TL;DR: ROBS is a high-risk, high-maintenance strategy. It is great for entrepreneurs who have $500k in a 401(k) but $0 in the bank and need to buy a franchise. For a profitable business like yours, an S-Corp usually offers the best balance of tax savings and “sleep-at-night” security.
High-Stakes “Retirement-to-Business” Loophole
For high-earning business owners in the Puget Sound area, the discovery of the Rollover for Business Startup (ROBS) strategy often feels like finding a hidden tax loophole. On paper, it sounds like the ultimate financial “cheat code”: use retirement funds to buy your own company, skip the personal income tax, and grow your business inside a tax-free Roth wrapper.
But the IRS doesn’t hand out $200,000 tax breaks without a very long list of strings attached. If you are currently operating as a profitable LLC and considering a shift to a ROBS C-Corp structure, here is what you need to know before making the leap.
The Allure: Why ROBS Looks Like a “No-Brainer”
The scenario is tempting for a successful property management LLC or SaaS firm. By rolling over 401(k) funds to buy shares in a new C-Corp, you technically:
- Eliminate Debt: You are “borrowing” from your future self, not a bank.
- Arbitrage Tax Rates: Shifting from a top personal bracket (~37%) to the flat 21% corporate rate.
- Turbo-Charge Retirement: Dividends paid from the C-Corp to the 401(k) (which owns the stock) grow tax-sheltered.
The Reality: What You Might Be Missing
While the math looks “earth-shattering,” the operational reality is a different story. Here are the primary “traps” that keep this from being a standard recommendation for every SMB:
- The “Bona Fide Employee” Rule: To qualify for ROBS, you must be a legitimate employee providing actual services to the C-Corp. You cannot simply use it as a passive shell to hold investments.
- Prohibited Transactions: The IRS is hyper-vigilant about “self-dealing.” If you use corporate funds for personal expenses, or if the 401(k) interacts with you in a way that provides an immediate personal benefit outside of your W-2 salary, the entire plan could be disqualified. This would trigger immediate taxes and penalties on the full amount of the rollover.
- The Employee Inclusion Requirement: This is the big one for growing firms. If you hire employees, you must allow them to participate in the same 401(k) plan that owns the company. This can create massive administrative complexity and potential fiduciary liability.
- Washington State Nuances: While Washington has no personal income tax, the Business & Occupation (B&O) Tax is a gross receipts tax. Shifting to a C-Corp doesn’t escape the B&O. Additionally, if you are in the Real Estate niche, the IRS looks closely at “passive” vs. “active” income in ROBS structures; passive rental income is generally a red flag.
Key Takeaways for SMB Owners
The Verdict: ROBS is a legitimate financing tool, but it is rarely a pure “tax play” for an already profitable business. It was designed to help people start businesses when they lack capital, not to help high-earners avoid pass-through taxation.
- Audit Risk: The IRS views ROBS as a “questionable” area. Expect higher scrutiny and mandatory annual Form 5500 filings.
- Exit Strategy Complications: Selling a business owned by a 401(k) is significantly more complex than selling a standard LLC or S-Corp. The “tax-free” exit sounds great, but the regulatory hurdles to get those funds out can be steep.
- The S-Corp Alternative: For a business with $1M in income, a properly structured S-Corp election often provides 80% of the benefit (FICA savings) with 5% of the audit risk and administrative headache.
| Feature | Current: LLC (Sole Prop) | Standard S-Corp Election | ROBS C-Corp |
| Federal Income Tax | Top Bracket (~37%) | Top Bracket (~37%) | 21% (Corporate Level) |
| FICA / Self-Employment Tax | ~15.3% on nearly all income | ~15.3% on Salary ONLY | ~15.3% on Salary ONLY |
| Double Taxation? | No | No | Yes (if taking personal dividends) |
| Audit Risk Profile | Low/Moderate | Moderate | High (IRS ROBS Compliance Project) |
| Admin Costs (Est.) | $1k – $3k / yr | $3k – $7k / yr (Payroll + Tax) | $10k – $15k+ / yr |
| Net Tax Bill (Est.) | ~$380k – $400k | ~$340k – $360k | ~$210k (Corp) + Dividend Tax |
Why the ROBS “Dream” Usually Hits a Wall
1. “There’s really no risk to my retirement funds.”
The risk shifts from “market risk” to “compliance risk.” In a ROBS, the 401(k) owns the business. If the IRS finds a single “prohibited transaction” (e.g., you paid for a personal trip on the company card or didn’t offer the plan to a future part-time employee), they can disqualify the entire plan. That makes the full $1M+ rollover immediately taxable as income, plus a 10% penalty.
2. “Income from the C-Corp paid to the Roth 401(k) as dividends.”
The Catch: You cannot roll a Roth IRA into a ROBS 401(k). You can only roll over Pre-tax (Traditional) 401(k) or IRA funds. While there is a “ROBS+” strategy that involves a Roth conversion, you would have to pay the massive tax bill upfront to get those funds into the Roth bucket before they start growing tax-free.
3. “The Roth 401(k) can buy and sell investments tax-free.”
A ROBS 401(k) is designed to own Employer Securities (your company stock). If the 401(k) starts acting like a standard brokerage account while also owning 100% of an active business you run, you enter a gray area of “Unrelated Business Taxable Income” (UBTI). The IRS wants the 401(k) to be a retirement vehicle, not an untaxed hedge fund for your private business.
The Hidden “Exit” Trap
If you sell your property management business for $5M in an LLC/S-Corp, you pay Capital Gains rates (~20%). If your Traditional ROBS 401(k) owns the business, that $5M flows back into the 401(k). You pay $0 tax now, but when you retire, every dollar you take out is taxed at Ordinary Income rates (up to 37%). You essentially trade a low capital gains tax for a high future income tax.
For a business already generating $1M in profit, the S-Corp election is the “Goldilocks” zone. It provides significant FICA savings without the “nuclear” risk of a ROBS disqualification.
Sidebar:
It’s a bit of a “linguistic Freudian slip” by the financial industry, isn’t it? The irony of an IRS-approved strategy sharing a name with a felony is not lost on us. In tax circles, we often joke that the name is a built-in warning. While it officially stands for Rollover for Business Startups, the acronym feels like a nudge from the universe: if you don’t handle it with extreme precision, someone is getting “robbed”—and it’s usually the business owner via IRS penalties.
The reality is you could “rob” your future self by mismanaging the C-Corp, thereby losing your retirement and your current cash to taxes. We usually refer to it as “The Compliance Tightrope.” It sounds much less criminal, but much more accurate to the daily reality of managing it.