Convoluted business offer.

[JG EA]

Visit today by a long time W-2 type client. He went to a seminar! (Of course he did.)

Anyway I would love your thoughts on this scheme he was presented with. He is going to become a franchise owner. But the thing I'm worried about is what he wants to do with his 401k. He got information from a CA company who will set him up as a C-Corp (only will work with a C-Corp) & roll his 401k. He puts assets in the C-Corp, the C-Corp with its capital and some extra borrowing invests in his new business.

1. Sets up a corp
2. Corp establishes the Profit Sharing Plan & Trust (ERISA with special enabling language).
& He establishes two checking accounts for C-Corp and for the Plan
3.Then they assist him with the rollover of 401k in the Profit Sharing Plan & Trust at his bank.
4. It says in the notes he got: "You as trustee, from the Trust checking account (Profit Sharing Plan & Trust)issue the first check to be received by the C-Corp checking account. You as President issue the first stock certificate back to you as Trustee for the benefit of your rollover account" That's called funding the Corp.
& Then there is some information about the shares that I really don't understand.
5. The C-Corp with its initial capita invests in a new or existing business or franchise.

Any thoughts??? Ever heard of this? Of course there are fees. Administration $800, Startup Costs $1,000, Plan Setup Fee $4,000 and an IRS Filing Fee $300.

[JohnH]

This scheme pops up every now & then in various incarnations. I don't know how to link to topics, but you can search on "IRA distribution to start business without penalty" and find a discussion about it.

I've had a couple of clients bring this up after hearing franchise pitches. My answer is always the same: "If you do this, you'll need to find another accountant." I don't have any interest in learning enough about them to actually form an opinion beyond "don't do it" - there are simply too many pitfalls.

He'd probably incur less risk investing his entire retirement plan in derivatives.

[veritas]

First things first

What experience does your client have in running a business? Is the franchise viable? Will your client have enough money to start the business through the build up time? How will your client cover personal expenses during that time? What kind of debt does your client have now? Have you helped your client with a business plan? By the way if it's a Quiznos forgetaboutit.

Your post did not address this and maybe you have covered it aready with your client. If not I would have this conversation before geting to the tax implications.

I am not against using retirement funds for starting a business. I've seen it before during economic slow downs. Executives and management are often cut first, moving into a business of their own often makes sense. They are tired of the corporate world and the lack of contol over their own destiny.

A big plus for us is, more business!

[JG EA]

Thanks for the search ideas. I found some interesting things.

I've had a couple of clients bring this up after hearing franchise pitches. My answer is always the same: "If you do this, you'll need to find another accountant." I don't have any interest in learning enough about them to actually form an opinion beyond "don't do it" - there are simply too many pitfalls. JohnH

I'm in agreement with this. That is just the way I feel. I have taken on some incredibly time consuming tax situations in the past in the hope that all the reasearch will help me with other situations. Usually the next time I have that situation I have to start all over anyway. Actually I did tell him to find another accountant - and for that reason - I don't want to learn about this. But I told him I'd do some thinking about it and give him some information. I already told him not to do anything yet without talking to an attorney for state rules.

What experience does your client have in running a business? Is the franchise viable? Will your client have enough money to start the business through the build up time? How will your client cover personal expenses during that time? What kind of debt does your client have now? Have you helped your client with a business plan? By the way if it's a Quiznos forgetaboutit. veritas

I didn't talk about this as much as I should, but he did just drop in. I was so focused on figuring out what the heck he was talking about.

Anyway I found a great article. It talked about potential problems: The dollars paid for the purchase of stock needs to be fore value - therefore a valuation of the new company is required. Is it worth as much as the retirement plan will pay? And that the biggest drawback is it is a gamble - not long term diversified but a startup venture.
Even though this was written in 2004 I think the points it makes are still valid.

http://www.businessweek.com/smallbiz/content/nov2004/sb20041118_0799_sb006.htm

[S T]

Some Discussion

JG there was also a discussion in the past on this, altho not in detail

http://www.thetaxbook.com/forums/showthread.php?t=9180&highlight=401k+corp

http://www.thetaxbook.com/forums/showthread.php?t=2712&highlight=401k+corp

About 5 years ago I had a client that used this same scenario, through an agency in San Diego, Calif. Of course I no longer prepare their taxes or have contact, so not sure the outcome.

Went something like this, form a coporation, funds from 401K transferred to Corp, then the loan from the 401K to purchase the franchise, much the same as you describe.

[erchess]

Simple Question Here

if someone wants to cash out their retirement account and go into business whether franchised or otherwise, why not simply do that and own the business outright whether it is a corporation, a partnership, proprietorship or what have you? What are the alleged and actual benefits of owning the business through its retirement plan? Would the taxpayer for example be able to treat the pension withdrawal as a rollover?

[MLINDER42]

Convuluted business offer

It is treated as rollover therefore no tax paid.Had one client wanting to do this talked him out of it. He went on to borrow the money business failed all he had left was house and 401k still intact. Thanks me every year at tax time.

[Zee]

Thanks for the search ideas. I found some interesting things.

I'm in agreement with this. That is just the way I feel. I have taken on some incredibly time consuming tax situations in the past in the hope that all the reasearch will help me with other situations. Usually the next time I have that situation I have to start all over anyway. Actually I did tell him to find another accountant - and for that reason - I don't want to learn about this. But I told him I'd do some thinking about it and give him some information. I already told him not to do anything yet without talking to an attorney for state rules.

I didn't talk about this as much as I should, but he did just drop in. I was so focused on figuring out what the heck he was talking about.

Anyway I found a great article. It talked about potential problems: The dollars paid for the purchase of stock needs to be fore value - therefore a valuation of the new company is required. Is it worth as much as the retirement plan will pay? And that the biggest drawback is it is a gamble - not long term diversified but a startup venture.
Even though this was written in 2004 I think the points it makes are still valid.
http://www.businessweek.com/smallbiz...0799_sb006.htm

I agree completely. While interesting, researching the tax law and potential pitfalls of situations like this is interesting (if you have the time), but has little long-term revenue-producing benefit.

The link you posted is a great summary. If the retirement plan contribution is to be the primary capitalization, how would the company have any value at all (beyond the initial capitalization, and before the retirement investment)? And, if the valuation of the company must exceed the value of the investment, how would that happen?

There must be a way around the stock valuation issue.

[JG EA]

Thanks for the other posts and sites and discussion - it has helped me. I called the client and told him 2 points from the article, cautioned him again and told him about the situation:

MLINDER42 ...Had one client wanting to do this talked him out of it. He went on to borrow the money business failed all he had left was house and 401k still intact. Thanks me every year at tax time.

He then said there would be money left over ($40, or so) and what would happen to that? Not knowing the answer to that question I said that would be a good question to ask the company and ask the attorney.
What a help it has been to "talk" about this with all of you.

[ChEAr$]

If I add right,

Visit today by a long time W-2 type client. He went to a seminar! (Of course he did.)

Anyway I would love your thoughts on this scheme he was presented with. He is going to become a franchise owner. But the thing I'm worried about is what he wants to do with his 401k. He got information from a CA company who will set him up as a C-Corp (only will work with a C-Corp) & roll his 401k. He puts assets in the C-Corp, the C-Corp with its capital and some extra borrowing invests in his new business.

1. Sets up a corp
2. Corp establishes the Profit Sharing Plan & Trust (ERISA with special enabling language).
& He establishes two checking accounts for C-Corp and for the Plan
3.Then they assist him with the rollover of 401k in the Profit Sharing Plan & Trust at his bank.
4. It says in the notes he got: "You as trustee, from the Trust checking account (Profit Sharing Plan & Trust)issue the first check to be received by the C-Corp checking account. You as President issue the first stock certificate back to you as Trustee for the benefit of your rollover account" That's called funding the Corp.
& Then there is some information about the shares that I really don't understand.
5. The C-Corp with its initial capita invests in a new or existing business or franchise.

Any thoughts??? Ever heard of this? Of course there are fees. Administration $800, Startup Costs $1,000, Plan Setup Fee $4,000 and an IRS Filing Fee $300.

That's 6100$ he won't have to invest in the market turn around due to start on January 9th.