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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75641  
Subject: BW: 401(k) to finance business start-up Date: 6/14/2010 5:48 PM
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BusinessWeek is reporting in May 31-Jun 6, issue p 52:

http://www.businessweek.com/smallbiz/content/may2010/sb20100...

Financial advisors have been telling people how to use their 401Ks to fund a business start up. You create a new company and set up a 401K plan. Then you move your existing 401K to the new company's 401K and use the funds to purchase stock in the new company.

BW is reporting the IRS is taking a close look at this kind of rollover. But sounds like it might be a nifty loophole for those looking to start their own business.
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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67216 of 75641
Subject: Re: BW: 401(k) to finance business start-up Date: 6/14/2010 6:51 PM
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pauleckler: "BusinessWeek is reporting in May 31-Jun 6, issue p 52:

http://www.businessweek.com/smallbiz/content/may2010/sb20100......

Financial advisors have been telling people how to use their 401Ks to fund a business start up. You create a new company and set up a 401K plan. Then you move your existing 401K to the new company's 401K and use the funds to purchase stock in the new company.

BW is reporting the IRS is taking a close look at this kind of rollover. But sounds like it might be a nifty loophole for those looking to start their own business."


I would want a formal opinion from someone, either the IRS or an accountant or lawyer with a good E&O policy (make that a gold-plated occurrence policy and I would want a copy thereof and and express indemnity regarding the advice).

I smell related party and prohibited transaction problems.

http://www.fairmark.com/rothira/real-prohibited.htm

"Prohibited transactions

A prohibited transaction occurs when you interact with your IRA in certain ways. Here are some of the things you aren't allowed to do:

"You can't sell property to your IRA, or buy property from your IRA.

. . .

You can't receive goods or services from your IRA, or provide goods or services to your IRA.

You aren't allowed to do any of these things directly or indirectly.

That means you can't avoid this rule by having your IRA deal with a company you own, or with a family member. And these are outright prohibitions: they aren't allowed even if you do everything in a fair and reasonable manner."

Id.

From whom is the IRA buying the stock?

At what valuation?

How can the IRA owner work for the company owned by the IRA?

Kaye Thomas is writing about owning investment real estate, but I see little difference with the referenced scheme.

I suspect that it will get really ugly.

IF an owner creates a prohibited transaction, then:

"The IRA is considered terminated as of the first day of the year in which the prohibited transaction occurred. Here's what that means:

- You have to pay tax on the same amount of income as if you withdrew the entire balance of your IRA.

- If you're under 59½, you have to pay the 10% early distribution penalty on that income.

[IOW,] You lose the benefit of having that money in your IRA for all the years you would have retained it for your retirement.

In short, you've nuked your IRA. In fact, the entire account is wiped out even if you only used part of it for the prohibited transaction."

Regards, JAFO

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67217 of 75641
Subject: Re: BW: 401(k) to finance business start-up Date: 6/14/2010 7:35 PM
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Jafo, I agree with everything you said.

However, the transactions would be with a 401k plan and not with an IRA. The rules for a 401k plan (or profit sharing plans in general, of which a 401k plan is a subset), are not the same as those for an IRA.

I have no idea if the proposed transaction (roll an IRA into a profit sharing plan, then have the profit sharing plan invest in the plan sponsor) would actually withstand scrutiny in any given case. But it does happen in the publicly-held stock world. It is not unusual for large corporate plans make their matching contributions in company stock.

So the concept is plausible. What differences there are between publicly held and privately held companies is something I don't know.

--Peter

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Author: JAFO31 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67218 of 75641
Subject: Re: BW: 401(k) to finance business start-up Date: 6/14/2010 7:51 PM
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ptheland: "Jafo, I agree with everything you said."

Thank you peter.

"However, the transactions would be with a 401k plan and not with an IRA. The rules for a 401k plan (or profit sharing plans in general, of which a 401k plan is a subset), are not the same as those for an IRA."

I guess I responded too quickly without fully engaging my brain.

"I have no idea if the proposed transaction (roll an IRA into a profit sharing plan, then have the profit sharing plan invest in the plan sponsor) would actually withstand scrutiny in any given case. But it does happen in the publicly-held stock world. It is not unusual for large corporate plans make their matching contributions in company stock.

So the concept is plausible. What differences there are between publicly held and privately held companies is something I don't know."


I am not a tax guy, and certainly do not know the entire code, but in other contexts public companies are often treated differently than private companies (regardless of size) --- somehtin about all those requried filings with the SEC. And, IIRC, significant owners (5% or 10%, IIRC) already have to carefl about about slary, versus dividends, etc.

And what kind of insurance does the plan sponsor and its trustees have to cover the fiduciary duty they owe to the beneficiary? I fail to see how most start-ups will satisfy the fiduciary duties involved.

http://www.401k-for-one.com/Trustees_Fiduciaries.html

http://www.duanemorris.com/articles/employer_checklist_401k_...

http://www.401khelpcenter.com/cw/cw_fiduciary.html

Given the failure rate of start-up businesses, one wonder what reserach would into a particular business would satisfy the applicable fiduciary duty?

Reards, JAFO

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67219 of 75641
Subject: Re: BW: 401(k) to finance business start-up Date: 6/14/2010 9:28 PM
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And what kind of insurance does the plan sponsor and its trustees have to cover the fiduciary duty they owe to the beneficiary?

Well, at the initial startup, the plan sponsor, the trustee, and the beneficiary are likely all the same person. While the fiduciary duties are technically still there, my uneducated guess is that it's probably pretty hard to sue yourself for breach of fiduciary duty to yourself.

Although given that legal precedents are just as wacky as tax law, there's probably a case somewhere where some nitwit successfully sued himself. (Probably for the insurance money, now that I think about it.)

--Peter

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Author: drippinfool Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67220 of 75641
Subject: Re: BW: 401(k) to finance business start-up Date: 6/15/2010 12:53 PM
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"...the plan sponsor, the trustee, and the beneficiary are likely all the same person."


If that doesn't raise red flags, I don't know what would.

-drip

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 67221 of 75641
Subject: Re: BW: 401(k) to finance business start-up Date: 6/15/2010 4:19 PM
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If that doesn't raise red flags, I don't know what would.

It wouldn't raise any red flags at all. It's very common in a small business for this to happen.

OK - technically, the plan sponsor would be the corporation, which is generally wholly owned by the individual. So the corporation is the plan sponsor, the corporation's owner is the plan trustee and the beneficiary of the plan.

All very ordinary for a small business.

--Peter

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