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Starting a business with retirement funds through a ROBS plan (Rollovers as Business Startups) can be a smart financing strategy – if it's done correctly. The IRS imposes strict requirements for Business Valuation in a ROBS plan to ensure the arrangement is compliant, fair, and not abusive. In this comprehensive guide, we will break down these IRS requirements in detail, citing the relevant IRS regulations, tax codes, and even case law that shape how ROBS plans must be valued. Business owners and financial professionals will find authoritative guidance on formal IRS valuation rules for ROBS, best practices to stay compliant, common pitfalls to avoid, and strategies to ensure your ROBS plan remains in the IRS’s good graces. Throughout, we’ll emphasize how proper valuation – often with the help of experts like SimplyBusinessValuation.com – is critical to protecting your retirement investment and keeping your ROBS 401(k) plan IRS-compliant.
ROBS at a Glance: A Rollover as Business Startup (ROBS) is an arrangement allowing you to use funds from a tax-deferred retirement account (such as a 401(k) or IRA) to purchase stock in your new corporation, effectively financing a startup or business acquisition with your retirement money without incurring early withdrawal taxes or penalties (Rollovers as business start-ups compliance project | Internal Revenue Service). While fully legal when properly executed, the IRS has noted that ROBS arrangements can be “questionable” if they primarily benefit a single individual (the entrepreneur) and are not operated in compliance with qualified plan rules (Rollovers as business start-ups compliance project | Internal Revenue Service). In other words, ROBS plans are not “abusive” per se, but the IRS closely scrutinizes them for any signs of non-compliance. A major part of that compliance is ensuring that the business’s stock is properly valued when your retirement plan buys it, and that it continues to be valued correctly each year.
Why Business Valuation Matters: When you use a ROBS, your new 401(k) plan is essentially investing in your own privately-held company’s stock. This raises a big question: What is the fair market value (FMV) of that stock? The IRS cares about this for several reasons. First, the law requires that retirement plans do not engage in prohibited transactions – for example, your plan cannot buy stock from your company (a disqualified person to the plan) for an inflated price or sell it for too low a price without running afoul of tax rules (Guidelines regarding rollover as business start-ups) (Guidelines regarding rollover as business start-ups). All transactions between the plan and the business must be at fair market value (“adequate consideration” in legal terms) to avoid prohibited transaction penalties. Second, the value of the stock determines the value of your 401(k) account in the plan. Plan assets must be valued at least annually at their fair market value by law (Retirement topics - Plan assets | Internal Revenue Service), and those values are reported to the IRS and Department of Labor (DOL) on Form 5500 each year. An accurate, defensible Business Valuation is therefore essential at the ROBS plan’s inception and on an ongoing basis. If valuations are done correctly, a ROBS can be a powerful tool (the IRS even issues determination letters on ROBS 401k plan documents, acknowledging their legal structure). But if valuations are mishandled, the entire arrangement can unravel, leading to plan disqualification, back taxes, penalties, or excise taxes – a nightmare scenario for any entrepreneur.
In this article, we’ll cover all the key IRS requirements and guidelines around ROBS plan valuations, including: initial stock valuation rules, annual valuation obligations, relevant IRS Code sections (like IRC §4975 on prohibited transactions and §401 on plan qualification), IRS and DOL regulations on valuing plan assets, and even important Tax Court cases that highlight the consequences of getting it wrong. We’ll also provide best practices to ensure your ROBS Business Valuation meets IRS standards, and point out potential pitfalls (such as “one-page” appraisals that the IRS has deemed inadequate (Guidelines regarding rollover as business start-ups), or forgetting to file required reports). Finally, we’ll demonstrate how professional appraisal services – such as SimplyBusinessValuation.com – can help business owners comply with ROBS valuation requirements efficiently and reliably. A Q&A section at the end will answer common questions that business owners and CPAs often have about ROBS valuation and compliance.
Let’s dive in and make sense of the IRS requirements for Business Valuation in a ROBS plan, so you can protect your retirement-funded business and keep your plan in full compliance.
Before we tackle the valuation specifics, it’s important to understand what a ROBS plan is and why the IRS pays special attention to them. A Rollovers as Business Startups (ROBS) plan is a funding strategy that allows entrepreneurs to roll over money from a qualified retirement plan to invest in a new business venture. Typically, the process works like this:
This structure allows you to use retirement funds to capitalize a business without taking a taxable distribution. However, once your retirement plan becomes a shareholder in your company, complex IRS rules kick in. The arrangement must be managed as both a qualified retirement plan and a corporate stock ownership structure. The IRS and DOL requirements that normally apply to any qualified plan (like a 401(k) plan) still apply to the ROBS 401(k). This includes rules on plan asset valuation, reporting, nondiscrimination, and prohibited transactions.
ROBS plans have drawn IRS attention because, if mishandled, they can skirt the edges of tax law. The IRS has conducted a compliance project on ROBS, finding that many plans had issues such as prohibited transactions or discrimination in operation (Rollovers as business start-ups compliance project | Internal Revenue Service) (Rollovers as business start-ups compliance project | Internal Revenue Service). The IRS noted that ROBS plans “while not considered an abusive tax avoidance transaction, are questionable” if they primarily benefit one individual (the business owner) and are not operated in accordance with plan rules (Rollovers as business start-ups compliance project | Internal Revenue Service). In fact, the IRS’s project found that many new ROBS-based businesses failed (leading to personal and retirement losses), and that some sponsors failed to file required forms or keep proper records (Rollovers as business start-ups compliance project | Internal Revenue Service) (Rollovers as business start-ups compliance project | Internal Revenue Service). One of the specific items IRS agents look at in ROBS compliance checks is “stock valuation and stock purchases.” (Rollovers as business start-ups compliance project | Internal Revenue Service) This underscores how crucial proper valuation is in the IRS’s eyes.
Key Point: The IRS is not inherently against ROBS arrangements – they even issue favorable determination letters on the 401(k) plan documents if requested, confirming the plan’s design meets the letter of the law (Rollovers as business start-ups compliance project | Internal Revenue Service). However, the IRS expects ROBS plan sponsors to strictly adhere to all rules that govern qualified plans and plan investments. Valuation of the business’s stock is one of those critical rules. The IRS requires that the plan’s purchase and holding of employer stock be done at fair market value, to protect the plan from abuse and ensure the transaction isn’t just a sham to withdraw retirement money tax-free (Guidelines regarding rollover as business start-ups) (Guidelines regarding rollover as business start-ups). With that foundation in mind, let’s explore the formal IRS valuation requirements that apply to ROBS plans.
When your retirement plan buys stock in a closely-held company (like your startup), valuation is everything. The IRS has several layers of requirements – drawn from the Internal Revenue Code, IRS regulations, and ERISA (the Employee Retirement Income Security Act) – to make sure that this transaction is fair and that plan assets are valued properly at all times. In this section, we’ll break down the key IRS requirements that specifically affect Business Valuation in a ROBS plan.
The first critical requirement comes at the very moment your ROBS 401(k) plan purchases stock in your new corporation. The purchase must be for “adequate consideration,” meaning essentially that the price paid for the stock reflects fair market value. This concept arises from the prohibited transaction rules in the tax code and ERISA:
Internal Revenue Code §4975 prohibits certain transactions between a plan and disqualified persons. Notably, it prohibits any sale or exchange of property between a plan and a disqualified person (IRC §4975(c)(1)(A)) (Guidelines regarding rollover as business start-ups). In a ROBS, your corporation is actually a “disqualified person” to your plan (because the business is owned by you, the plan participant, and employs you) (Guidelines regarding rollover as business start-ups). Therefore, the sale of stock (which is property) from the corporation to the plan is by default a prohibited transaction unless an exemption applies.
ERISA §408(e) provides an exemption from the prohibited transaction rule for a plan’s acquisition or sale of “qualifying employer securities” (i.e., employer stock) if the transaction is for “adequate consideration.” (Guidelines regarding rollover as business start-ups) This exemption is crucial – it’s what makes a ROBS transaction possible without immediate violation. Under ERISA §3(18), in the case of an asset (like private stock) without a ready market, “adequate consideration” is defined as “the fair market value of the asset as determined in good faith by the trustee or named fiduciary” following proper regulations (Guidelines regarding rollover as business start-ups). In simpler terms, your 401(k) plan can legally buy stock in your company only if the price paid equals the stock’s fair market value, determined in good faith.
If the stock purchase is not for adequate consideration (FMV), then the exemption doesn’t apply, and the transaction is considered “prohibited.” The tax consequences for a prohibited transaction are severe: IRC §4975(a) imposes a 15% excise tax on the amount involved, and if not corrected promptly, §4975(b) imposes a 100% tax on that amount (Guidelines regarding rollover as business start-ups). In essence, a prohibited transaction can disqualify the plan and result in the IRS treating the entire rollover as a taxable distribution (plus penalties). Clearly, no one wants that outcome.
How does this translate into a requirement? It means that at the time of the rollover investment, the business must be valued to determine a fair share price. The IRS expects that a ROBS plan sponsor will obtain a proper valuation or appraisal of the startup business to set the price of the shares that the plan will buy. You cannot simply decide arbitrarily that your new C-corp is “worth” the exact amount of your 401(k) rollover. In fact, IRS investigators have noted that in many ROBS arrangements they examined, the value of the stock was simply pegged to whatever amount of cash was rolled over, without any substantive analysis – often a “single sheet of paper” appraisal was produced, stating the new company’s stock value equals the available rollover funds (Guidelines regarding rollover as business start-ups). The IRS finds such threadbare valuations highly questionable (Guidelines regarding rollover as business start-ups). If the business has no activity yet (as is common in a brand-new startup) aside from the cash from the plan, a valuation must consider what the business plan is, any assets or intellectual property, contracts, or other factors that contribute to value. A valuation that merely says “Company X is worth $200,000 because that’s how much the individual had in their IRA” will raise red flags. The IRS explicitly warned: “The lack of a bona fide appraisal raises a question as to whether the entire exchange is a prohibited transaction.” (Guidelines regarding rollover as business start-ups)
IRS Guidance: In an internal memorandum, IRS officials stated that ROBS arrangements involve exchanging retirement assets for stock “the valuation of which may be questionable.” They observed that often the stock value is set equal to the available funds, with appraisals “devoid of supportive analysis,” and cautioned that if the true enterprise value doesn’t support that price, a prohibited transaction may have occurred (Guidelines regarding rollover as business start-ups) (Guidelines regarding rollover as business start-ups). To comply, the onus is on the plan fiduciaries (typically you, as the plan owner and administrator) to determine the fair market value in good faith. Best practice (which we’ll cover more later) is to hire an independent business appraiser to perform a formal valuation of the company at the time of the stock issuance. This provides evidence that the purchase price = fair market value. Remember, if the IRS ever challenges the transaction, you must be able to prove that the plan paid no more than fair market value for the shares (Guidelines regarding rollover as business start-ups). If the IRS were to find that the plan overpaid (or underpaid) for the stock, they could assert the exemption doesn’t apply and the stock purchase was a forbidden deal.
It’s worth noting that fair market value (FMV) is generally defined as the price at which a willing buyer and willing seller would transact, both having reasonable knowledge of the relevant facts and neither being under compulsion. For a brand-new business, FMV might be derived from the assets contributed (e.g. cash in bank, equipment, intellectual property) and the potential of the business (if any). In many ROBS cases, initially the corporation has little more than a business plan and the cash from the rollover. Even so, documenting an appraisal that justifies that the stock you issued to the plan is worth what the plan paid is a formal requirement. In fact, having a written appraisal may be essential to demonstrate “good faith” in determining FMV. The DOL regulations and ERISA outline that the plan trustee can determine the value in good faith, but practically, unless you are a valuation expert, you should rely on a qualified appraisal report to support that determination.
Obtaining a fair valuation at the time of the rollover is just the first step. The IRS also requires ongoing valuation of the business within the ROBS plan at least once every year. This requirement stems from both general plan administration rules and specific reporting obligations:
Annual Valuation Requirement (Rev. Rul. 80-155): In a landmark ruling, Revenue Ruling 80-155 (1980), the IRS made it clear that defined contribution plans (like 401(k)s, profit-sharing plans, stock bonus plans, etc.) must value their trust assets at least once per year at fair market value (Issue snapshot – Third party loans from plans | Internal Revenue Service) (Retirement topics - Plan assets | Internal Revenue Service). The reason is that participants’ account balances (and any distributions) must be ascertainable and based on actual value. The IRS reiterated this in an official “Retirement Topics” publication: “Plan assets must be valued at fair market value, not cost. An accurate assessment of fair market value is essential to a plan’s ability to comply with the Internal Revenue Code requirements and Title I of ERISA.” (Retirement topics - Plan assets | Internal Revenue Service) The IRS further explains that improper valuations can lead to a host of compliance problems – from prohibited transactions to violating contribution limits or discrimination tests (Retirement topics - Plan assets | Internal Revenue Service). In short, every retirement plan is expected to perform a valuation of its assets at least annually, on a specified date, using a consistent method (Retirement topics - Plan assets | Internal Revenue Service).
For a ROBS 401(k) plan, this means you need to determine the fair market value of your private company’s stock at least once a year, typically at the end of the plan year. This is identical to how publicly traded investments in a 401(k) are valued (they get a market quote); for your privately held stock, you must obtain a periodic appraisal. Failure to do so is more than just a bad idea – it can be considered a plan qualification failure under IRC §401(a), because most plan documents explicitly require annual valuation of trust assets (Issue snapshot – Third party loans from plans | Internal Revenue Service). If your plan document says, for example, “the trustee shall value the trust’s assets at least annually at fair market value,” and you don’t do it, your plan is not operating according to its terms and not following IRS rules – jeopardizing its qualified status (Issue snapshot – Third party loans from plans | Internal Revenue Service) (Issue snapshot – Third party loans from plans | Internal Revenue Service).
Form 5500 Reporting: The IRS (in conjunction with the DOL) requires that most retirement plans file an annual return/report known as Form 5500 (or 5500-SF/5500-EZ for certain small or solo plans). A ROBS 401(k) plan is not exempt from this filing, even if it covers only the business owner. (Many ROBS entrepreneurs mistakenly think they qualify for the “one-participant plan” exception to Form 5500 filing, but the IRS has clarified that if the plan’s assets are invested in the sponsoring company’s stock, the plan is not eligible for that exception (Rollovers as business start-ups compliance project | Internal Revenue Service). The rationale: in a ROBS, the plan, not the individual, effectively owns the business, so it’s not a standard one-participant plan). Therefore, each year you generally must file a Form 5500 or 5500-SF reporting the plan’s financial condition (Chapter 7: The Annual Requirements of Rollovers for Business Start-Ups - Guidant). One of the key pieces of information required is the value of the plan’s assets (including the value of the employer stock held). If your business is the main asset of the plan, you must have a credible, up-to-date valuation to report. The Form 5500 instructions and schedules (such as Schedule H or I) specifically ask for the fair market value of employer securities held by the plan at year-end.
For example, Guidant Financial (a major ROBS provider) notes: “Form 5500 shows the IRS and DOL the current value of all the plan assets, including the Qualified Employer Securities (QES) you originally purchased. To determine the year-end value, you’ll need a Business Valuation. A Business Valuation shows the worth of the stock and any other assets your corporation holds.” (Chapter 7: The Annual Requirements of Rollovers for Business Start-Ups - Guidant). The process typically involves updating the company’s financial statements (balance sheet, income statement) after year-end and providing them to a valuation expert or your plan administrator who will help determine the stock’s value for the plan’s reporting. If the company has grown, the stock value may have increased; if the company suffered losses, the value may have decreased – either way, it must be measured.
Timing: The valuation should coincide with the plan year-end. Most ROBS plans choose either a calendar year or fiscal year for the plan. You have up to 7 months after the plan year-end to file Form 5500 (Chapter 7: The Annual Requirements of Rollovers for Business Start-Ups - Guidant) (e.g., July 31 for a calendar-year plan), so the valuation should be done as soon as possible after year-end to meet the filing deadline. Not filing a required Form 5500 can result in hefty DOL penalties, and the IRS can also impose penalties for late filing. More so, failure to file or filing with obviously incorrect asset values will draw scrutiny – exactly what you want to avoid. The IRS’s ROBS compliance project identified failure to file Form 5500 as a common problem and reason for compliance checks.
Participant Statements and Fiduciary Duty: If your ROBS 401(k) plan has more than just you as a participant (say you hire employees who can join the plan), ERISA would require that participants receive periodic benefit statements showing their account balance. Even if you are the only participant, as the plan fiduciary you have a duty to manage the plan prudently. Part of prudence is knowing what the plan’s investments are worth. As the IRS has pointed out, prudent management and the exclusive benefit rule (IRC §401(a)(2)) hinge on proper valuation – you can’t know if the plan is being run for the exclusive benefit of participants if you don’t know what the plan’s assets are truly worth (Retirement topics - Plan assets | Internal Revenue Service). Over- or under-valuing the company could lead to misallocation of contributions or even someone (you or an employee) getting a distribution that’s too high or too low.
Bottom line: The IRS requires an annual fair market valuation of the business owned by the plan. Practically, this means getting a professional Business Valuation every year. In fact, many ROBS plan providers include annual valuation services or guidance as part of their administration packages, precisely because it’s an expected requirement. One industry valuation firm notes, “IRS guidelines require the plan to have a fair market value at inception and annually as part of the plan’s filings.” (Using ValuSource Pro to carry out valuations for ROBS strategies. Featuring Samuel Phelps - ValuSource). Another emphasizes that ROBS strategies require an annual Business Valuation to remain compliant (Using ValuSource Pro to carry out valuations for ROBS strategies. Featuring Samuel Phelps - ValuSource). These are not just suggestions – they are reflections of the IRS’s rules we discussed: Rev. Rul. 80-155’s annual valuation mandate and the Form 5500 reporting rules.
Beyond the fundamental rules of fair market value at purchase and annual valuation, there are a few other important regulatory considerations to keep in mind:
Proper Valuation Methods: The IRS doesn’t prescribe a single method for valuing a private business, but it expects valuations to be reasonable and well-founded. Standard valuation approaches (income approach, market approach, asset-based approach) should be employed as appropriate. The appraisal should consider all relevant factors (assets, liabilities, earnings, market conditions, etc.). If the IRS were to audit your plan, they might not second-guess a professionally done valuation, but they will question unsubstantiated numbers. In one internal memo, IRS examiners noted seeing valuations where the appraisal “usually approximates available funds” (basically the valuation magically equaled the rollover amount) and cautioned agents to consider whether any “inherent value” exists in the entity beyond the injected cash (Guidelines regarding rollover as business start-ups). The appraisal must be bona fide – if it’s just a rubber stamp for the cash contributed, the IRS may view the transaction as an abuse.
Correction of Overvaluation/Undervaluation: If it turned out that the price the plan paid was not fair (perhaps an overvaluation), the IRS guidance suggests a corrective action: for instance, the company might have to undo the transaction or make the plan whole by redeeming the stock and contributing cash equal to the true value plus earnings (Guidelines regarding rollover as business start-ups). This is essentially unwinding the deal to fix a prohibited transaction. Such drastic measures can be costly and unwieldy, so it’s far better to get the valuation right from the start.
Nondiscrimination (Benefit, Rights and Features): One issue the IRS has flagged is that ROBS arrangements may inadvertently violate qualified plan nondiscrimination rules if not carefully structured. If your plan is set up so that only you (a highly-compensated employee/owner) benefit from the plan’s ability to invest in employer stock, and other employees aren’t allowed the same opportunity, the IRS could view that as a discriminatory benefit. The IRS memo on ROBS mentioned developing cases for Benefits, Rights and Features discrimination when only the founder can use the ROBS stock feature (Guidelines regarding rollover as business start-ups). The takeaway for valuation: if you do bring on employees who participate in the 401(k) plan, you may need to offer them the same ability to buy company stock through the plan (which would then also require valuation for any such transactions), or you need to amend the plan to remove the stock feature before it causes a problem. Ensure your valuation process could handle additional investors if, say, down the line your employees’ 401(k) money is also buying shares. This isn’t an immediate valuation requirement from the IRS, but it’s a rule that hovers in the background and ties into plan operations.
IRS Compliance Checks and Recordkeeping: The IRS can initiate a compliance check or audit of a ROBS plan. If they do, they will ask for documentation, including how you determined the value of the stock. In their 2009–2010 ROBS project, IRS agents asked for records on “stock valuation and stock purchases” from plan sponsors (Rollovers as business start-ups compliance project | Internal Revenue Service). Being prepared with a formal valuation report for the initial transaction and each year’s valuation will go a long way toward satisfying such inquiries. Conversely, if you lack documentation or have only cursory valuations, it will raise further questions.
Case Law as Cautionary Tales: While there haven’t been many Tax Court cases specifically attacking a ROBS 401(k) that was operated correctly, there are related cases involving similar structures (particularly with IRAs) that underscore the importance of following IRS rules. For example, in Ellis v. Commissioner, a taxpayer rolled his 401(k) into an IRA and had the IRA acquire a business (somewhat akin to a ROBS, but using an IRA/LLC). He then had the company pay him a salary. The Tax Court and 8th Circuit Court of Appeals held that this salary arrangement violated the prohibited transaction rules – essentially, the IRA owner was deemed to be using plan assets (the company) for personal benefit, disqualifying the IRA (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law) (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law). The entire IRA became taxable, and the taxpayer owed taxes and penalties exceeding 50% of the IRA’s value (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law) (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law). The Ellis case highlighted that just because you route funds through a plan doesn’t mean you can ignore the plan rules. Paying yourself improperly or using the company as a conduit for personal gain can trigger disqualification. In the ROBS context, paying yourself a reasonable salary for actual work is generally permissible (you are an employee of the C-corp, after all), but it must be reasonable and not an indirect way to siphon off retirement funds. The Peek v. Commissioner case (Tax Court 2013) is another warning: two taxpayers used a similar rollover strategy and then personally guaranteed a loan for the business. The personal guarantee was held to be an indirect extension of credit to the plan, hence a prohibited transaction, disqualifying their IRAs (IRS Addresses Prohibited Transactions In ROBS Transactions – Strategic Tax Advisors – STA – Business Tax Reviews) (IRS Addresses Prohibited Transactions In ROBS Transactions – Strategic Tax Advisors – STA – Business Tax Reviews). These cases underscore that ROBS plans must avoid any prohibited transactions beyond just the stock purchase itself – and one of the best ways to avoid problems is by adhering strictly to valuation requirements (so that the stock purchase is fair) and then operating the plan and company in a arms-length, compliant manner thereafter.
To sum up the IRS legal framework: the IRS requires that a ROBS plan’s investment in the business be at fair market value, and that the plan’s holding of that investment be valued at least annually at fair market value. These requirements are grounded in tax code provisions (like IRC §§401 and 4975), IRS rulings (Rev. Rul. 80-155), and ERISA exemptions (ERISA §408(e) and ERISA §3(18)). Failing to meet these requirements – e.g., by not getting a proper valuation or by letting valuations lapse for years – can lead to serious consequences, including plan disqualification or prohibited transaction penalties. In the next sections, we’ll discuss how to ensure compliance with these rules and what best practices to follow for ROBS valuations. We’ll also look at common pitfalls that business owners should be wary of when managing a ROBS plan.
It’s worth emphasizing what’s at stake if you do not adhere to the IRS’s valuation requirements in a ROBS plan. The rules we discussed are not mere formalities – they are there to protect the integrity of retirement funds. Ignoring them can lead to significant penalties and tax problems:
Prohibited Transaction Excise Taxes: As discussed, if the stock purchase or any subsequent dealings are not at fair market value, the IRS may deem it a prohibited transaction (since the plan dealt with the company, a disqualified person, on non-fair terms). The cost of a prohibited transaction is 15% of the amount involved right off the bat (IRC 4975(a)), and if not corrected, 100% of the amount involved (IRC 4975(b)) (Guidelines regarding rollover as business start-ups). “Amount involved” typically means the entire amount of the plan’s investment. For example, if your plan invested $200,000 in your company and that was deemed prohibited, you’d owe $30,000 initially (15%) and potentially $200,000 if not fixed – an enormous hit.
Plan Disqualification & Distribution of Assets: In certain cases, particularly egregious ones, the IRS could disqualify the entire plan retroactively. This would mean the rollover that funded the plan becomes a taxable distribution as of the date it occurred. All that money you thought was safely tax-deferred in a plan would be treated as if you took it out (and if you’re under 59½, an early withdrawal penalty could apply too). This is essentially what happened in the Ellis case with the IRA – the entire IRA was deemed distributed and taxable (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law) (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law). With a 401(k), the IRS typically uses excise taxes for prohibited transactions, but disqualification is possible if the plan fails fundamental qualification requirements. For example, not valuing assets properly could be seen as a failure to follow plan terms/Code §401(a) requirements, and the IRS might threaten disqualification unless corrected. Disqualification is a nuclear option – not common if issues can be resolved via correction programs or closing the plan – but it looms as the ultimate consequence.
IRS Audits and Headaches: Even short of full disqualification, non-compliance can trigger audits and complex correction procedures. The IRS has programs (like the Employee Plans Compliance Resolution System) to correct plan errors, but going through them can be costly and time-consuming – often requiring hiring attorneys or compliance specialists. For instance, if you failed to do valuations for a few years and thus filed incorrect Form 5500s, you might have to go back, get retroactive appraisals, amend filings, and possibly pay penalties.
Legal Liability (Fiduciary Breach): If you have other employees in the plan and you don’t uphold your fiduciary duties (e.g., you don’t properly value the stock and that harms their accounts), you could face DOL action or even civil lawsuits. ERISA holds plan fiduciaries personally liable for losses to the plan caused by breaches of their duties. Not maintaining an accurate valuation could be construed as a breach of the duty of prudence. While this is more a DOL/ERISA angle, it is part of the overall compliance picture.
Lost Tax Benefits: One subtle consequence – if your plan is disqualified or you engage in a prohibited transaction, not only can the rollover become taxable, but you also lose the tax-sheltered growth going forward. Any gains in the business’s value that occurred under the plan could become immediately taxable to you personally. This defeats the whole purpose of doing a ROBS, which is to grow your business with pre-tax dollars and pay tax later in retirement.
Opportunity Cost and Distraction: Apart from direct penalties, dealing with IRS non-compliance can distract you from running your business. You could end up spending thousands on fixing compliance issues (whereas a proper valuation might have cost far less). If the IRS puts your plan under a microscope, they may find not just valuation issues but any other foot-fault (e.g., late 5500s, not offering the plan to an eligible employee, etc.). So, one issue can snowball.
In short, non-compliance with IRS valuation rules in a ROBS plan is extremely risky. The cost of doing it right – hiring a professional appraiser annually, keeping good records, filing forms – is minimal compared to the potential cost of doing it wrong. We cannot stress enough that accurate, well-documented business valuations are your best defense in a ROBS plan audit and your ticket to maintaining the plan’s tax-qualified status.
Now that we’ve covered the scary part, let’s turn to the proactive side: how to ensure compliance and run your ROBS plan properly.
Staying on the right side of the IRS requires diligence and good practices. Here are the best practices that business owners and plan administrators should follow to meet IRS requirements for ROBS valuations:
1. Obtain a Qualified Independent Appraisal at Startup: When your ROBS 401(k) plan is about to purchase stock in your new corporation, engage a professional business valuator to appraise your company. Ideally, this valuator should be a credentialed expert (for example, a Certified Valuation Analyst (CVA), Accredited in Business Valuation (ABV) CPA, Accredited Senior Appraiser (ASA), or similar). The appraisal should be in writing and comprehensive, detailing the methods used and the reasoning behind the concluded value. This report will establish the price per share for the stock that the plan will buy. By doing this, you create a solid paper trail demonstrating that the plan paid fair market value (adequate consideration) for the shares (Guidelines regarding rollover as business start-ups). An independent appraisal carries more weight than any informal estimate you might make as the owner – it proves you went the extra mile to ensure compliance. SimplyBusinessValuation.com, for instance, specializes in providing such independent, IRS-compliant valuations, ensuring that the initial stock transaction is backed by a defensible fair market value analysis.
2. Document Everything: Keep copies of all valuation reports, financial statements, and communications regarding the valuation. If you used projections in the valuation, keep documentation of those projections. If your company was pre-revenue, document any contracts, franchise agreements, market studies, or other data given to the appraiser. In an IRS compliance check, you may be asked for how you determined the stock’s value (Rollovers as business start-ups compliance project | Internal Revenue Service). Having that appraisal report and supporting documents on file will answer that question decisively.
3. Perform Annual Valuations and Do Them Consistently: Mark your calendar for annual valuations. Many ROBS businesses choose a calendar year-end for simplicity. After each fiscal year or plan year, gather your company’s financial results and engage an appraiser (or the same firm) to update the valuation. Follow a consistent methodology year to year (unless a change is justified). This aligns with the IRS guidance that valuations should be done on a “specified date” each year and using methods “consistently followed and uniformly applied” (Retirement topics - Plan assets | Internal Revenue Service). Consistency shows that you’re not manipulating values; you’re simply reporting them. Each year’s valuation will inform your Form 5500 reporting and any participant statements. It will also be critical if, for example, you decide to take some distribution or if the business is sold – you’ll need the most recent FMV to allocate proceeds correctly.
4. Use Realistic Assumptions and Projections: When working with your appraiser, ensure that the assumptions used (about revenue growth, profit margins, etc.) are reasonable. Overly optimistic projections might boost the valuation without basis, whereas pessimistic ones might undervalue the company. Either extreme could be problematic: overvaluation could be seen as the plan overpaying for stock (benefiting the business/owner), while undervaluation could be seen as the plan getting a bargain to the owner’s benefit if the owner holds some shares. The goal is accurate FMV. It’s fine if the initial valuation essentially equals the cash rolled in (often, a new company’s value is largely the cash it has, since operations haven’t started), but make sure the report explains why that is (e.g., “the company’s only asset is $X cash and it has yet to commence operations, hence the equity value is approximately $X”). If later the company acquires assets, wins contracts, or starts generating earnings, those factors should reflect in the new valuation.
5. Comply with Form 5500 Filing Obligations: Always file your Form 5500 (or 5500-SF/5500-EZ as appropriate) on time, and ensure the plan asset values reported match your valuation. If your valuation report says the company is worth $500,000 as of 12/31, that is the number that should appear on the form for the value of that asset. Keep the valuation report in your records in case the IRS or DOL ever question the figures. Remember, as the IRS pointed out, many ROBS mistakes involved not filing a 5500 due to misunderstanding the rules. Don’t fall into that trap – file the return and use it as an opportunity to demonstrate compliance (by showing the proper values).
6. Monitor the Business and Update Valuations for Major Events: Aside from the routine annual valuation, certain events might merit a fresh valuation out of cycle. For example, if you bring in a new investor who buys shares (outside of the plan) or if you issue more stock to the plan in exchange for additional rollovers, each of those transactions should be at a fair value determined at that time. Similarly, if your business experiences a dramatic change (say you lost a major contract or conversely got an offer from a buyer), it might affect value. For plan purposes, the annual requirement is usually sufficient, but be mindful of any situation where you might inadvertently have the plan transact at an outdated value.
7. Ensure Plan and Corporate Formalities are Respected: Keep the retirement plan’s activities at arm’s length. The plan should be recognized as a shareholder of the company. That means if the company issues stock certificates, one certificate should be in the name of, for example, “XYZ Corp 401(k) Plan, [Trustee Name], Trustee” for the number of shares the plan owns. The plan’s ownership percentage should be clear. If any dividends are issued (though rare in a startup; more likely profits are reinvested), they should go to the plan’s account. Observing these formalities will support the valuation process because it clarifies what the plan owns and that the plan’s investment is separate from your personal ownership (if any). It also helps avoid unintended prohibited transactions – e.g., don’t commingle personal funds with plan-owned shares.
8. Work with Experienced ROBS Professionals: Running a ROBS plan isn’t a typical do-it-yourself project. The stakes are high, and the rules are nuanced. It’s wise to work with a Third Party Administrator (TPA) or service provider who specializes in ROBS arrangements. Many such providers (Guidant, Benetrends, etc.) offer ongoing plan administration that includes coordinating the annual valuation and ensuring paperwork is in order. They can prepare your plan’s annual report and Statement of Value for the plan (Chapter 7: The Annual Requirements of Rollovers for Business Start-Ups - Guidant) (Chapter 7: The Annual Requirements of Rollovers for Business Start-Ups - Guidant). While you, as the plan sponsor, remain ultimately responsible, having professionals guide you means fewer chances to slip up. SimplyBusinessValuation.com, for instance, can be part of that professional support team – focusing specifically on delivering credible business valuations needed for the plan’s compliance, and liaising with your TPA or CPA to get the numbers right.
9. Don’t Ignore Other Plan Requirements: This is a general best practice – while valuation is our focus, remember that your ROBS 401(k) plan is a qualified retirement plan. That means you need to follow all the usual rules: covering employees who become eligible, not discriminating in contributions, depositing any salary deferrals timely, issuing any required participant notices, etc. If your business grows and you hire staff, work with your plan administrator to keep the plan in compliance on those fronts. Why mention this here? Because a compliant plan overall lends credibility to your ROBS setup. If everything else is run correctly, an IRS agent is more likely to trust your valuations too. Conversely, if your plan is a mess, they’ll assume the valuation is suspect as well. In short, overall compliance and good governance create a trustworthy context for your valuations.
10. Prepare an Exit Strategy: This might not seem like a “compliance” tip, but it’s important. Consider how you will eventually unwind the ROBS arrangement. Is the plan going to sell its shares back to you or to a third party when you retire? Will the business likely be sold, triggering a payoff to the plan? Having an idea of this can inform your valuations and record-keeping. For instance, if you plan to buy out the plan’s shares personally down the road, you’ll definitely need a solid valuation at that time to set a fair price (again to avoid a prohibited transaction of buying the stock for too cheap from the plan). By keeping your valuations up to date annually, when the time comes for exit, you’ll have a history of values and justification for the final number. Many ROBS entrepreneurs plan eventually to roll the business out of the plan (so they own it personally) or to dissolve the plan once the business is mature. Both scenarios will hinge on knowing the stock’s value to do it correctly.
Following these best practices not only keeps the IRS satisfied but also provides financial clarity for you as a business owner. Knowing the true value of your company year over year is a useful management insight as well – it’s not just a compliance exercise. It can help you gauge how well your business is performing and whether your retirement investment is growing.
Next, let’s specifically address some common pitfalls to avoid in ROBS plan valuations, which will reinforce some of the points above and highlight mistakes others have made (so you won’t repeat them).
Even with the best intentions, ROBS plan sponsors can stumble into mistakes. Here are some common pitfalls and traps related to Business Valuation in ROBS plans, along with tips on how to avoid them:
Pitfall 1: Assuming the Rollover Amount = Business Value (No Real Appraisal) – Many entrepreneurs think, “I’m investing $150,000 from my 401(k) into my startup, so the company is obviously worth $150,000.” They then document the stock purchase at that value without further analysis. The IRS has explicitly criticized this scenario, noting that often ROBS promoters present valuations where the “sum certain” equals the available retirement funds, with no support (Guidelines regarding rollover as business start-ups). The danger here is if the company isn’t really worth that (for instance, if some of that cash immediately goes to pay a hefty promoter fee or is spent on costs that don’t translate into assets or business value), the plan may have overpaid for stock. Avoid this by getting a thorough appraisal at the start. Even if the appraised value comes out very close to the cash amount, it will have reasoning behind it – and if it doesn’t (say the appraisal says your nascent business is only worth $100K out of the $150K you put in, due to startup costs, fees, or inherent risk), you’ll know that beforehand and can structure the transaction appropriately (maybe the plan only buys $100K worth of shares and treats the other $50K carefully, or you adjust share pricing). Never just wing it with value – always substantiate.
Pitfall 2: Using a Non-Qualified or Biased Appraiser – Some business owners might ask their local CPA or a friend who “knows about finance” to write a quick valuation letter. Unless that person is actually qualified in Business Valuation, this could backfire. The IRS will look at the credentials of who did the appraisal if it comes up for audit. Using a credentialed, independent appraiser is key. Do not use someone who has a conflict of interest (for example, you should not be the one valuing your own company for the plan; nor should a family member or someone who is not independent). Also avoid anyone using overly simplistic methods (like just book value) if it’s not appropriate. Avoid this by engaging a reputable valuation firm (like SimplyBusinessValuation.com or similar) with experience in IRS-related valuations. They will produce a report that can stand up to scrutiny. The cost of a professional appraisal is well worth avoiding the pitfall of an inadequate valuation. Remember the IRS noted that many valuations they saw were just a “single sheet of paper” signed by a so-called specialist (Guidelines regarding rollover as business start-ups) and deemed those questionable. You want more than a one-pager – you want a full report.
Pitfall 3: Skipping or Delaying Annual Valuations – After the initial setup, some owners forget about the valuation until years later (perhaps when they want to take money out or the IRS comes knocking). This is a big no-no. If you fail to value the stock annually, your Form 5500 might show the same stock value year after year, which can raise suspicion (for example, if it’s unchanged, the IRS might suspect you haven’t bothered to update it, since rarely does a business not change value at all). The IRS has noted that if a plan reports the same value across multiple years for an asset (like a loan or stock) with no change, it likely indicates no proper appraisal was done (Issue snapshot – Third party loans from plans | Internal Revenue Service). Avoid this by marking a recurring date to perform the valuation (e.g., every December or every fiscal year end). Work with your TPA who will usually remind you – Guidant Financial, for instance, gathers financial info from clients each year specifically to produce the annual valuation and include it in the plan’s annual report (Chapter 7: The Annual Requirements of Rollovers for Business Start-Ups - Guidant) (Chapter 7: The Annual Requirements of Rollovers for Business Start-Ups - Guidant). Consider the annual valuation a non-negotiable requirement (because it is, per IRS rules (Retirement topics - Plan assets | Internal Revenue Service)). If cash is tight to pay for an appraisal, factor that cost into your annual budget – it’s part of the cost of using a ROBS strategy.
Pitfall 4: Not Filing Form 5500 (and thus hiding the need for valuation) – Some ROBS plan sponsors, wrongly advised, think they don’t have to file Form 5500 if the plan assets are below $250,000. As mentioned, that exception doesn’t apply to ROBS in most cases (Rollovers as business start-ups compliance project | Internal Revenue Service). If you skip the 5500, you might also think you can skip the valuation (since no one is asking for the number). This is a double mistake. The IRS found many ROBS plans that didn’t file the 5500; those became targets for compliance checks (Rollovers as business start-ups compliance project | Internal Revenue Service). Avoid this by always filing the required forms. Even a one-participant ROBS plan must file a 5500-EZ if assets ≥ $250k, and if < $250k, the IRS still encourages filing or at least maintaining records because once you exceed that threshold or terminate the plan, you’ll have to report. It’s best to treat a ROBS plan as if it must file regardless. This forces discipline – you’ll make sure to get valuations to have accurate info to report. Plus, the new 401(k) plan likely had over $250k from the rollover to start, so you probably fall in the filing requirement from year one anyway.
Pitfall 5: Prohibited Transactions via Indirect Benefits – While not directly a “valuation” problem, certain actions can indirectly relate to the valuation and compliance. For example, using the corporation’s cash (which largely came from the plan) to pay yourself back or to pay personal expenses could be construed as misuse of plan assets. Promoter fees are one example: if your corporation immediately uses a chunk of the plan-invested cash to pay the ROBS promoter or consultant fees, the IRS has indicated this could be a prohibited transaction (Guidelines regarding rollover as business start-ups). The reasoning is that the promoter might be a fiduciary or at least the payment diminishes plan assets for something that benefited you (starting the plan). To avoid issues, such fees should be structured properly (often paid by the corporation as a legitimate business expense, which is okay, but if the promoter was also an investment advisor to the plan, that’s sticky). How does this tie to valuation? If $X of the plan’s money left the company as fees right after the stock purchase, the true value of the company might be lower than what the plan paid. If that wasn’t accounted for, the plan effectively overpaid. Avoid this by ensuring any setup fees are reasonable and by factoring all expenses into the valuation model (for instance, subtract the fee expense in the opening balance sheet or projections). Also, avoid any personal guarantees on loans (as noted earlier, that’s a direct prohibited transaction in cases like Peek (IRS Addresses Prohibited Transactions In ROBS Transactions – Strategic Tax Advisors – STA – Business Tax Reviews)). If you must get an SBA loan, discuss with a ROBS consultant how to do it without violating rules (some suggest having the individual not the plan own a certain percentage of the business so the guarantee is tied to that portion – it’s complicated). The main point: after the plan owns the stock, treat the plan as a separate investor whom you must not shortchange.
Pitfall 6: Neglecting the “Exclusive Benefit” rule – Every plan must be maintained for the exclusive benefit of participants and beneficiaries (IRC 401(a)(2)). If you run the business in a way that suggests you’re deriving personal benefit at the plan’s expense, the IRS or DOL could claim a breach of this rule. For example, if you pay yourself an unreasonably high salary such that the company’s value (and thus the plan’s share value) suffers, one could argue you diverted value from the plan to yourself. Or if you lease property from yourself at above-market rent using the company’s funds, similarly. These might not be direct valuation issues, but they affect the value and raise prohibited transaction concerns (IRS Addresses Prohibited Transactions In ROBS Transactions – Strategic Tax Advisors – STA – Business Tax Reviews). Avoid this by keeping dealings fair. Pay yourself a market salary for your role – document the justification (so if IRS looks, you can show it wasn’t excessive). Any transactions between the company and you (or your relatives) should be at market rates or avoided. By running a clean operation, the valuations will reflect genuine business performance and there will be no hidden “leakage” of value that regulators could pounce on.
Pitfall 7: Failing to Include All Assets/Liabilities in the Valuation – Sometimes a ROBS company might have more assets than just the cash from the plan. Perhaps you, as the founder, also put in some cash separately, or the company took on a small loan, or acquired equipment. Make sure the valuation considers all assets and liabilities. If you personally put in money as a separate capital contribution, note that the plan and you now have to share ownership – which complicates things and definitely requires valuation to ensure each gets the appropriate share percentage. Ideally, ROBS providers recommend only using the retirement money initially to keep it simple (100% plan-owned company). If you mix sources, it’s not forbidden, but it heightens the need for precise valuation so that, say, if you contributed $50k personally and the plan contributed $200k, the ownership split (20/80 in that case) is fair. Avoid errors by clear accounting and communicating everything to your appraiser.
Pitfall 8: Letting the Business Languish (Non-Startup) – The IRS memo pointed out a scenario where a “start-up” doesn’t actually start up – meaning the corporation took the retirement money, but then hardly pursued any business (no franchise purchased, no real operations begun) (Guidelines regarding rollover as business start-ups). In such cases, the valuation that justified the exchange is basically just a round trip of cash, and if that business goes nowhere, the IRS might argue the whole thing was a sham to get money out of the 401(k). They indicated that if inherent value doesn’t materialize (no bona fide business activity), the transaction could be considered abusive (Guidelines regarding rollover as business start-ups) (Guidelines regarding rollover as business start-ups). Avoid this by genuinely engaging in the business you planned. It’s understandable that not all businesses succeed (the IRS found many ROBS businesses failed within a few years (Rollovers as business start-ups compliance project | Internal Revenue Service)), but you must show a good faith effort. If the business fails, your plan’s shares might become worthless – that’s an investment risk the IRS acknowledges. But if you never really tried, the IRS could recharacterize the deal as simply an early IRA withdrawal in disguise. So, make sure to treat your business as a real business – get customers, make sales, follow your business plan. This also will make your valuations meaningful (reflecting actual operations rather than hypotheticals).
By being aware of these pitfalls and actively avoiding them, you greatly increase the likelihood that your ROBS plan will operate smoothly and stay compliant. Many of these pitfalls boil down to a common theme: don’t cut corners. Valuation and compliance might seem like areas to possibly save a buck or two, but that’s false economy. The cost of mistakes is far higher than the cost of doing things right.
Navigating the IRS requirements for ROBS valuations can be complex and time-consuming. As a business owner, your focus is on building your company – yet you have this ongoing responsibility to prove to the IRS that your retirement plan’s investment is legitimate and fairly valued. This is where SimplyBusinessValuation.com becomes an invaluable partner.
Expert ROBS Valuation Services: SimplyBusinessValuation.com is a professional service that specializes in Business Valuation, including valuations for ROBS 401(k) plans. We understand the unique nature of ROBS transactions and the scrutiny the IRS places on them. Our team consists of experienced, credentialed valuation experts who have performed numerous valuations for companies funded by rollovers. This means we are familiar with the IRS’s expectations and common pitfalls – and we know how to produce robust valuation reports that meet or exceed IRS standards.
Independent and Credible Appraisals: When you engage SimplyBusinessValuation.com, you get an independent third-party appraisal of your business. Independence is key to credibility. We have no stake in your business; our only job is to determine a fair market value. Because of this, our reports carry weight. If an IRS agent or CPA examines the valuation, they will see it was done by a qualified appraiser, following professional valuation methodologies, complete with analysis and justification. This instills trust and can significantly smooth out any inquiries or audits. It essentially “audit-proofs” the valuation aspect of your ROBS plan.
Comprehensive Reports Meeting IRS Criteria: Our valuation reports typically include a detailed description of your business (or business plan if it’s a startup), economic and industry analysis, financial statement analysis, and an explanation of the valuation approaches used (income approach like discounted cash flow, market comparables, asset-based approach, etc., depending on what’s appropriate). We explicitly state the concluded fair market value of the equity and thus the stock. Such thorough documentation aligns with the IRS’s notion of a “bona fide appraisal”, avoiding the scenario of the flimsy one-page valuation that IRS examiners dislike (Guidelines regarding rollover as business start-ups). By having a SimplyBusinessValuation.com report on file, you demonstrate that you took valuation seriously and followed formal requirements.
Assistance at Inception and Annually: SimplyBusinessValuation.com can work with you right at the inception of your ROBS plan to set the initial stock value, and then on an annual basis to update the valuation. We can coordinate timelines so that each year’s appraisal is ready in time for your Form 5500 filing. We also offer consultations if there are significant changes during the year – for example, if you are considering bringing in a new investor or if you want to buy out the plan’s shares, we can perform a valuation for that transaction and advise on how to structure it fairly. Essentially, we become your valuation partner throughout the life cycle of your ROBS-funded business.
Collaboration with Your Financial Team: We know that ROBS compliance is a team effort – it may involve your CPA, a TPA, an attorney, or a financial advisor. SimplyBusinessValuation.com is accustomed to working alongside other professionals. We can provide the necessary valuation figures and even narrative that your CPA needs for the 5500 or that your attorney might need to respond to IRS queries. By being a one-stop specialist on the valuation piece, we free up your CPA/attorney to focus on legal and accounting compliance, making the whole compliance process more efficient.
Education and Guidance: We don’t just hand over a report – we help you understand it. As a business owner, you may not be familiar with valuation concepts; our experts take the time to explain the findings and answer your questions. This empowers you to make informed decisions. For example, if the valuation comes in lower than expected, we’ll explain why – maybe the business had lower cash flows or higher risk factors – and what might help increase value in the future. If it’s higher, we’ll caution how to manage growth while staying compliant. This educational approach means you’re not left in the dark about your own company’s valuation. And if down the road the IRS or DOL asks questions, you’ll be well-prepared to address them because you understand the basis of the valuations.
Tailored Solutions for ROBS Exits: When it comes time to unwind the ROBS (perhaps you’re ready to retire and take distributions, or you want to terminate the plan and own the company outright), SimplyBusinessValuation.com can assist with valuation for the exit strategy. This might involve valuing the company for a stock buyback or for an outright sale. By having continuity – the same valuation firm that’s tracked the company for years – the final valuation is built on a deep understanding of your business’s history. We ensure the final transaction (like the plan selling shares to you or a third party) is at a fair price, maintaining compliance up to the very end of the plan.
Peace of Mind: Perhaps the most valuable thing we offer is peace of mind. As a business owner using a ROBS, you likely have heard that the IRS keeps a close eye on these plans. That concern can weigh on you. By engaging professionals like SimplyBusinessValuation.com, you can sleep better knowing that a critical compliance element – proper valuation – is being handled meticulously. You are far less likely to face nasty surprises in an audit, and you can confidently show any interested party (be it IRS, DOL, a potential investor, or a CPA reviewing your plan) that your business valuations are accurate and up-to-date.
At SimplyBusinessValuation.com, we pride ourselves on being a valuable ally for business owners in ROBS arrangements. We understand you took a bold step to invest in your own business with your retirement funds, and we want to help ensure that decision pays off, not only in business success but in hassle-free compliance.
By leveraging our services, you essentially have an ongoing compliance partner for the valuation aspect of your ROBS plan – allowing you to focus on growing your business, while we handle the complex calculations and documentation needed to keep the IRS satisfied.
Q1: What exactly is a ROBS plan, in simple terms, and is it legal?
A: A ROBS (Rollovers as Business Startups) plan is a mechanism that lets you use money from a tax-deferred retirement account (like a 401(k) or IRA) to start or buy a business without paying taxes or penalties on the withdrawal, by rolling the funds into a new 401(k) plan that invests in your company’s stock (Rollovers as business start-ups compliance project | Internal Revenue Service). In practice, you form a C-corporation, create a new 401(k) for that company, roll your old retirement funds into the new plan, and then the plan buys shares in the corporation (giving the company cash to operate). Yes, ROBS plans are legal – the IRS does not consider them per se abusive (Rollovers as business start-ups compliance project | Internal Revenue Service). However, they must be done right. The IRS has specific requirements (like proper valuation, nondiscrimination, etc.) to ensure the arrangement isn’t being misused. If those rules are followed, a ROBS plan can legally fund your business startup. The IRS even issues determination letters on these plans to affirm they meet the tax code requirements (Rollovers as business start-ups compliance project | Internal Revenue Service). The key is compliance in operation – that’s where many get tripped up if they’re not careful.
Q2: Why does the IRS care so much about Business Valuation in a ROBS plan?
A: Because valuation is the linchpin that ensures the transaction is fair to the retirement plan and that no one is siphoning off retirement funds improperly. When your 401(k) plan buys stock in a private company (your startup), there’s no public market price to reference. The IRS wants to make sure the plan isn’t overpaying or underpaying for that stock. If the plan overpays, it means your personal business got more of your retirement money than it should have – possibly a prohibited transaction benefiting a disqualified person (you or your business) (Guidelines regarding rollover as business start-ups) (Guidelines regarding rollover as business start-ups). If the plan underpays, it could mean you or someone gave the plan a sweetheart deal (also problematic). Fair market value determination protects the integrity of the plan. Additionally, the IRS requires annual valuations because they need to know the true value of the plan’s assets for tax regulation purposes (like ensuring contributions aren’t excessive, distributions are correct, etc.) (Retirement topics - Plan assets | Internal Revenue Service). In short, proper valuation prevents abuse (like tax avoidance schemes) and ensures the plan remains a legitimate retirement plan investment rather than a disguised distribution of funds.
Q3: Do I really need a professional appraisal for my ROBS-funded business? The business is brand new with just my rolled-over cash in it.
A: Yes, you do. Even if the only asset initially is cash, a professional appraisal is highly recommended (and effectively required) to document the stock’s fair market value at the time the plan purchases it. The IRS expects a “bona fide appraisal” (Guidelines regarding rollover as business start-ups) – especially because in many ROBS arrangements the value claimed for the stock equals the cash invested, which is exactly what they find questionable without analysis (Guidelines regarding rollover as business start-ups). A new business may not have much history, but an appraiser will consider factors like the business plan, any agreements (franchise contracts, leases), the intended use of funds, comparable startup valuations, etc., in addition to the cash. This provides a good faith valuation that you can show the IRS. If you skip a professional appraisal and just state the company is worth, say, $200,000 because that’s what you rolled over, the IRS could challenge that if the business later doesn’t materialize as planned. Moreover, Revenue Ruling 80-155 essentially mandates annual valuations by plan fiduciaries (Retirement topics - Plan assets | Internal Revenue Service), and it’s implied that those should be based on sound valuation methods. Using a certified appraiser is the safest way to fulfill your fiduciary duty to determine FMV. In sum, while there’s a cost to getting an appraisal, it’s a necessary investment in keeping your ROBS compliant.
Q4: Can I do the Business Valuation myself to save money, or have my CPA do it?
A: It’s not advisable for you to do it yourself. As the business owner and plan participant, you are not independent – any valuation you do could be seen as biased. Also, unless you have formal training in Business Valuation, the IRS may not consider your valuation methodologically sound. Having your CPA do it might be acceptable if the CPA is experienced in valuations and not a disqualified person to the plan (if the CPA is also an insider in the company or plan, that’s an issue). However, many CPAs are not valuation specialists. The best course is to hire an independent valuation professional (or a firm like SimplyBusinessValuation.com). That gives you an objective report. Keep in mind, the IRS doesn’t explicitly forbid you or a CPA from doing a valuation, but if audited, an in-house or flimsy valuation will get a lot more scrutiny and skepticism. An independent appraisal carries more weight and shows you took the proper steps. In the words of DOL regulations under ERISA’s “adequate consideration” requirement, fair market value must be determined “in good faith by the trustee or named fiduciary” (Guidelines regarding rollover as business start-ups) – a trustee can rely on an expert to meet that good faith requirement. So, use an expert. It’s money well spent for the protection it offers.
Q5: How often do I need to value my business in a ROBS plan?
A: At least once per year. The IRS requires annual valuations of plan assets for defined contribution plans (Issue snapshot – Third party loans from plans | Internal Revenue Service). Typically, you’d do it at the end of each plan year (e.g., December 31 if on calendar year). Annual valuations are needed for the Form 5500 reporting (Chapter 7: The Annual Requirements of Rollovers for Business Start-Ups - Guidant) and to allocate earnings to participants’ accounts properly. If there’s a triggering event in between (like the plan buying more stock or selling stock), you’d also do a valuation at that time. But assuming no major events, a valuation every year is the standard. Additionally, you’d need a valuation whenever the plan or you plan to dispose of the shares (like if you’re terminating the plan and distributing the stock or the company is being sold). But as a routine, think yearly. As one ROBS administrator succinctly put it: “ROBS strategies require an annual business valuation… performed to establish a share value” (Using ValuSource Pro to carry out valuations for ROBS strategies. Featuring Samuel Phelps - ValuSource). This keeps you compliant and informed.
Q6: My business is small and hasn’t changed much this year – do I still need an annual valuation?
A: Yes. Even if little has changed, you still need to document the value. It might be that the value hasn’t moved much – that’s okay, the valuation will report perhaps a similar number as last year, with reasoning (like the company is still developing, or had roughly the same financial position). The key is you must go through the process. The IRS wants to see that you updated the valuation according to the rules. If you skip a year assuming “no change,” it will appear as non-compliance. Also, sometimes subtle changes could affect value (maybe you depreciated some equipment, or took on a loan, or the market environment changed). The valuation doesn’t necessarily have to be a full-blown new 50-page report if truly nothing changed – some appraisers offer an update letter or shorter update report for subsequent years if the baseline is established. But it does need to be updated with the latest data (even a stagnating business’s balance sheet has one less year of cash burn or one more year of small profits, etc., which affects net assets). So, short answer: always do the annual valuation, even for a small or seemingly static business. It’s a requirement, not an optional checkup.
Q7: What happens if I don’t get a valuation and the IRS finds out?
A: If you fail to get required valuations, a few things could happen. First, your Form 5500 might be inaccurate (since you likely guessed a value), which can itself lead to penalties or at least an IRS inquiry. In an audit, the IRS could cite you for failure to value assets as required by Rev. Rul. 80-155 (Issue snapshot – Third party loans from plans | Internal Revenue Service) and potentially treat it as a plan operational failure. They would likely require you to obtain retroactive valuations (which could be costly) and correct any discrepancies (for example, if the stock was actually worth less, making corrective contributions to participants’ accounts might be needed). In the worst case, if not valuing led to significantly improper outcomes (like someone took a distribution for more or less than they should have, or an employee was disadvantaged), they could pursue plan disqualification. Also, not having a valuation at the start could lead them to determine the stock purchase was not for adequate consideration, hence a prohibited transaction – meaning excise taxes (15% or 100% of the investment) and the requirement to “correct” by possibly unwinding the transaction (Guidelines regarding rollover as business start-ups). Essentially, not getting a valuation opens you up to the IRS recalculating things with hindsight, which likely won’t be favorable. It also marks you as a non-compliant fiduciary, which is not a position you want. So, the fallout can be corrected through compliance programs if caught (often with penalties or sanctions), but it’s a mess you want to avoid. Think of annual valuations as part of the “must-do” list, similar to how you wouldn’t skip filing a tax return – you shouldn’t skip valuations for your ROBS plan.
Q8: What are the penalties if the IRS determines my valuation was wrong or the stock purchase was not at fair market value?
A: The main penalties would come from treating it as a prohibited transaction. If the IRS says, “Your plan paid more for the stock than it was worth” or “the valuation was deficient, so we don’t accept that the transaction met the adequate consideration exemption,” then they could impose the IRC 4975 excise taxes: 15% of the amount involved, and if not promptly corrected, 100% (Guidelines regarding rollover as business start-ups). They would also require correction – meaning you’d have to fix the deal so the plan is put in the position it should have been. That could mean the company returning money to the plan or issuing more shares to the plan to make up value, etc., plus interest for lost earnings (Guidelines regarding rollover as business start-ups). Additionally, any tax benefits could be unwound – for instance, if they disqualify the plan, the entire rollover becomes taxable income to you (plus possible early withdrawal penalties). The Tax Court cases like Peek and Ellis illustrate this: in Peek, the prohibited transaction (personal guarantee) caused the IRA to be disqualified from day one, meaning a big tax bill (IRS Addresses Prohibited Transactions In ROBS Transactions – Strategic Tax Advisors – STA – Business Tax Reviews); in Ellis, paying himself led to the entire IRA being taxable and penalties on top (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law) (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law). For a 401(k) ROBS, the IRS might lean toward the excise tax route rather than immediate disqualification, but either way, it’s costly. There could also be penalties for filing false information if the 5500 had wrong values knowingly, and if extreme, even potential criminal implications (though that would be rare and usually only if fraud is involved). But typically, you’re looking at financial penalties and the requirement to fix things under IRS supervision – which could end up costing a significant portion of your retirement funds. In short: wrong valuation -> possible prohibited transaction -> 15%/100% excise taxes and corrective action -> maybe plan disqualification if uncorrectable. None of that is a pleasant outcome.
Q9: Can I pay myself a salary from my ROBS-funded business? Will that affect the plan or valuation?
A: Yes, you absolutely can pay yourself a salary – in fact, most people using ROBS do so because they will work in the business and need income. Paying yourself a reasonable salary for actual services rendered is allowed. The key is “reasonable” and not excessive. The plan’s investment in the company doesn’t preclude the company from having normal expenses like payroll. The IRS in Ellis took issue because the taxpayer basically used an IRA (which has stricter rules) and then funneled payments to himself through the company (Using your Rollover IRA to Buy Yourself a Job? Think Twice and Carefully! – Williams Parker Attorneys at Law). With a 401(k) plan, it’s generally accepted that the owner will draw a wage. The IRS has not banned salaries in ROBS; however, if your salary is exorbitant relative to the company’s earnings, the IRS could view it as a way of diverting the retirement assets to yourself (a kind of indirect self-dealing). That could violate IRC 4975(c)(1)(E), dealing with plan assets for own benefit (Guidelines regarding rollover as business start-ups). From a valuation perspective, your salary is an expense that will reduce the company’s profits (and thus potentially its value). A valuator will include your salary in the cash flow analysis. If you pay yourself a market rate, then the remaining profit (or loss) is true business performance. If you underpay yourself, the company’s profit might look high, inflating value (though any buyer would adjust for a market wage). If you overpay, the company might show a loss or low profit, deflating value (but you got the cash in your pocket). So it’s best to pay a normal salary. In summary: salary – yes, allowed. But keep it reasonable and for real work performed, and be aware that extreme compensation could attract IRS attention as a potential violation or could distort the valuation if not accounted for properly. Many ROBS promoters recommend taking a modest salary in the early stages to preserve business capital – but that’s a business decision. Just document your role and pay yourself what your work is worth to the business.
Q10: If I take an SBA loan or other financing for the business, does it impact the ROBS arrangement or valuation?
A: It can. Taking a loan for the business isn’t inherently a problem for the ROBS – businesses often need loans. However, be very cautious about personal guarantees. Most SBA loans require the owners to personally guarantee the loan. In a ROBS, the owner (you) might not technically own the stock – your 401(k) plan does. But practically, the SBA will likely still ask for your personal guarantee if you are running the company (and often they may require you personally own at least some shares). If you personally guarantee a loan that benefits the plan’s investment (the company), the IRS could view that as an extension of credit between you (disqualified person) and the plan, which is a prohibited transaction (IRS Addresses Prohibited Transactions In ROBS Transactions – Strategic Tax Advisors – STA – Business Tax Reviews). The Peek case is exactly that scenario with an IRA: personal guarantees on business loans blew up the plan (IRS Addresses Prohibited Transactions In ROBS Transactions – Strategic Tax Advisors – STA – Business Tax Reviews). Some ROBS providers have gotten opinions or developed structures to try to avoid this issue, but it remains a grey area. Before taking an SBA or bank loan, consult with your ROBS attorney/consultant. They might structure it so that you personally own a small percentage of the company, and only guarantee for that portion, or find lenders who won’t require a guarantee (rare). As for valuation: if the company takes on debt, the equity value in the company might change. The valuation will consider any new debt. If you personally guarantee a loan and that loan improves the company’s outlook (and value), ironically you’ve increased the plan’s asset value but endangered the plan’s compliance. So it’s a trade-off to consider carefully with professional advice. In summary: Loans – OK for business growth; Personal guarantee of those loans – potentially a serious issue for ROBS (seek advice before doing so).
Q11: How do I eventually get my money out of the ROBS plan? What’s the exit strategy, and do I need valuations then?
A: Great question – eventually, you’ll want to either sell the business or retire and take distributions. There are a few exit paths:
No matter which route, valuation plays a key role. You will need a solid valuation to set the price for any internal transfer (buying out the plan), or to report a distribution’s value, or even to evaluate offers from potential buyers. The good news is, if you’ve been doing annual valuations, you’ll have a baseline and likely an appraiser who knows your company. That makes the exit valuation smoother and more accurate. In summary, you’ll get your money out by either selling the business or the plan’s shares, or distributing the assets. And yes, you will need valuations at that stage to do it correctly and comply with IRS rules on transactions and distributions.
Q12: How does SimplyBusinessValuation.com assist with ROBS plan valuations and compliance?
A: SimplyBusinessValuation.com is a service dedicated to providing independent, professional business valuations for situations exactly like ROBS plans. We help at all stages:
In essence, SimplyBusinessValuation.com acts as your valuation compliance partner. Instead of you having to find a valuation expert each year and worry about whether they understand ROBS, you have a consistent go-to resource with us. Our expertise in IRS compliance and focus on Business Valuation means you get top-quality service. By using us, you demonstrate to the IRS that you’re taking the valuation requirements seriously and getting unbiased, professional opinions on value. This greatly reduces risk and frees you to focus on running your business. We help make sure that the valuation component of your ROBS plan is rock-solid, which in turn helps keep your entire ROBS arrangement secure and in good standing with the IRS.
Conclusion: Using a ROBS plan to fund your business can be a fantastic way to invest in yourself – but it comes with the responsibility of adhering to IRS requirements, especially in terms of valuing your business. By understanding and following the rules outlined above – ensuring fair market value at inception, performing annual valuations, avoiding prohibited transactions, and seeking professional help when needed – you can keep your ROBS plan compliant and successful. This extensive look at “What are the IRS Requirements for Business Valuation in a ROBS Plan?” has highlighted that compliance is absolutely doable with knowledge and diligence. With the right practices and partners (like SimplyBusinessValuation.com for your valuation needs), you can focus on growing your company, confident that your retirement plan investment is both building your future and meeting all IRS guidelines. Here’s to your business success – and to keeping it by the book, so the only thing you have to worry about is serving your customers and making your venture thrive!
