What Effect Does 401(k) Business Financing Have on Taxes?

If you’re looking at your 401(k) retirement account as a possible source of funding for your business, you need to think ahead. What effect does 401(k) business financing have on your taxes? Pango Financial has compiled a quick guide to highlight the effects of this financing method on your future tax filings.

401(k) Loans vs. Financing

There are a couple of different ways you can use your 401(k) account to fund your business. You can take out a loan against your 401(k) or utilize a rollover for business startups, also known as ROBS.

When you take out a loan against your 401(k), those funds are tax-exempt as long as you pay back the loan on time, but you will be charged a withdrawal fee. Some plans will charge interest with every repayment installment, but that interest gets paid back into your own 401(k) account.

Meanwhile, financing with a ROBS plan allows you to avoid any withdrawal fees associated with taking money out of the account. You also don’t have to worry about incurring taxes on late repayments because ROBS financing is not a loan.

C-Corps and Double Taxation

When you work with a financial advisor to roll over your 401(k) funds into a new account, they will help you set up your business as a C-corporation. Some business owners balk at C-corps because they are subject to two forms of taxation.

C-corporations must pay taxes on both their income and any corporate profits that get distributed to stockholders. However, the double taxation effect is ultimately negligible. The dividends that get paid to stockholders are on a tax-deferred basis, and your corporate income tax can be offset by paying yourself a reasonable salary as an employee. After all, your salary is a corporate expense that can be written off.

ROBS and Taxation

Many business owners utilize ROBS financing to avoid paying extra tax penalties. When you establish a ROBS, that money is not taxed. To remain compliant with the terms of the rollover and avoid unexpected taxation, remember the following tips:

  • Use the funds for your business, not personal use.
  • Report all of your business income to the IRS when tax season comes around.
  • Offer your employees the opportunity to buy into your 401(k) program, per the requirements of the rollover.

How does 401(k) business financing affect your taxes? When executed properly, rolling your 401(k) retirement funds into a new account can help you save on excess taxes while funding your business.

Curious about other funding options for your business? Take advantage of Pango Financial’s funding solutions tool today.