ROBS, ERSOPs, and Ersatz ESOPs

In the last few years, there has been quite a bit of promotion of something called an "ERSOP" (employee rollover stock ownership plan). The idea is that someone wanting to start a business can take funds out of a retirement plan at one company and roll them into a new plan at a startup company, using the funds to buy company stock. The new plan could be an ESOP, but is more likely to be a profit sharing or 401(k) plan because the regulations are simpler.

This is perfectly legal if done right, but the promoters were generally recommending something that was too good to be true. One site that said it had approval for hundreds of such plans and the whole process would cost $4,000.

Now the IRS has chimed in. It calls the plans, charmingly enough, ROBS (rollovers as business startups). In an October 1, 2008, memorandum (available in PDF format at this link), the IRS stated that "employees in some arrangements have not been notified of the existence of the plan, do not enter the plan or receive contributions or allocable shares of employer stock. Additionally, we have identified that plan assets are either not valued or are valued with threadbare appraisals. Required annual reports for some plans have not been filed. In several situations, we have also found that the business entity created from the ROBS exchange has either not survived, or used the resultant assets on personal, nonbusiness purchases."

The IRS is particularly concerned that these plans will not have appropriate valuations and will fail the anti-discrimination tests. In an August 27, 2010, call-in meeting, the agency said it was now taking a particularly hard look at these plans as potential abusive transactions. While it is true that the IRS has issued letters of determination for these plans, that is far from their saying that the operation of these plans is legitimate, so anyone thinking of doing this needs to act with great caution to do it properly.

Interestingly, the IRS has also uncovered another popular scam that may remind ESOP veterans of an ESOP scam. When S ESOPs were created, promoters of dubious ethics started selling the idea that a company could split off a management company from the operating company, put a 100% ESOP in the management company, then funnel all the profits of the operating company into the management company. The IRS shut that down as a listed transaction. Now the same idea has surfaced, only the management company is setting up a defined benefit plan, again funneling all the profits of the operating company to the management company to fund it. Look for the IRS to shut these down too.