was properly communicated — which is exactly what the IRS looks for during review.

The same process also addresses the IRS's related concern about Inactivity in Cash or Deferred 401(k) Arrangements — some plans fail to give participants the opportunity to make 401(k) contributions. The Summary Plan Description and enrollment forms resolve this by design.

The IRS Memorandum underscores a single truth: there is much more to creating a compliant ROBS structure than drafting paperwork and rolling over money. The issues involved in designing, establishing, and operating a compliant plan are highly technical and highly complex. The IRS has clearly stated its intent to closely examine these structures.

All tax-law compliance requires ongoing monitoring and reporting. This is not a one-time setup. A qualified TPA — someone who specifically addresses every issue raised here with every client, from initial exploration through ongoing administration — is the difference between a bulletproof plan and a future audit.

This is why Fund My Franchise works with Tenet Financial Group. Tenet designs, installs, and administers thousands of ROBS plans. Their consultants are credentialed and their compliance procedures are applied uniformly to every plan they touch. No shortcuts, no improvisation.