Prohibited Transactions
Under IRC 4975(c), certain transactions between a retirement plan and “disqualified persons” are prohibited. As a ROBS founder, you are a disqualified person with respect to your 401(k) plan. Understanding these rules is critical.What’s Prohibited
The following transactions between you (or the C-Corporation) and the 401(k) plan are prohibited:Direct Prohibitions (IRC 4975(c)(1))
| Category | What It Means | Example |
|---|---|---|
| (A) Sale or lease of property | No buying/selling/leasing property between you and the plan | Leasing your personal office space to the C-Corp |
| (B) Lending or credit | No loans or credit extensions between you and the plan | Personally guaranteeing a business loan |
| (C) Furnishing goods/services | No providing goods or services between you and the plan | The plan paying for your personal expenses |
| (D) Transfer of plan assets | No using plan income/assets for your personal benefit | Directing the company to pay you an unchecked salary |
| (E) Self-dealing by fiduciary | No dealing with plan assets in your own interest | Setting your own compensation without oversight |
| (F) Kickbacks | No receiving personal consideration from plan-related parties | Taking a commission from a vendor servicing the plan |
What’s NOT Prohibited (Normal ROBS Patterns)
These are commonly misunderstood as violations but are standard ROBS practices:Paying yourself a salary from the C-Corp
Paying yourself a salary from the C-Corp
Not prohibited — in fact, it’s required. You must be a W-2 employee with reasonable compensation. The key is that compensation must be at arm’s-length market rates and documented through board resolutions. The Ellis v. Commissioner case found a violation only because the founder had unchecked authority to direct his own pay with zero independent oversight — not because salary itself is prohibited.
Purchasing stock in a new C-Corp at par value
Purchasing stock in a new C-Corp at par value
Not prohibited. This is the standard ROBS transaction. For a newly formed company, the stock price IS the par value because the company’s value equals its initial investment. No independent appraisal is needed at formation.
Using ROBS funds as working capital
Using ROBS funds as working capital
Not prohibited. That’s the entire point. Once the 401(k) purchases C-Corp stock, the corporation has the sale proceeds as working capital for legitimate business expenses.
Paying yourself a salary from day one
Paying yourself a salary from day one
Not prohibited. You don’t need to wait for “independent operating revenue.” The C-Corp has capital from the stock purchase, and you are a W-2 employee entitled to reasonable compensation from the start.
Genuine Red Flags
These situations require careful attention or may indicate a prohibited transaction:- Personal guarantees on any business debt — fatal under Peek v. Commissioner
- Self-directed compensation without any board documentation — flagged in Ellis v. Commissioner
- Loans between the plan and the founder — direct violation of 4975(c)(1)(B)
- Commingling personal and plan assets in bank accounts
- Roth accounts used as primary ROBS funding source — Roth funds aren’t eligible
- Passive investment with no operating business — ROBS requires an active operating company
- Stock price inflated above actual company assets — relevant for acquisitions, not new formations
The Reasonable Compensation Standard
Your salary as founder-employee must meet two tests:- Market rate — compensation is comparable to what someone in a similar role and industry would earn
- Documented — compensation is approved through board resolutions or formal corporate governance
Having independent board members is a best practice for mature ROBS companies, but it is not an IRS requirement at formation. Most ROBS startups begin with the founder as sole director. The critical requirement is documentation, not independent approval.
Penalties
| Violation | Tax |
|---|---|
| Prohibited transaction occurs | 15% excise tax on the amount involved, per year |
| Not corrected within taxable period | Additional 100% tax on the amount involved |
| IRA-based plan disqualified | Entire balance taxed as ordinary income |
Key Case Law
See what courts have ruled on ROBS prohibited transactions.