Consider financing via your 401(k) even if your CPA advises against it

2019-04-03T15:37:10+00:00April 3rd, 2019|Tags: , , , , |

Consider financing via your 401(k) even if your CPA advises against it

by Tim Seiber, CFE

Most CPAs will discourage you from tapping your 401(k) to start or grow your franchise business. They usually give this advice because they’re either unfamiliar with the Rollover as Business Start-Ups (ROBS) program or are uncomfortable with the tax structure of a C corporation.

Generally, the benefits that franchisees receive from utilizing the ROBS program far outweigh any concerns. Since the IRS created ROBS through the ERISA Act of 1974, the program has been a great way for thousands of entrepreneurs to open their businesses debt free. So before you let your CPA persuade you that it’s a poor option, you should understand the specifics behind their negative view.

Defining a C corporation
Under the federal tax code, business entities are categorized as either pass-through or non-pass-through business entities, with the main difference being that pass-through entities are not required to pay corporate taxes. These include sole proprietorships, partnerships, and S
corporations.

C corporations are non-pass-through entities that are completely separate taxpayers from their owners and are subject to corporate taxes. This is often where pushback from a franchisee’s CPA comes in. Because income earned by the C corporation is taxed at the corporate level and any distributions made to stockholders (i.e., wages) are taxed at the stockholder’s individual tax bracket, the potential for double taxation scares off tax advisers who are unfamiliar with the other benefits of the ROBS program.

But this should not be the only consideration when looking at ROBS as a funding option, because while double taxation might occur, the
C corporation structure offers advantages for small business owners versus pass-through entities.

Advantages of a C corporation
Although pass-through businesses are not subject to federal corporate income taxes, they can still face a substantial tax burden from federal, state, and local taxes.

Last year’s new tax reform significantly reduced the tax disadvantage of utilizing a C corporation structure. The corporate tax rate decreased to 21 percent, which is lower than the tax rate for pass-through income, and because most individual tax brackets also decreased, distributions are taxed at a lower rate as well.

Operators of C corporations may also withdraw salaries from the corporation profits, which aren’t taxed at the corporate level. If the company pays its employees enough to offset the entire net profit, then no corporate income tax is due, eliminating the double taxation
potential.

The benefits of a C corporation extend much further than a lower tax rate, however. Other advantages include:

  • The opportunity to shift income and retain earnings within the company for future growth.
  • No requirement to make the fiscal year coincide with the calendar year.
  • The ability to deduct 100 percent of medical premiums.
  • Eligibility to deduct charitable contributions as a business expense.

And the most significant advantage of all? A C corporation is the only business entity that supports ROBS, which is often the only viable funding solution for many start-up businesses.

Tim SeiberWant to learn more about financing options for your franchise? FranFund designs smart all-in-one funding plans that grow with your franchise and set you up for long-term success. We are here to help if you are considering leaving your current job to start a new venture or if you are looking to expand your existing operation. Get started today at bit.ly/franfund-fd or email Tim at taseiber@franfund.com.