One aspect of Rollovers as Business Startups (ROBS) that often surprises entrepreneurs is that they can pay themselves a salary through their business. However, to take a salary as a ROBS-funded small business or franchise owner, you need to handle it with caution. The IRS has strict rules about how ROBS plans are set up and operated. Falling out of compliance could result in you paying penalties or taxes on the money you used to fund your business.
If you’re preparing to fund your business with ROBS, it’s important to understand the restrictions surrounding owner compensation.
ROBS and owner salary restrictions
Using your retirement funds to invest in your small business can be a strategic and lucrative decision. While perfectly legal, ROBS is highly regulated by numerous federal agencies. The question of owner salary is one area where owners have the potential to fall out of compliance if it’s not handled correctly.
The biggest thing to remember is that ROBS-funded business owners must act in the best interest of the new 401(k) plan established for their business. This is established under the IRS’s “Exclusive Benefit Rule.” You cannot make financial decisions that result solely in individual gain. Your financial decisions must have benefits for your employees and their beneficiaries, as well. If you decide to take a salary, this rule applies.
Therefore, the salary you take must be a reasonable amount of income. It cannot be considered excessive given the industry your business operates in and the amount of time and labor you contribute. Taking an excessive salary is not in line with the best interests of your business or retirement plan. This could flag you for non-compliance.
Additionally, you must be a bona fide employee of the business you fund with ROBS. You are not required to take compensation to be considered an employee. However, you cannot passively accept a salary without actively working for your company.
Salary best practices
Understanding the rules and restrictions surrounding compensation in a ROBS-funded business is only half the battle. All business owners, with or without ROBS, must consider how their compensation will affect the business overall.
The following tips can help you determine when to take a salary and how much to take to best support your growing business and remain in ROBS compliance.
- Research salary options: There is no single right answer when it comes to determining a reasonable salary for a business owner. It’s smart for owners to look into salary ranges to find a “reasonable” amount. Look at other businesses in your industry, average pay ranges for your region and the typical salary for the title you maintain in your company. The salary you take should also reflect the amount and type of work you put into your business each day.
- Take salary from operating income: It’s smart for all business owners—not just ones who use ROBS—to defer taking a salary until their business is relatively stable. Waiting to accept compensation until your business has operating income ensures that you aren’t using startup funding for just yourself. In ROBS, this shows that you didn’t take money from the proceeds of the ROBS investment immediately. Instead, you have used the funds to invest and grow the business to the point where a salary became possible.
- Contribute to your new retirement plan: Under ROBS, you’ll have access to a new retirement savings account. You can—and should—make contributions to this account to continue to save for retirement. Investing in this account from the salary you take further proves that you’re using ROBS primarily as an investment vehicle for retirement.
At the end of the day, you’ll want to work with your ROBS administrator to determine the best time and amount to pay yourself a salary. Your third-party administrator will ensure you stay in compliance with ROBS rules while building a growing business.
Contact Tenet Financial Group to learn more about ROBS and begin your journey of funding your small business.