Why Making The S Election is Prohibited for a ROBS Corporation

The ROBS Exemption from the PT Rules

The ROBS funding transaction is a transaction in plan assets; the plan pays cash to the corporation in exchange for the employer stock which it holds for the benefit of the ROBS owner as a plan participant. As a transaction in plan assets, the ROBS investment would be prohibited if it were not for an exemption that is provided by statute at ERISA section 408(e) and IRC sec. 4975(d)(13) (for convenience, this exemption is referred to hereinafter as the ROBS PT Exemption). To avoid becoming the subject of a substantial PT and costly excise tax, it is vital for a ROBS plan to meet several factual conditions so that it may meet the requirements of the ROBS PT Exemption. 

One of the conditions for the ROBS PT Exemption is that the stock must meet the definition of a qualifying employer security (QES) under IRC sec. 407(d)(5). One particular characteristic required for the stock to meet the definition of QESis that the entity issuing the stock must be a C corporation. 

The ROBS entity must always be a C corporation.

The PT rules specifically exclude from the definition of QES any ownership interests in entities other than a C corporation, including an S corporation (unless the plan is an ESOP, which is a completely different kind of plan). This provision also prohibits issuance of QES  to a retirement plan by any other non-C-corporation type of entity, such as a sole proprietorship, LLC or partnership. 

The S corporation prohibition is of particular relevance to ROBS plan sponsors because corporations are often advised by unknowledgeable tax preparers that S corporation status is more advantageous than the C status, from an income tax perspective. Unfortunately, however, S corporation status is forbidden because it would take the ROBS plan out of the ROBS PT Exemption. Therefore, a ROBS corporation should not accept the advice to take the S election, as doing so immediately creates a PT. 

Correcting the S election can and must be done as soon as possible. Time is money when it comes to correcting any PT, especially the S election for a ROBS corporation. If you have a ROBS corporation and you have made the S election, contact an ERISA attorney immediately for help with the correction.

The Bottom Line is: Always ensure that your ROBS corporation maintains its C corporation status to avoid violating the Prohibited Transaction (PT) rules. Changing to an S corporation could immediately disqualify your plan from the ROBS PT Exemption, leading to costly penalties.

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