ROBS + Roth + Act 60 = GRAND SLAM!
Our ‘ROBS Act 60’ 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 60 business in a way that allows unlimited Act 60 dividends to flow tax free to your Roth 401k WITHOUT GILTI or deemed dividend taxes. Once accumulated in your Roth 401(k) 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 60 business, it provides a unique way to grow your retirement funds with unlimited accumulations that have a 4% tax overhead.
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 60 start-up.
The ROBS Act 60 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 60 Strategy
First, you create a new Puerto Rico C-corporation. Because the Qualified Employer Securities (QES) purchase is central to the ROBS Act 60 strategy, the Act 60 business you start must operate as a C-corporation, 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 needs to be an 'operating company' under DOL rules, and by being formed in the jurisdiction of Puerto Rico is eligible to receive the Act 60 tax benefits. Assuming the federal source of income requirements are met, a Puerto Rican Act 60 C-corporation’s income would enjoy a 4% income tax rate exempt from US federal income tax.
After establishing the C-corporation, a retirement plan needs to be setup for your Act 60 business. Almost exclusively a standard 401(k) Plan that includes a Roth provision are chosen, although you still have other select options such as defined benefits, defined contributions, profit sharing or a combination of plans.
The Act 60 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 401(k) Plan is set up, a third party administrator helps administer the Plan, and an investment advisor can be picked to manage the actual investments after the Act 60 dividends accrue into the Plan.
Concurrent with the ROBS transaction being performed, the Act 60 for Export Services or Export Trade application is submitted for approval. The decree is issued in the name of the C-corporation, and it's shareholders, with the 401(k) Plan accountholders of the corporation also named as shareholders.
Act 60 Export Service and Export Trade providers operating under a Tax Exemption Grant will enjoy the following Key tax incentives during the 15 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 or Export Trade Income. Tax free distributions are paid to the shareholders - including your 401(k) Plan Roth account.
Upon having the 401(k) Plan setup for the C-corporation, you then roll your eligible retirement funds from your existing personal retirement account to the new 401(k) Plan. 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 60 through this transaction. All eligible employees must be offered the opportunity to purchase the company stock (QES) with their retirement funds during the time it is offered.
After you rollover your pre-tax funds into the new 401(k) Plan, 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. Existing Roth retirement funds are not eligible to be used in this strategy.
*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.
Now that funds are in the company 401(k) Plan Roth account, the Plan then purchases stock in the C-corporation 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-corporation.
Once the QES transaction is complete, your retirement funds have capitalized the corporation and 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 60
No Bona Fide Residency Required
While all Act 60 income must be sourced in Puerto Rico properly, which may include having owner employees and resident employees performing income producing activities while present in Puerto Rico, individual bona fide residency is not required of the 401(k) account holder ~ YOU ~ to keep all of the Act 60 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 60 business as usual.
Unlimited Roth 401(k) Accumulations
All eligible Act 60 income is taxed at 4% and completely exempt from federal income tax.
- Future unlimited Act 60 dividend distributions accumulate into the Roth account tax free without federal income tax, GILTI or deemed dividend tax
- Future earnings from the Roth 401(k) account investments grow and compound tax free
- Future Roth 401(k) account retirement distributions are tax free
However, it is important to keep in mind that ROBS Act 60 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 60 provider who can guide you through this product every step of the way.
I approached Edgar with a desire to own my Act 20 (previous to Act 60) in my 401(k). When everyone else said it couldn't be done, Edgar and his team 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 401(k) and build my retirement. I couldn't be happier with his creativity, efforts, and great service!
- Noah R.