ROBS + Roth + Act 20 = GRAND SLAM!
Our ‘ROBS Act 20’ solution is a strategy we developed and pioneered in Puerto Rico that uses a little known funding arrangement which allows you, as a US resident, to tap into your qualified retirement funds penalty-free to capitalize your Act 20 business in a way that allows unlimited Act 20 dividends to flow tax free to your Roth 401k WITHOUT GILTI or deemed dividend taxes. Once accumulated in your Roth 401k all future earnings and retirement distributions are forever tax free! Sound too good to be true? It’s not, we promise.
The ROBS arrangement is a complex structure, that uses various federal Internal Revenue Service (IRS), Department of Labor (DOL) and Employment Retirement Income Security Act (ERISA) regulations, that when structured in the right framework form a viable small business capitalization option. When ROBS is used with an Act 20 business, it provides a unique way to grow your retirement funds with unlimited accumulations that have a 4% tax overhead.
Below are the six basic steps to set up the ROBS Act 20 strategy:
What is a Roll Over as Business Startup (ROBS)?
The ROBS arrangements are governed by ERISA. The ROBS structure takes advantage of an exception to the IRS prohibited transaction rules found in ERISA § 408(e) and IRC § 4975(d)(13) which permits a 401(k) plan to buy “Qualifying Employer Securities (QES),” which is defined as stock of a ‘C’ Corporation. The ROBS structure essentially involves a C Corporation adopting a 401(k) plan and the 401(k) plan using rollover retirement funds to purchase stock in the Corporation (QES purchase transaction). The Corporation would then use the monies received in exchange for the stock to fund the Act 20 start-up.
The ROBS Act 20 strategy consists of multiple elements, and sub elements, that must each meet specific requirements and be performed in proper sequences to make the strategy work properly.
Six Steps of the ROBS Act 20 Strategy
Create a New C Corporation
First, you create a new C corporation. Because the Qualified Employer Securities (QES) purchase is central to the ROBS Act 20 strategy, the Act 20 business you start must operate as a C corp, which has the ability to sell stock. (Other entity types such as an LLC, LLP, S Corp or Sole Proprietorship are prohibited from issuing QES.)
The C corporation does need to be an 'operating company' under DOL rules, but does not need to qualify as a "bona fide resident" of Puerto Rico in order to get the Act 20 tax benefits. Assuming the federal source of income requirements are met, a Puerto Rican Act 20 C corporation’s income would enjoy a 4% income tax rate exempt from US federal income tax.
Setup a 401(k) Plan for your C Corporation
After establishing the C corp, a retirement plan needs to be setup for your Act 20 business. Almost exclusively standard 401(k) plan that includes a Roth provision are chosen, although you have other select options such as defined benefits, defined contributions, profit sharing or a combination of plans.
The Act 20 business you start must operate as a C corp, which has the ability to sell stock. Other entity types such as an LLC, LLP, S Corp or Sole Proprietorship are prohibited from issuing Qualified Employer Securities (QES).Once a plan is set up, a custodian needs to be picked to manage the actual investments after the Act 20 dividends accrue into the plan.
File the Act 20 Application for your C Corporation
Concurrent with the ROBS transaction being performed, the Act 20 for Export Services application is submitted for approval. The decree is issued in the name of the C corporation, with the shareholder being the 401(k) plan of the corporation.
Act 20 Export Service providers operating under a Tax Exemption Decree will enjoy the following Key tax incentives during the 20 year term of such decree:
1. 4% flat income tax rate on Puerto Rico sourced Export Services Income.
2. 100% tax-exempt distributions from earnings and profits (dividends) derived from the Export Services Income. Tax free distributions are paid to the shareholders - your 401(k) plan.
Roll Existing Funds into the New 401(k) Plan
Upon having the 401(k) plan setup for the C corp, you then roll your eligible retirement funds from your existing personal retirement account to the new 401(k) plan of the C corp. This is where the “rollover” part of Roll-Overs for Business Start-ups comes from.
All rollover participants - which in practice includes yourself - must be bona fide, actively involved, employees of the company. You cannot become a passive investor in the ROBS Act 20 through this transaction. All eligible employees must be offered the opportunity to purchase the company stock with their retirement funds during the time it is offered.
Perform In-plan Roth Rollover
After you rollover your pre-tax funds into the new 401(k), you perform an In-plan Roth Rollover (IRR) which allows you to transfer the non-Roth portion of your 401(k) into a designated Roth account within the same plan. Only vested retirement funds qualify to be rolled over. The pre-tax funds rolled into the 401(k) from your existing retirement plan are considered as vested.
*The In-plan Roth Rollover from a pre-tax account will result in the entire amount of the rollover being included in gross income and becomes taxable income to the participant. However, there will not be a penalty.
The 401(k) Plan Buys Stock in the C Corporation
Now that funds are in the company 401(k) plan Roth account, the plan then purchases stock in the C corp through a Qualified Employers Securities (QES) purchase transaction. The 401(k) plan must pay adequate consideration for Fair Market Value (FMV), but cannot pay more than Fair Market Value (FMV), for the stock it purchases in the C corp.
Once the QES transaction is complete, your retirement funds are now available to the corporation to begin operating and paying for business expenses, like buying equipment, leasing space, hiring employees, etc.
Benefits of Using ROBS Act 20
No Bona Fide Residency Required
While all Act 20 income must be sourced in Puerto Rico properly, which may include having having employees performing income producing activities, individual bona fide residency is not required of the 401(k) account holder ~ YOU ~ to keep all of the Act 20 tax benefits.
This removes the burden of counting days for the presence test, meeting closer connection tests and tax home tests, while still allowing you to actively participate and fully manage and operate your Act 20 business as usual.
Unlimited Roth 401(k) Accumulations
All eligible Act 20 income is taxed at 4% and completely exempt from federal income tax.
- Future unlimited Act 20 dividend distributions accumulate into the Roth account tax free without income, GILTI or deemed dividend tax
- Future earnings from the Roth 401(k) account investments grow tax free
- Future Roth 401(k) account retirement distributions are tax free
However, it is important to keep in mind that ROBS Act 20 only works if every element of the federal and Puerto Rico rules and guidelines are met when setting it up, and when maintaining ongoing compliance. That’s why it is very important to work with an experienced ROBS Act 20 provider who can guide you through this product every step of the way.
We did the first ever ROBS Act 20 with Edgar's help!
I approached Edgar with a desire to own my Act 20 in my 401k. Everyone else said it couldn't be done. With a get it done attitude, Edgar worked through all the legal and ERISA issues and created the first ever ROBS Act 20 in Puerto Rico. Now my tax exempt dividends flow up to my Roth 401k and build my retirement. I couldn't be happier with his creativity, efforts, and great service!
ROBS + Roth + Act 20 = GRAND SLAM!
Schedule a Discovery Session to explore how ROBS Act 20 can increase your bottom line. You'll always know the next step to take, with the assurance of our world-class support every step of the way.