4.72.11  Prohibited Transactions (Cont. 1)

4.72.11.3 
Prohibited Transactions

4.72.11.3.7 
Acquisition of Employer Securities or Employer Real Property

4.72.11.3.7.1  (09-22-2014)
Eligible Plans

  1. Defined benefit plans and most money purchase plans may not acquire qualifying employer securities or qualifying employer real property exceeding 10 percent of that plan’s assets. However, money purchase plans that were in existence on September 2, 1974 and on that date invested primarily in employer securities may invest in qualifying employer securities or qualifying employer real property exceeding 10 percent of their assets.

    Example:

    Company A's money purchase plan was established in 1979. It recently acquired qualifying employer securities from the employer which increased its holdings in Company A to well over 25 percent of the plan's assets. The acquisition is a prohibited transaction because a money purchase plan established after 1974 may not acquire or hold qualifying employer securities exceeding 10 percent of its assets.

  2. The excise taxes described in IRC 4975 apply only in the instance of a prohibited transaction between a plan and a disqualified person. Because ERISA 406 and ERISA 407 are broader in their application than the Internal Revenue Code, there might be a prohibited transaction under Title I for which the IRC 4975 excise tax cannot be imposed.

    1. A prohibited transaction under Title I can result from acquisitions from third parties as well as from the holding of securities or real property in excess of the prescribed limits.

    2. However, real property acquired through a non-cash contribution by the employer to satisfy a funding obligation is considered a sale or exchange and is a prohibited transaction. See IRM 4.72.11.3.1, Sale, Exchange or Leasing of Property, for the discussion on the Keystone case. The DOL in Interpretive Bulletin 94–3, 59 F.R. 66735 (December 28, 1994) applied the holding in the Keystone case to defined contribution plans and welfare plans as well as to defined benefit plans.

  3. Other defined contribution plans, such as profit-sharing or stock bonus plans, are "eligible individual account plans" permitted to acquire qualifying employer securities or qualifying employer real property exceeding 10 percent of the plan’s assets if the acquisition of these investments is specifically provided for in the plan.

    1. However, if the benefits payable under an individual account plan are taken into account in determining the benefits payable to a participant under any defined benefit plan, the plan is not an "eligible individual account plan."

    2. Thus, if a participant’s benefit payable under a defined benefit plan is offset by the participant’s profit-sharing plan account, the profit-sharing plan is not an eligible individual account plan. See ERISA 407(d)(3)(C).

4.72.11.3.7.2  (09-22-2014)
Qualifying Employer Securities and Qualifying Employer Real Property

  1. Generally, a plan may not acquire any employer securities or employer real property that is not "qualifying."

    1. An employer security is a security issued by an employer of employees covered by the plan or an affiliate of such employer. See ERISA 407(d)(1) and ERISA 407(d)(7).

    2. A qualifying employer security is stock, a marketable obligation or other evidence of indebtedness) or an interest in a publicly traded partnership. DOL regulation 2550.407d–5 provides further guidance with respect to the definition of qualifying employer security.

  2. A marketable obligation is a bond, debenture, note, or certificate or other evidence of indebtedness that meets certain requirements that insure the obligation is acquired at a price that is not unfavorable to the plan. See ERISA 407(e). A marketable obligation is not qualifying unless immediately after the acquisition of the obligation:

    1. The plan holds no more than 25 percent of the aggregate amount of the outstanding debt issue.

    2. At least 50 percent of the aggregate amount of the issue is owned by persons independent of the issuer.

    3. No more than 25 percent of the assets of the plan are invested in obligations of the employer or an affiliate of the employer.

    Example:

    B Corporation maintains an eligible individual account plan which has invested 70 percent of its assets in recently issued bonds of the employer. The plan purchased 60 percent of a recent issue of the employer's marketable obligations. The obligations are not qualifying employer securities because the plan purchased more than 25 percent of the issue and because the plan has more than 25 percent of its assets invested in obligations of the employer.

  3. A marketable obligation is not qualifying unless purchased:

    1. On a national securities exchange.

    2. From an underwriter.

    3. Directly from the issuer at the same price that would be established for a party entirely independent of the issuer. See ERISA 407(e)(1).

  4. Stock or an interest in a publicly traded partnership acquired on or after December 17, 1987 by a defined benefit plan or money purchase pension plan is not qualifying under ERISA 407(f)(1) unless immediately following the acquisition of such stock:

    1. No more than 25 percent of the aggregate amount of stock of the same class issued and outstanding at the time of the acquisition is held by the plan.

    2. At least 50 percent of the aggregate amount of stock of the same class of stock is held by persons independent of the issuer.

  5. After January 1,1993, for Title I purposes only, the employer securities owned (not merely acquired) by these plans must meet certain requirements. See ERISA 407(d)(5) and 407(e).

4.72.11.3.7.2.1  (09-22-2014)
Qualifying Employer Real Property

  1. Employer real property is defined in ERISA 407(d)(2) as real property (and related personal property) which is owned by a plan and leased to an employer of employees covered by the plan or to an affiliate of such employer. This term is often confused with property that is owned by an employer. Employer owned property leased to the plan is not exempt under ERISA provisions relating to the acquisition and holding of qualifying employer real property.

    Example:

    Company C reports on the Form 5500 filed for its defined contribution plan that it owns employer real property or employer securities valued at $200,000. Its statement of assets, however, lists no real estate holdings and corporate debt and lists equity instruments valued at $25,000. This discrepancy may indicate that the filer is confusing employer real property (i.e., property owned by the plan and leased to the employer) with property owned by the employer and leased to the plan.

  2. Qualifying employer real property is defined in ERISA 407(d)(4) as parcels of employer real property that:

    1. Are geographically dispersed (there must be more than one property).

    2. Are suitable (or adaptable without significant cost) for more than one use (even if such property is leased to only one lessee).

    3. Insofar as their acquisition or retention is concerned, comply with the requirements of Part 4 of Subtitle B of Title I of ERISA other than the diversification requirements. In other words, the investment in employer real property is prudent, in accordance with plan documents, etc., but not necessarily sufficiently diversified so as to minimize the risk of large losses to the plan.

4.72.11.3.7.2.2  (09-22-2014)
Adequate Consideration

  1. Eligible plans that acquire or hold qualifying employer securities or qualifying employer real property must also assure that the acquisition, sale, or lease is for adequate consideration, i.e., FMV or the price that a third party independent of the issuer would pay for such property.

    1. For employer securities (or employer real property) for which there is a generally recognized market, the market will determine the adequacy of consideration.

    2. In almost all other instances this requires an appraisal from a party independent of the employer.

    Example:

    The defined contribution plan of D Corporation leases several properties it owns at different locations to the employer. D Corporation proposes that the plan purchase a warehouse next to the corporation's present facilities for $100,000 without an appraisal. Without a third party's appraisal of the value of the building, there is likely to be no reliable way to establish that the building was purchased for adequate consideration. Therefore, one or more prohibited transactions are likely to occur.

4.72.11.3.7.2.3  (06-14-2002)
No Commission

  1. No commission may be charged with respect to a transaction involving the acquisition, sale or lease of employer securities or employer real property to or from a disqualified person.

4.72.11.3.7.2.4  (09-22-2014)
Examination Steps

  1. Determine whether the employer property is real property or securities. Compare the amount reported on Form 5500 in response to the employer securities or real property question with the amount listed in the statement of assets and liabilities for corporate debt and equity instruments and/or real estate and mortgages.

  2. Determine the total percentage of the plan’s assets invested in employer securities or real property. Compare the amount reported in the prohibited transactions section of the Form 5500 with the amount of total assets listed for the plan.

  3. If the plan is a defined benefit plan, check to see whether the plan had more than 10 percent of its assets invested in employer securities or real property immediately after the acquisition, and, if so, whether the DOL has granted an administrative exemption to permit the acquisition.

  4. If the plan is a defined contribution plan, determine whether the plan is an "eligible individual account plan."

    1. If the plan is a money purchase pension plan with more than 10 percent of its assets invested in employer securities or real property, make sure the plan was in existence on September 2, 1974, and invested primarily in employer securities on that date.

    2. Determine whether the plan specifically provides for the acquisition and holding of qualifying employer securities and qualifying employer real property.

    3. Make sure that benefits payable under the individual account plan are not taken into account in determining the benefits payable to any participant under any defined benefit plan of the employer.

  5. If the employer property is securities:

    1. Determine that the plan has purchased qualifying employer securities in accordance with the criteria under ERISA 408(e). See IRM 4.72.11.3.7, Acquisition of Employer Securities or Employer Real Property.

    2. Determine whether the plan purchased nonpublicly traded securities without an independent appraisal, and whether the stock was purchased from an employer that is a closely-held corporation. In this situation, determine if the acquisition of the securities is for adequate consideration. See IRM 4.72.11.3.7.2.2, Adequate Consideration.

  6. If the employer property is real property:

    1. Determine that the plan has purchased qualifying employer real property in accordance with the criteria under ERISA 407(d)(4). See IRM 4.72.11.3.7.2.1, Qualifying Employer Real Property.

    2. Determine whether there are at least two parcels of employer real property.

      Note:

      In Lambos v. Commissioner, 88 T.C. 1440 (1987), the U.S. Tax Court held that two parcels of land situated in different parts of the same county were not geographically dispersed. The Tax Court stated that an economic condition peculiar to the county would significantly affect the entire plan. By the same reasoning, contiguous (or nearly contiguous) land separated by a state or county line may not be sufficient to establish geographic dispersal.

    3. If there was a sale or exchange of employer real property, determine whether there was an independent appraisal of the land before the acquisition. See IRM 4.72.11.3.7.2.2, Adequate Consideration.

4.72.11.3.7.3  (06-14-2002)
Terminated Plans

  1. Terminated plans or plans merged with other plans to form a new plan are of special concern because the disposition of plan assets may not be adequately reported and may be prohibited.

4.72.11.3.7.3.1  (06-14-2002)
Disposition of Qualifying Employer Securities

  1. Plans are permitted to dispose of qualifying employer securities upon termination by offering such property to the employer at FMV. Any transactions with respect to employer securities require the payment of adequate consideration. Therefore, the price at which an employer buys back employer securities from a terminating plan must be based upon FMV.

4.72.11.3.7.4  (06-14-2002)
Disposition of Qualifying Employer Real Property

  1. Upon plan termination, qualifying employer real property may be sold to the employer or placed on the market as the plan fiduciaries deem appropriate.

4.72.11.3.7.4.1  (09-22-2014)
Disposition of Employer Real Property or Employer Securities Not Qualifying

  1. Any employer securities or employer real property that are not qualifying to begin with may not be sold to the employer upon termination of the plan. Such a sale is not a correction within the meaning of Treas. Reg. 53.4941(e)–1(c), and therefore, would constitute a second prohibited transaction. See Rev. Rul. 81–40.

4.72.11.3.7.4.2  (06-14-2002)
Disposition of Other Plan Assets

  1. In the case of a plan merger or consolidation, each participant’s account balance after the transaction must be equal to or greater than each participant’s account balance prior to the transaction. See IRC 414(l).

4.72.11.3.7.5  (09-22-2014)
Wasting Trusts

  1. All plan assets must be distributed as soon as administratively feasible after the amendment terminating the plan was adopted.

  2. Generally, a distribution which is not completed within one year following the date of plan termination specified by the employer will be presumed not to have been made as soon as administratively feasible. See Rev. Rul. 89–87.

  3. A plan under which all assets are not distributed as soon as administratively feasible is an ongoing plan and must continue to meet the qualification requirements of IRC 401(a) and the Form 5500 reporting requirements.

    Note:

    The Form 5500 filed for the year in which the plan terminated should accurately report the plan’s assets and liabilities before and after termination as well as the benefits distributed to employees and/or the assets transferred to a new plan in the case of mergers.

4.72.11.3.7.6  (11-01-2010)
Examination Steps

  1. Review the Form 5500 filed for the current plan year or the two previous plan years, determine whether any assets of the plan were sold to a disqualified person prior to the plan’s termination.

  2. For employer securities or employer real property reported by the plan, determine:

    1. How they were disposed of prior to termination.

    2. Whether a third party appraisal was obtained in those cases where there was no recognized market for the securities.

    3. Whether an independent third party appraised the real property.

    4. Whether the real property was sold to the employer or an affiliate.

  3. Determine whether:

    1. Any potentially non-exempt loans were reported on the Form 5500.

    2. An extension was given on any prior loans involving a substantial portion of the plan’s assets.

  4. If the plan held mortgages on property bought with participant loans, determine whether the disposition of the mortgage resulted in a taxable distribution to the participant when the plan terminated.

  5. Determine whether there was a net loss to the plan preceding termination. Such a loss may indicate an underlying prohibited transaction involving a sale of assets to a disqualified person for less than FMV or a previous purchase of assets from a disqualified person at an inflated price.

4.72.11.4  (09-22-2014)
Prohibited Transactions Tax

  1. IRC 4975(a) and (b) impose a two level, nondeductible excise tax on each prohibited transaction entered into by a disqualified person (other than a fiduciary acting only as such). Pending issuance of final regulations under IRC 4975, the excise tax on prohibited transactions is calculated in the same manner as the excise tax on self-dealing transactions with respect to private foundations. Because the terms "amount involved" and "correction" have not changed, this is generally the case even though the first level excise tax rates are now different. However, see Rev. Rul. 2002-43, where the first level excise tax rates change.

    Note:

    The validity of Treas. Reg. 141.4975–13 was upheld in Rutland v. Commissioner, 89 T.C. 1137 (1987). The Rutland case also reaffirms the holding in Lambos. See IRM 4.72.11.3.7.2.4, Examination Steps.

4.72.11.4.1  (11-01-2010)
First Level Tax

  1. An excise tax is imposed on a disqualified person (other than a fiduciary acting only as such) for each prohibited transaction with the plan.

  2. Where a fiduciary participates in a prohibited transaction, in a capacity other than as a fiduciary, he/she is to be treated as a disqualified person subject to an excise tax.

    1. An excise tax imposed on the disqualified person is 15 percent of the "amount involved" in the prohibited transaction for each year or partial year in the taxable period.

    2. Additional information and examples for calculating the excise tax are found in Exhibit 4.72.11-4, Computation of the Amount Involved and the IRC 4975(a) Excise Tax for a Continuous Prohibited Transaction and Exhibit 4.72.11-5, Computation of the Amount Involved and the IRC 4975(a) Excise Tax for a Continuous Prohibited Transaction with Repayments.

4.72.11.4.1.1  (11-01-2010)
Second Level Tax

  1. If the prohibited transaction is not corrected within the taxable period an excise tax of 100 percent of the "amount involved" is imposed on the disqualified person. See Exhibit 4.72.11-6, Computation of the Amount Involved and the Second Tier Excise Tax under 4975(b) for a Continuous Prohibited Transaction with Repayments.

  2. Under IRC 4961, the second tier excise tax can be abated if the prohibited transaction is corrected during the taxable period.

4.72.11.4.1.2  (07-29-2008)
Liability

  1. If more than one disqualified person is liable for the first or second level excise tax, then all such persons are jointly and severally liable for the excise tax.

4.72.11.4.1.3  (11-01-2010)
Taxable Period

  1. The term "taxable period" means the period beginning with the date on which the prohibited transaction occurs and ending on the earliest of the date on which:

    1. Notice of deficiency is mailed under IRC 6212 with respect to the tax imposed by IRC 4975(a).

    2. The tax imposed by IRC 4975(a) is assessed.

    3. Correction of the prohibited transaction is completed.

  2. A prohibited transaction occurs on the date on which the terms and conditions of the transaction and the liabilities of the parties have been fixed. When a notice of deficiency is not mailed because there is a waiver of the restriction on assessment and collection of a deficiency, or because the deficiency is paid, the date of filing of the waiver or the date of payment of the deficiency is treated as the end of the taxable period.

4.72.11.4.2  (09-22-2014)
Amount Involved First Level

  1. The "amount involved" under IRC 4975(f)(4) is generally the greater of the amount of money and FMV of other property given or received.

  2. The FMV for first level excise tax purposes is measured as of the date of the prohibited transaction.

    Example:

    A corporation that maintains a plan purchases equipment from the plan for $12,000. The FMV of the equipment is $15,000. The amount involved on the first level excise tax is $15,000. If the corporation paid $20,000 the amount involved would be $20,000.

  3. The method for determining the amount involved is described in more detail in:

    1. IRM 4.72.11.4.2.1. Excess Compensation.

    2. IRM 4.72.11.4.2.2, Use of Money or Property.

    3. IRM 4.72.11.4.2.3, Less than FMV Received.

4.72.11.4.2.1  (09-22-2014)
Excess Compensation

  1. Generally, services exempted from treatment as a prohibited transaction because they fall within the statutory exemptions provided by IRC 4975(d)(2) and (10) are not subject to the excise tax unless the compensation is deemed to be excessive. In such a case, the "amount involved" is the excessive compensation.

    Example:

    An investment advisor to a defined benefit plan is paid $100.00 per day for each day worked. It is determined that only $60.00 per day is reasonable based upon the facts in the case. The amount involved for the violation of IRC 4975(c)(1)(C) in this case would be $40.00 per day.

4.72.11.4.2.2  (09-22-2014)
Use of Money or Property

  1. Where the use of money or other property is involved, the "amount involved" is the greater of the amount paid for such use or the FMV of such use for the period for which the money or other property is used.

  2. For example, in the case of a lease of a building by a plan to a disqualified person, the "amount involved" is the greater of the amount of rent received by the plan from the disqualified person or the fair rental value of the building for the period such building is used by the disqualified person. See Treas. Reg. 53.4941(e)-1(b)(2)(ii).

    Example:

    If on January 1, 2010, the plan borrowed $100,000 from the employer, a disqualified person, at six percent interest while the prevailing rate in the financial community for loans of a similar nature at the time of the loan was 10 percent, the "amount involved" would be $10,000 (the $100,000 loan x the 10 percent interest rate). The amount of the first level excise tax for 2010 would be $1,500 (15 percent x $10,000).

    Example:

    If the plan leased its building to a disqualified person for $10,000 a year and the fair rental value was $11,000, the "amount involved" for purposes of the IRC 4975(a) tax would be $11,000. However, if the fair rental value was $9,000 the "amount involved" for purposes of the IRC 4975(a) excise tax would be $10,000.

4.72.11.4.2.3  (09-22-2014)
Less than FMV Received

  1. In the case of a prohibited transaction which would otherwise be protected from the excise tax by virtue of a statutory or administrative exemption or a transitional rule, but failed to meet the conditions of such exemption or transitional rule solely because the plan paid more, or received less than the FMV for the property transferred or a reasonable interest rate in the case of loans, the "amount involved" is the difference between the FMV over the amount the plan paid or received if the parties made a good faith effort to determine FMV. See Treas. Reg. 53.4941(e)-1(b)(2)(iii).

  2. A good faith effort is ordinarily made when the:

    1. Person making the valuation is not a disqualified person, is competent to make such valuations and is not in a position to derive an economic benefit from the value utilized.

    2. Valuation method is a generally accepted one for valuing comparable property for purposes of arm's-length business transactions.

    Example:

    Assume in this case a good faith effort was made to determine FMV value. The amount paid in the transaction was $5,000.00 and the FMV was determined to be $5,500.00. The "amount involved" would be $500.00. In a similar case where a good faith effort was not made, the amount involved would be $5,500.00.

4.72.11.4.3  (07-29-2008)
Amount Involved Second Level

  1. For determining the "amount involved" for second level excise tax purposes, the first level excise tax guidelines may be used except that the "amount involved" is the highest FMV during the taxable period. This provision is to insure that the person subject to the excise tax will not postpone correction of the prohibited transaction in order to earn income on such amounts.

  2. The FMV used in determining the "amount involved" for second level excise tax purposes is not necessarily the same as the FMV used for corrections under IRM 4.72.11.4.3.1, Correction.

4.72.11.4.3.1  (09-22-2014)
Correction

  1. Correcting a prohibited transaction means undoing the transaction to the extent possible. The resulting financial position of the plan may be no worse after the correction than if the highest fiduciary standards had been applied. The date of correction may end the taxable period with respect to which the first level excise tax is imposed if the correction is completed prior to the mailing of the notice of deficiency. However, the main significance of a correction is to avoid the second level 100 percent excise tax set forth in IRC 4975(b).

    Note:

    For purposes of a correction, undoing of the prohibited transaction does not constitute another prohibited transaction, and in correcting the prohibited transaction, the higher of the FMV of the property given or received, either at the occurrence of each prohibited transaction or at the time of correction, must be utilized. Also, the FMV for "correction" is not necessarily the same as the FMV for "amount involved." See IRM 4.72.11.4.2, Amount Involved First Level. However, the Service has stated that a correction under the DOL's Voluntary Fiduciary Correction Program, generally, will be deemed to be accepted as a correction under IRC 4975. In addition, section 612 of PPA'06, which is effective after August 16, 2006, and applies only to certain transactions involving securities and commodities, generally provides a correction period of 14 days. See IRC 4975(d)(23) and IRC 4975(f)(11).

4.72.11.4.3.1.1  (11-01-2010)
Correction Involving Use of Money or Property

  1. If a disqualified person uses the money or property of a plan, correction includes, but is not limited to, the termination of such use. In addition, the disqualified person must pay to the plan the excess, if any, of the combination of:

    1. FMV (greater of the value at the time of the prohibited transaction or at the time of correction) for the use of the money or property over the amount paid for the use until termination.

    2. Amount that would have been paid by the disqualified person for the period such disqualified person would have used the property if such termination had not occurred, over the FMV (at the time of correction) for the use for such period.

4.72.11.4.3.1.2  (11-01-2010)
Correction Involving Use of Money or Property by a Plan

  1. If a plan uses the property of a disqualified person, correction includes, but is not limited to, termination of such use. In addition, the disqualified person must pay to the plan the excess, if any, of both:

    1. The amount he/she received from the plan over the FMV (lesser of the value at the time of the prohibited transaction or at the time of correction) for the use of the money or property until the time of termination.

    2. The FMV at time of correction for the use of the money or property (for the period the plan would have used the money or property if termination had not occurred), over the amount that would have been paid by the plan after termination for use in such period.

4.72.11.4.3.1.3  (06-14-2002)
Correction of Sales of Property by a Plan

  1. In the case of a sale of property by a plan to a disqualified person for cash, undoing the transaction includes, but is not limited to, rescinding the sale.

    1. The amount returned to the disqualified person must not exceed the lesser of the cash received by the plan or the FMV of the property received by the disqualified person.

    2. The FMV to be returned is the lesser of the FMV on the date the prohibited transaction occurred or at the time of rescission of the sale.

    3. The disqualified person must also return to the plan any net income derived from the use of the property to the extent that it exceeds any income derived by the plan during the taxable period from its use of the cash received from the original sale, exchange or transfer.

4.72.11.4.3.1.4  (09-22-2014)
Resale Prior to End of Taxable Period

  1. If, prior to the end of the taxable period, the disqualified person resells the property in an arm's-length transaction to a bona fide purchaser other than the plan or another disqualified person, rescission of the original sale is not required. See IRM 4.72.11.4.3.1.3, Correction of Sales of Property by a Plan.

  2. The disqualified person must pay to the plan the excess, if any, of the greater of:

    1. The FMV of the property on the date of correction, (the date on which the money is paid over to the plan).

    2. The amount realized by the disqualified person from the arm’s-length sale, over the amount which would have been returned to the disqualified person.

  3. In addition, the disqualified person must pay to the plan any net profits realized through the use of the property during the taxable period.

4.72.11.4.3.1.5  (11-01-2010)
Correction of Sale of Property to a Plan

  1. In the case of the sale of property to a plan by a disqualified person for cash, undoing the transaction includes, but is not limited to, rescission of the sale where possible. To avoid placing the plan in a position worse than if such rescission were not required, the amount received from the disqualified person pursuant to the rescission is the greatest of:

    1. Cash paid to the disqualified person.

    2. FMV of the property at the time of the original sale.

    3. FMV of the property at the time of rescission.

  2. In addition to rescission, the disqualified person is required to pay over to the plan any net profits he/she realized after the original sale with respect to the consideration he/she received from the sale to the extent such income during the taxable period exceeds the income derived by the plan during the taxable period from the property which the disqualified person originally transferred to the plan.

4.72.11.4.3.1.6  (06-14-2002)
Resale by Plan

  1. If the plan resells the property before the end of the taxable period in an arm's-length transaction to a bona fide purchaser, other than a disqualified person, no rescission is necessary.

    1. In such an instance, the disqualified person must pay over to the plan the excess, if any, of the amount which would have been paid to the plan if rescission had been required over the amount which the plan realized on the resale of the property.

    2. In addition, the disqualified person is required to pay to the plan any net profits over the plan’s income he/she realized.

4.72.11.4.3.1.7  (06-14-2002)
Compensation Paid

  1. If a plan pays compensation to a disqualified person for the performance of personal services that are reasonable and necessary to carry out the provisions of the plan, correction requires paying back to the plan any amount considered excessive. Termination of employment is not required.

4.72.11.4.3.1.8  (11-01-2010)
Less than FMV Received

  1. In the case of a transaction described in IRM 4.72.11.4.2.3, Less than FMV Received, correction will occur if the plan is paid an amount equal to the "amount involved" plus any additional amounts necessary to compensate it for the loss of the use of the money (amount involved) or other property during the period from the date of the prohibited transaction to the date of correction.

4.72.11.5  (09-22-2014)
Transactions Identified on Form 5500

  1. The Form 5500 series return contains several questions designed to determine if the plan has been involved in a prohibited transaction or party-in-interest transaction. A party-in-interest is a defined term under Title I of ERISA that, in most instances, is parallel to a disqualified person.

    For example, schedules to the Form 5500 series returns request data relating to plans investing in employer securities or employer real property, plan loans, sales, exchanges or leases of property, relationships between plan fiduciaries and service providers and the purchase of non-publicly traded securities without a third party appraisal. The questions on the Form 5500 series returns are designed to identify potential problem areas.

4.72.11.5.1  (06-14-2002)
Examination Steps

  1. If a transaction with a party-in-interest/disqualified person is reported on the Form 5500 series return, investigate to determine if the transaction is a prohibited transaction. For a transaction between the plan and a disqualified person to be a prohibited transaction, it must be one of the transactions described in IRC 4975(c)(1) that is neither statutorily exempt under IRC 4975 nor the subject of an administrative exemption.

  2. Potential prohibited transactions may not be identified on the Form 5500 series return by a direct response to a question. This may occur because of an incorrect interpretation of the definition of party-in-interest/disqualified person, because the plan administrator believes the transaction to be exempt, because the plan administrator does not realize that the transaction is a party-in-interest transaction, or because the plan administrator is not aware of the transaction.

4.72.11.6  (09-22-2014)
Statute of Limitations

  1. The statute of limitations must be protected for purposes of assessing the excise taxes on prohibited transactions. The statute on a prohibited transaction is governed by the year of the plan as indicated on the Form 5500 series return and not the return for the taxable year of the disqualified person. See IRM 4.71.9.5.1, Statute of Limitations for Forms 5500/1041 and IRM 4.71.9.6.1, Securing Consents for Forms 5500/1041, for a more detailed discussion.

    Note:

    The Form 5500 series return is the return for the plan only. The excise tax on a prohibited transaction is assessed against the disqualified person and is reported on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans. See IRM 4.71.9.5.2, Statute of Limitations for Forms 5330 and IRM 4.71.9.6.2, Securing Consents for Forms 5330.

  2. The statutory period is different for a "continuing" transaction, e.g., a loan or lease, versus a "discrete" transaction, e.g., a sale.

    1. In a continuing transaction, the prohibited transaction is deemed to recur on the first day of each subsequent taxable year of the disqualified person. The filing of the Form 5500 series return starts the statute running only for transactions occurring in the year for which the return is filed. Therefore, in the instance of a continuing prohibited transaction, a separate determination as to when the statute expires must be made for each subsequent tax year if the prohibited transaction has not been corrected.

    2. In a discrete transaction, a determination as to the running of the statute of limitations need only be made for the year in which the transaction occurred. See G.C.M. 38846 as modified by G.C.M. 39066 and by G.C.M. 39475.

  3. If there is inadequate disclosure of a prohibited transaction on the Form 5500 series return, the statute of limitations is generally six years rather than the normal three years. However, to protect the interests of the government, the six-year statute should be protected, to the extent possible, as if it were a three-year statute.

    Note:

    Regardless whether the three year or the six year statute of limitations applies, the applicable statutes of limitations on the returns of the disqualified persons are for the tax years that correspond to the plan years and are controlled by the Form 5500 series return.

  4. A prohibited transaction of a continuing nature may occur where the plan and the disqualified person are on different years. If the transaction is not corrected before the end of the plan year that overlaps the disqualified person’s tax year the disqualified person will have engaged in two prohibited transactions within the year and would have to file at least two Form 5330 returns.

    Example:

    A prohibited transaction of a continuing nature occurred in C Corporations’ profit-sharing plan on July 31, 2012. The plan year and the trust are on a fiscal year, July 1 to June 30. The tax year of the disqualified person is a calendar year. The prohibited transaction is timely and adequately reported on the Form 5500 for the plan and trust year 2013. The disqualified person must file a Form 5330 for calendar year 2012 and another Form 5330 for calendar year 2013, if the transaction was not corrected on or before December 31, 2012. No Form 5330 would be due if the IRC 4975(a) excise tax was assessed or notice of the IRC 4975(a) excise tax was mailed by December 31, 2012. Either of these actions would cause the taxable period to end.
    Assuming that the taxable period has not ended, there would be one prohibited transaction in calendar year 2012 and two prohibited transactions in calendar year 2013. In calendar year 2012, there would be the initial prohibited transaction. In calendar year 2013, the second year of the first taxable period, there would be a pyramiding of the initial prohibited transaction and because of the absence of a correction event on or before December 31, 2012, calendar year 2013 also the first year of the taxable period for the second prohibited transaction (deemed to occur on January 1, 2013).
    Because all of the transactions took place during the plan year ended June 30, 2013, the statute of limitations is controlled by the Form 5500 filed for the plan year ending on June 30, 2013.
    If the Form 5500 return was filed timely without extensions and with adequate disclosure, the statute of limitations would not end until January 31, 2017, for the Forms 5330 due in 2012 and 2013.

    Note:

    See IRC 6501(l)(1), IRC 6501(e)(3), Imperial Plan, Inc. v. United States, 95 F.3d 25 (9th Cir. 1996) and Thoburn v. Commissioner, 95 T.C. 132 (1990).

  5. When necessary solicit Form 872, Consent to Extend the Time to Assess Tax or Form 872-A, Special Consent to Extend the Time to Assess Tax. Insure the consent is prepared properly. Indicate excise tax and extend the statute for the appropriate length of time. The disqualified person must sign the extension. If more then one disqualified person is involved in the transaction, a separate extension is secured from each disqualified person, Each disqualified person is considered jointly liable for the excise tax and the correction.

Exhibit 4.72.11-1 
List of Granted Class Exemptions

Prior revisions of this exhibit have listed class exemptions from the prohibited transaction rules that have been granted. However, because of the large number and the frequency of the changes, this is no longer practical. See the DOL websites listing class exemptions from the prohibited transaction rules going back to 1975; individual exemptions from the prohibited transaction rules going back to 1996; and EXPRO exemptions from the prohibited transaction rules issued under Prohibited Transaction Exemption 96-62 (PTE 96-62).

EXPRO is the common name for the class exemption (PTE 96-62) that allows the Department of Labor to authorize relief from the prohibited transaction rules on an expedited basis.

Exhibit 4.72.11-2 
Relationship Between Employer and Disqualified Person

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Exhibit 4.72.11-3 
Relationship Between Non-corporate Employer and Disqualified Person

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Exhibit 4.72.11-4 
Computation of the Amount Involved and the IRC 4975(a) Excise Tax for a Continuous Prohibited Transaction

Facts
The disqualified person, a calendar year taxpayer who is not a participant or beneficiary of the plan, borrowed $40,000 from the plan's trust. The interest rate on the loan is 5.75 percent for 2010, 6.25 percent for 2011 and 8 percent for 2012. The disqualified person could have obtained the loan at a bank at the prime interest rate for short term business loans +2 percent. The loan was made on April 1, 2010. No interest was paid on the loan until December 31, 2012. On December 31, 2012, a payment of the principal amount of the loan plus interest at the fair market rate, e.g., the prime interest rate for short term business loans + 2 percent, was made. As a result, the transaction was corrected on December 31, 2012. The prime interest rate on short term business loans was 3.25 on April 1, 2010, January 1, 2011 and January 1, 2012.

Computation of the Amount Involved
Since the prohibited transaction was a loan, an additional prohibited transaction is deemed to occur on the first day of each taxable year in the taxable period after the taxable year in which the loan occurred. Treas. Reg. 53.4941(e)-1(e)(1). Based on the facts, there are three loans (one actual and two deemed) subject to the first tier excise tax. As a result of interest not being paid on time, the unpaid interest is added to the outstanding extension of credit on the first day of each of the taxable years after the taxable year in which the initial prohibited transaction occurred. See Janpol v. Commissioner, 101 T.C. 518 (1993).

Prime Rate for short term business loans + 2 percent
1. April 1, 2010 - 3.25 percent + 2 percent = 5.25 percent
2. January 1, 2011 - 3.25 percent + 2 percent = 5.25 percent
3. January 1, 2012 - 3.25 percent + 2 percent = 5.25 percent




Initial Tax    
  Date Principal Interest Rate Time Amount Involved
1. April 1, 2010 $40,000.00 5.25 percent 275/366 $ 1,577.87
2. January 1, 2011 41,577.87 5.25 percent 1 2,182.84
    (initial loan + unpaid accrued interest)
3. January 1, 2012 43,760.71 5.25 percent 1 2,297.44
    (initial loan + unpaid accrued interest)

Computations of Tax

  2010 Taxable Year
2011 Taxable Year
2012 Taxable Year
1st Taxable period/Loan 1 $ 1,577.87 $1,577.87 $1,577.87
2nd Taxable period/Loan 2 ------ 2,182.84 2,182.84
3rd Taxable period/Loan 3 ------ ------- 2,297.44
Total $1,577.87 $3,760.71 $6,058.15
Times the appli cable rate x .15
________
x .15
________
x .15
______
1st level tax $ 236.68 $564.11 $908.72
Total All Years = $1,709.51

Exhibit 4.72.11-5 
Computation of the Amount Involved and the IRC 4975(a) Excise Tax for a Continuous Prohibited Transaction with Repayments

Facts
A disqualified person, a calendar year taxpayer who was not a participant or beneficiary of the plan, borrowed $240,000 from the trust of a calendar year, profit-sharing plan on April 1, 2010. (A participant or beneficiary of a plan is limited to the dollar amounts and percentage set forth in IRC 72(p)). Under the terms of the loan, the interest rate on the loan was set at the fair market rate (which is defined as the prime interest rate on that date + 2 percent). The prime interest was 3.25 percent on April 1, 2010, January 1, 2011 and January 1, 2012. As a result, the fair market rates was 5.25 percent on April 1, 2010, January 1, 2011 and January 1, 2012. Under the terms of the borrowing, payments of principal and interest were due on the tenth day of each month (beginning May 10, 2010) with final payment due on March 31, 2012. The amount of each monthly payment applied towards the principal was set at $10,000. All payments of principal and interest were timely and the prohibited transaction was corrected on March 31, 2012.

Computation of the Amount Involved
Since the prohibited transaction was a loan, an additional prohibited transaction is deemed to occur on the first day of each taxable year in the taxable period after the first taxable year of the disqualified person to whom the loan was made. Treas. Reg. 53.4941(e)-1(e)(1). In this case, the amount involved on January 1st varies depending on the taxable period involved, i.e., generally, the FMV interest rate at the time of the prohibited transaction. This is described in IRC 4975(f)(4)(A) in the case of the first tier excise tax and in IRC 4975 (f)(4)(B) in the case of the second tier excise tax. See GCM 39424, CC:EE-95-83 (Oct. 23, 1985), and Medina v. Commissioner, 112 T.C. 51 (1999).

Fair Market Rate = Prime Rate +2 percent
1. April 1, 2010 - 5.25 percent
2. January 1, 2011 - 5.25 percent
3. January 1, 2012 - 5.25 percent
Initial Tax
  Date Principal Interest Rate Time Amount Involved
1. April 1, 2010 $ 240,000 5.25 percent 275/366 $9,467.21
2. January 1, 2011 160,000* 5.25 percent 1 8,400.00
3. January 1, 2012 40,000** 5.25 percent 90/365 517.81
* $240,000 - $80,000 (eight timely payments of principal of $10,000 each during the 2010 taxable year + eight timely payments of interest)
** $160,000 - $120,000 (12 timely payments of principal of $10,000 each during the 2011 taxable year + 12 timely payments of interest)

Computations of Tax

  2010 Taxable Year 2011 Taxable Year 2012 Taxable Year
1st Taxable Period/Loan 1 $ 9,467.21 $ 9,467.21 $ 9,467.21
2nd Taxable Period/Loan 2 --- 8,400.00 8,400.00
3rd Taxable Period/Loan 3 --- --- 517.81
Total $ 9,467.21 $ 17,867.21 $ 18,385.02
times applicable rate x .15
________
x .15
________
x .15
______
1st level tax $1,420.08 $2,680.08 $2,757.75
Total All Years = $6,857.91

Exhibit 4.72.11-6 
Computation of the Amount Involved and the Second Tier Excise Tax under IRC 4975(b) for a Continuous Prohibited Transaction with Repayments

Facts
A disqualified person, a calendar year taxpayer who was not a participant or beneficiary of the plan, borrowed $240,000 from the trust of a calendar year, profit-sharing plan on April 1, 2010. (A participant or beneficiary of a plan is limited to borrowing the dollar amounts and percentage set forth in IRC 72(p)). Under the terms of the loan, the interest rate on the loan was set at the fair market rate (which was the prime interest rate + 2 percent). The prime interest rate on April 1, 2010, was 3.25 percent, the prime interest rate on January 1, 2011, was 3.25 percent and the prime interest rate on January 1, 2012, was 3.25 percent. As a result, the fair market rates were 5.25 percent, 5.25 percent and 5.25 percent, respectively. Under the terms of the borrowing, payments of principal and interest were due on the 10th day in each month beginning May 10, 2010. The amount of each monthly payment applied towards the principal was set at $10,000. All payments of principal and interest through December 2011 were timely. No payments were made after that date. On March 31, 2012, the IRC 4975(a) excise tax was assessed. Therefore, the taxable periods that began on the dates on which the prohibited transactions occurred or were deemed to occur ended.

Computation of the Amount Involved
Since the prohibited transaction was a loan, an additional prohibited transaction is deemed to occur on the first day of each taxable year in the taxable period after the first taxable year of the disqualified person to whom the loan was made. See Treas. Reg. 53.4941(e)-1(e)(1)(i). In this case, the amount involved when calculating the second tier excise tax is the greater of the interest rate on the loan or the highest fair market interest rate (Treas. Reg. 53.4941(e)-1(b)(3)) during the taxable periods that ended on March 31, 2012. In the instance of an ongoing prohibited transaction, e.g., a loan or lease, each loan or lease is a separate prohibited transaction that has its own taxable period (Treas. Reg. 53.4941(e)-1(e)(1)(ii) (Example 2)) and its own statute of limitations.

Higher of highest FMV during the taxable period or the interest rate on the loan during the taxable period
1st taxable period - 4/1/2010 - 3/31/2012 - 5.25 percent vs. 5.25 percent
2nd taxable period -1/1/2011 - 3/31/2012 - 5.25 percent vs. 5.25 percent
3rd taxable period - 1/1/2012 - 3/31/2012 - 5.25 percent vs. 5.25 percent

Second tier tax

  Date Principal Higher Interest Rate Time Amount Involved  
1. 4/1/2010 $240,000 5.25 percent 275/366 9,467.21  
2. 1/1/2011 160,000* 5.25 percent 1 8,400.00  
3. 1/1/2012 40,000** 5.25 percent 90/365 517.81  
          $18,385.02 x 100 percent = $18,385.02

* $240,000 - $80,000 (8 timely payments of principal of $10,000 each + 8 timely payments of interest)
** $160,000 - $120,000 (12 timely payments of principal of $10,000 each + 12 timely payments of interest)

Note:

The information presented in the exhibits is for illustrative purposes only. The revenue agent should bear in mind that varying factors such as leap years (366 days), number of decimal places used, interest compounding, proration method, etc., will yield different calculation results.


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