Sunday, January 19, 2014

401k Franchise Business Financing / Steps to Invest IRA funds in a franchise business

Over at Harvard Law we read:  There are essentially two methods to invest IRA funds in a franchise. While both methods are allowable under the IRS regulations, both have their own set of rules, so both should be carefully understood and analyzed before investing IRA retirement funds in a franchise business. Method one entails investing the IRA funds passively in a franchise and method two involvesactively investing IRA funds in the franchise business (whether existing or start up franchise financing) by transferring the IRA proceeds to a roll over as business startup 401k profit sharing plan (ROBS PSP 401k).
Following is the complete breakdown of both IRA franchise business financing methods
Method 1: Invest IRA funds actively in a franchise entails the following:
  • A new C-corporation is established.
  • Corporation sponsors a new 401k/PSP.
  • The IRA funds are transferred to a new brokerage account opened for the 401k/PSP.
  • The new franchise corporation issues stock shares to the 401k/PSP for the benefit of the franchisee.
  • The franchisee must be an employee of the franchise business and he or she may take a reasonable salary.
  • The franchisee’s family members may be employees of the franchise business and receive reasonable compensation for their services.
  • To the extent that the corporation generates profits and elects to distribute those profits to the owners of the business, the percentage of the profits associated with the shares held in the 401k/PSP will flow back to the 401k/PSP brokerage account.
Method 2: Invest IRA funds passively in a franchise:
When IRA funds are passively invested in a franchise business the following applies:
  • The IRA owner/participant may not personally benefit from his or her IRA’s investment in the franchise business; therefore the IRA owner may not receive a salary.
  • The IRA owner may not work for the franchise.
  • The IRA owner may not serve as a director, officer or in any position having powers or responsibilities similar to those of officers or directors.
  • The following family members of the IRA holder may not work for the franchise business:
    • The IRA owner’s spouse
    • The IRA owner’s parents
    • The IRA owner’s grandparents
    • The IRA owner’s children
  • When investing the IRA passively in a franchise business, the investment is consummated either in the name of the IRA custodian f/b/o the IRA, or a single member IRA LLC is setup (after the IRA has been transferred to a self-directed IRA custodian such as IRA Services Trust Company); the IRA LLC is then funded with self-directed IRA funds, and the IRA LLC purchases stock shares in the case of C-Corporation, or units in the case of an LLC in the franchise business.
Compliance Note 1: The S-Corporation rules restrict an IRA or any type of retirement account from owning stock shares in an S-Corporation.
  • After the IRA or IRA LLC buys stock or units in the franchise business, the franchise business issues a stock certificate in the name of the IRA, or in the name of the IRA LLC.
  • Profits resulting from the IRA’s ownership percentage in the franchise flow back to the IRA or IRA LLC.
Compliance Note 2. When an IRA or an IRA LLC invests passively in an operating business, gains in excess of $1,000 will be subject to unrelated business income tax and must file Form 990-T.
To learn more about financing your business or franchise with your retirement money, check out these pages:


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