4.72.8 Valuation of Assets in Defined Contribution Plans

Manual Transmittal

April 16, 2021

Purpose

(1) This transmits revised IRM 4.72.8, Employee Plans Technical Guidelines, Valuation of Assets in Defined Contribution Plans.

Material Changes

(1) Added Internal Controls sections. Amended and renamed IRM 4.72.8.1, Program, Scope and Objectives. Added sections IRM 4.72.8.1.1, Background; IRM 4.72.8.1.2, Authority; IRM 4.72.8.1.3, Responsibility; IRM 4.72.8.1.4, Program Management and Review; IRM 4.72.1.5, Program Controls; and IRM 4.72.8.1.6, Acronyms

(2) Moved material in previous IRM 4.72.8.1.1, Valuation in Defined Contribution Plans, and IRM 4.72.8.1.2, Formality of Valuation, to IRM 4.72.8.2, Valuation of Assets.

(3) IRM 4.72.8.1.5 (1), was updated for TBOR guidance from the Division Counsel/Associate Chief Counsel (National Taxpayer Advocate Program) and Branch 3 of the Associate Chief Counsel (Procedure and Administration).

(4) Moved material in previous IRM 4.72.8.2, Form 5500 Information, to IRM 4.72.8.3. Sequentially updated the subsections that followed.

(5) Updated IRM 4.72.8.6.3 (2) to reflect the final regulations issued on August 29, 2005 and deleted IRM 4.72.8.6.3 (3) and IRM 4.72.8.6.3 (4) because the prior regulations and proposed regulations are no longer relevant. Sequentially updated the rest of IRM 4.72.8.6.3.

(6) Updated IRM 4.72.8.6.3 (5) by adding “but was modified by and superseded by Rev. Proc. 2005-25” to the end of the sentence.

(7) Updated IRM 4.72.8.6.3 (6) by deleting “modified and superseded Rev. Proc. 2004-16.”

(8) Updated IRM 4.72.8.7.1 (2) to clarify that a cash contribution is generally made to the plan, but it doesn’t have to be paid in cash to be deductible under IRC 404.

(9) Updated IRM 4.72.8.8.1 (3) to clarify when an independent appraiser’s valuation is required. Sequentially updated the rest of IRM 4.72.8.8.1.

(10) Updated IRM 4.72.8.8.1 (4) to change the reference to IRC 170(f)(11)(E).

(11) Updated IRM 4.72.8.8.1 (4)(b) to change the reference to 26 CFR 1.170(A)-13(c)(3)(ii)(F).

(12) Updated this IRM for plain language and editorial changes throughout.

Effect on Other Documents

This supersedes IRM 4.72.8, dated August 29, 2016.

Audience

Tax Exempt and Government Entities
Employee Plans

Effective Date

(04-16-2021)


Eric D. Slack
Director, Employee Plans
Tax Exempt and Government Entities

Program Scope and Objectives

  1. Purpose: This IRM provides guidance on valuing assets in qualified defined contribution retirement plans.

  2. Audience: Employee Plans examiners and other specialists

  3. Policy Owner: Director, Employee Plans

  4. Program Owner: Employee Plans

  5. Program Goal: The information in this IRM is designed to help examiners determine the fair market value (FMV) of assets in defined contribution plans. To achieve this objective this IRM discusses, among other things, factors for determining value, timing of asset valuations, interim valuations, types of plan assets, as well as examination steps.

  6. This IRM doesn’t address the valuation of assets in a defined benefit plan. See 26 CFR 1.412(c)(2)-1 and 26 CFR 1.430(g)-1(c) for the FMV of assets and actuarial value of assets in a defined benefit plan.

Background

  1. EP Examinations determines if a retirement plan is qualified under IRC 401 and the underlying regulations, and therefore exempt from tax under IRC 501.

  2. For plans to comply with the requirements of the Internal Revenue Code (Code) and Title I of the Employee Retirement Income Security Act (ERISA), it is essential that they accurately assess the FMV of assets. For instance, the FMV of assets must be accurately determined to preclude any of the following:

    1. Prohibited transaction under IRC 4975

    2. Exclusive benefit violation under IRC 401(a)

    3. Violation of the limitation on contributions and other additions under IRC 415(c)

    4. Excess deduction under IRC 404

    5. Violation of the minimum funding requirements under IRC 412

    6. Discrimination violation under IRC 401(a)(4)

Authority

  1. The primary objective of the Employee Plans examination program of returns is regulatory, with emphasis on continued qualification of exempt organizations and employee benefit plans. EP selects and examines returns per Policy Statement 4-119, IRM 1.2.1.5.36 to:

    1. Promote the highest degree of voluntary compliance with the statutes governing qualification of plans and exemption of certain types of organizations from tax.

    2. Determine the extent of compliance and the causes of noncompliance with the tax laws by plans and organizations.

  2. IRC 7602 gives EP the authority to:

    1. Examine any books, papers, records or other data necessary to complete an examination.

    2. Issue summonses for the production of such books, papers, records or other data; or to the proper person, to give testimony under oath as may be relevant, or material, to such inquiry.

Responsibilities

  1. The Director, EP supervises and is responsible for:

    1. EP Rulings and Agreements

    2. EP Examination functions

    3. EP Program Management Staff

  2. The Director, EP Examination, supervises and is responsible for:

    1. EP Examinations

    2. EP Examinations, Area Managers

Program Management and Review

  1. Treasury Regulation Part 801, Balanced System for Measuring Organizational and Employee Performance Within the Internal Revenue Service, 26 CFR 801.1 mandates certain quality measures for TE/GE exams. TE/GE Shared Services (SS):

    1. Created the CP&C function in May 2017.

    2. Moved EP and EO Special Review groups, under the former Examination Planning and Review unit in the respective Exam functions to CP&C.

    3. Gave CP&C, SS, Special Review (SR) the responsibility to review and report case quality for all TE/GE exams.

  2. The Tax Exempt Quality Measurement System (TEQMS) is the quality control system TE/GE uses to oversee the entire examination program. TEQMS has three quality control measures:

    1. Proper Identification, Development and Resolution of Issues

    2. Taxpayer Communication (Internal & External)

    3. Timeliness

  3. Special Review (SR) evaluates exam cases, reports TEQMS results and alerts management of areas that need attention and recommends quality improvements.

  4. SR expects the following benefits from exam quality review reporting:

    1. Get data for quality management reports and address improvement opportunities.

    2. Increase consistency in exams.

    3. Identify possible training or continuing professional education needs.

      Note:

      See, IRM 4.70.7, TE/GE Examinations, Special Review (SR) and Tax Exempt Quality Measurement System (TEQMS) Procedures

Program Controls

  1. Mandatory Review ensures agents conduct examinations according to technical, procedural and administrative requirements. IRM 4.71.14 Employee Plans Examination of Returns, EP Mandatory Review. Examiners and managers must:

    1. Do all examinations according to Policy Statement 1-236, Fairness and Integrity in Enforcement Selection, IRM 1.2.1.2.36

    2. Be familiar with and act according to the Taxpayer Bill of Rights. The Taxpayer Bill of Rights (TBOR) lists rights that already existed in the tax code, putting them in simple language and grouping them into 10 fundamental rights. Employees are responsible for being familiar with and acting in accord with taxpayer rights. See IRC 7803(a)(3), Execution of Duties in Accord with Taxpayer Rights. For additional information about the TBOR, see https://www.irs.gov/taxpayer-bill-of-rights.

    3. Be familiar with and act according with the applicable provisions of the Taxpayer First Act. https://irssource.web.irs.gov/TFA/Lists/Provisions/Provisions.aspx

Acronyms

  1. This table lists acronyms used in this IRM and their definitions.

    Acronym Definition
    EO Exempt Organizations
    EP Employee Plans
    CP&C Compliance, Planning and Classification
    DOL Department of f Labor
    ERISA Employee Income Security Act
    ESOP Employee Stock Ownership Plan
    FMV Fair Market Value
    HCE Highly Compensated Employee
    NHCE Non-Highly Compensated Employee
    SR Special Review
    SS Shared Services
    TE/GE Tax Exempt and Government Entities
    TEQMS Tax Exempt Quality Measurement System

Valuation of Assets

  1. In a profit sharing, money purchase or stock bonus plan, the valuation of assets will determine the value of a participant’s account, and ultimately, a participant’s distribution.

  2. In an Employee Stock Ownership Plan (ESOP), the valuation affects both the deduction and distribution. For employer securities that aren’t readily tradable on an established securities market, IRC 401(a)(28)(C) requires an independent appraiser to do all valuations for activities carried on by the plan. See Notice 2011-19, 2011-11 IRB 550 and 26 CFR 1.401(a)(35)-1(f)(5) for the definition of readily tradable on an established securities market.

  3. Whether a formal valuation is required depends on the plan transactions and the form of the plan.

    Example:

    Asset valuation in a single participant plan, a self-directed account, or frozen plan can be less formal in a year in which the plan or self- directed account receives no contributions and makes no distributions or change in investments.

  4. Whether a plan’s method for valuing assets is reasonable is based on the facts and circumstances.

    1. Except for certain employer securities held by an ESOP, there is no absolute requirement that a plan’s annual valuation be based on an independent appraisal.

    2. On the other hand, it may be reasonable for you to request an appraisal for hard-to-value assets under certain circumstances, such as when distributions are made to plan participants.

    3. Whether an independent appraisal is required or not, you may use the valuation guidelines in Rev. Rul. 59-60, 1959-1 CB 237, as modified by Rev. Rul. 65-193, 1965-2 C.B. 370, to support your review for reasonableness.

Form 5500 Information

  1. Form 5500, Annual Return/Report of Employee Benefit Plan, Schedule H, Financial Information, Schedule I, Financial Information--Small Plan, and Form 5500-SF, Short Form Annual Return/Report of Small Employee Benefit Plan require a statement of plan assets information.

  2. The asset and liability section requires FMV and plan liability as of the beginning and end of the current plan year.

  3. The income and expense section asks for the contribution, earnings on investments, benefit payments and expenses. In addition, Form 5500 Schedules H and I specifically asks for unrealized appreciation or depreciation of plan assets.

  4. A question on Form 5500 Schedules H and I asks whether any non-cash contributions (real estate, collectibles and closely held stock, etc.) were made to the plan, the value of which was neither readily determinable on an established securities market nor set by an independent third party appraiser.

    Note:

    The IRS position is that contributions of property to pension plans and certain other defined contribution plans are prohibited transactions if they aren’t covered by a statutory or administrative exemption. The Supreme Court ruled in favor of the IRS in Keystone Consolidated Industries v. Commissioner, 508 U.S. 152 (1993).

  5. A question on Form 5500 (Schedules H and I) asks whether the plan holds any assets whose current value was neither readily determinable on an established market nor set by an independent third-party appraiser.

  6. A question on Form 5500 applicable to ESOPs (Schedule R, Retirement Plan Information), asks if the ESOP holds any stock that is not readily tradable on an established securities market.

Examination Steps

  1. Determine whether the plan reports assets with the same values in successive years. If the plan reports the same value for an asset as the prior year Form 5500, it may indicate that the plan didn’t have a yearly valuation, requiring further examination.

  2. Determine whether there is a sudden jump in plan asset values in the year the plan makes a large distribution to highly compensated employees (HCEs). The plan assets may not have been revalued in prior years, when the plan only made distributions to non-highly compensated employees (NHCEs). This indicates there might be discrimination under IRC 401(a)(4).

    1. For plan terminations submitted for a determination letter including Form 6088, Distributable Benefits from Employee’ Pension Benefit Plan, determine whether only the accounts of HCEs remain at plan termination. Compare it to Form 5500 for the current year to see if any NHCEs participate in the plan. If none participate in the current year, look at Form 5500 for prior years to determine whether the plan only made distributions to NHCEs in those years.

    2. For plans not terminating, check Form 8955-SSA, Annual Registration Statement Identifying Separated Participants With Deferred Vested Benefits, to see if mostly separated HCEs’ accounts remain in the trust.

  3. Refer to the Form 5500 question on unrealized appreciation/depreciation. There may be a valuation problem if there is no response to this question when the plan reports investments in any corporate stock or security.

  4. Look at the Form 5500 question on non-cash contributions. If the plan sponsor contributed the property, determine whether and by whom the property was valued in the year of the contribution.

  5. Look at the Form 5500 question on plan assets whose current value was neither readily determinable nor set by an independent third party appraiser. If there is an affected asset, determine whether and by whom the asset was valued.

  6. For ESOPs, look at the Form 5500 (Schedule R) question on stock that is not readily tradable on an established securities market. If the plan holds any non-readily tradable stock not appraised by an independent third-party appraiser, determine whether the securities were valued that year and by whom. See IRM 4.72.4, Employee Stock Ownership Plans (ESOPs) and IRM 4.72.8.8, ESOP Issues.

    Note:

    A valuation problem may exist if you find any of these items on Form 5500.

Timing of Asset Valuations

  1. Profit-sharing, stock bonus and money purchase plans are required to make distributions according with amounts stated or determinable and credited to participants; accordingly, the funds under these trusts must be allocated to participants’ accounts in accordance with a definite formula.

  2. If amounts to be allocated or distributed to a particular participant are to be determinable, these plans must have a valuation of investments held by the trust, at least once a year, on a specified inventory date, per a method consistently followed and uniformly applied. The plan must use the fair market value on the inventory date. The plan must adjust participants’ accounts according to the valuation, Rev. Rul. 80-155.

Interim Valuations

  1. Under Rev. Rul 80-155, in addition to the required annual valuation, interim valuations are permitted. So, a plan provision allowing interim valuations at a trustee’s discretion is permitted if these valuations aren’t discriminatory under IRC 401(a)(4).

    1. A plan with a valuation date of January 1, the first day of the plan year, which also requires interim valuations at the end of each month in which assets had significant market fluctuations (as defined in the plan) may not be discriminatory.

    2. However, if a defined contribution plan was amended to provide for interim valuations during a time in which plan asset values were rising and in which HCEs were receiving distributions, the plan could violate IRC 401(a)(4).

  2. The valuation dates for account balances are not IRC 411(d)(6) protected benefits. So, a decrease in benefits caused by a change in the date for valuing plan assets is not a decrease in benefits prohibited by IRC 411(d)(6). See 26 CFR 1.411(d)-4, Q& A –1(d)(8).

Examination Steps

  1. Determine whether plan assets have been valued annually at FMV.

  2. If there are interim valuations, determine that the plan has an annual valuation date and permits interim valuations.

  3. Check whether interim valuations are discriminatory under IRC 401(a)(4).

  4. If the valuation doesn’t appear to be accurate, consider making a referral requesting an Engineer specialist in valuation, per IRM 4.71.6.11, Employee Plans Examination of Returns, Employee Plans Referrals. A DOL referral may also be warranted.

Determining Asset Values

  1. Rev. Rul. 59-60 provides guidance for determining the value of plan assets. This revenue ruling provides methods for valuing shares of stock of closely held corporations for estate and gift tax purposes and you may use the listed factors to determine values of assets in qualified plans.

    Note:

    The list of factors to consider in Rev. Rul. 59–60 is not an exclusive list for valuing closely-held employer securities. You may need to consider other factors when appropriate. Also, not all of the listed factors are relevant to all companies and transactions.

  2. Determine how much of the plan’s valuation details you should examine based on the plan assets involved.

    Example:

    The valuation should contain substantial detail if it values a limited partnership interest or a closely held corporation.

  3. When appropriate, stock values should be discounted due to a lack of marketability and, if appropriate, a control premium should be added to the stock value.

Factors for Determining Value

  1. There are a number of factors to consider when determining the value of an asset. See Rev. Rul. 59-60. For example:

    1. Nature and history of the business issuing the security

    2. General economic outlook and the outlook for the specific industry

    3. Book value of the securities and the financial condition of the business

    4. Company’s earning capacity

    5. Company’s dividend paying capacity

    6. Goodwill value

    7. Recent stock sales

ERISA 3(18)

  1. ERISA 3(18) applies for some prohibited transaction exemptions under both ERISA and the Code.

  2. ERISA 3(18) defines the term adequate consideration for "assets other than a security for which there is a generally recognized market" as the FMV of the asset as determined in good faith by the trustee or named fiduciary per the plan terms and according to the regulations.

  3. Proposed Department of Labor (DOL) Reg. 2510.3–18(b)(2) defines "fair market value" as the price at which an asset would change hands between a willing buyer and a willing seller when either party is not under any compulsion to enter into the transaction.

Examination Steps

  1. Determine, after you carefully review the plan asset valuation, if the value assigned to an asset differs from what you expect.

  2. Determine the value of publicly traded securities by checking their prices through online resources.

  3. When you determine the FMV of closely held stock, determine how the company valued closely held company shares.

    1. Check whether the share prices as reported on Form 5500, auditor report, rise and fall with its earnings. If the company’s earnings have fallen but the report says the price per share has risen or remained constant, it may indicate an incorrect valuation. Request an explanation.

    2. Determine whether there have been any recent sales of the company’s stock. Make sure the sales price is consistent with the valuation.

    3. If the current valuation relies on a previous valuation, check the employer’s audit report to see if the company’s earnings have fallen since the valuation report was written. If they have, the value of the shares should have also likely fallen. The plan fiduciary can no longer rely on the price per share from the valuation report because the facts on which it was based have changed. Similar rules apply if the company’s earnings have risen since the valuation report was written.

    4. Other factors used to determine the FMV of closely held stock include their book value, dividend paying capacity and the goodwill value of the company.

  4. In an investment or holding company, determine whether the valuation gave the greatest weight to the assets underlying the security to be valued. In a company which sells products or services, determine whether the valuation gave the greatest weight to earnings.

  5. If the valuation appears to be inadequate, verify its accuracy by asking for another valuation from a fiduciary or qualified appraiser.

Types of Plan Assets

  1. Plans may invest a portion of their assets in limited partnerships and invest directly in real property, or in mortgages on real property. Section 404(a)(1)(C) of ERISA requires that investments be diversified to minimize the risk of large losses unless it is not prudent to do so.

  2. Plans may also invest in life insurance contracts. See below for a safe harbor that plans may use when they distribute these contracts.

Partnerships

  1. The partnership itself can invest in virtually any type of asset.

  2. Generally, limited partnership interests are not listed on national securities exchanges.

  3. The valuation of a plan’s interest in a partnership is especially important in a year in which the plan makes a distribution.

Examination Steps
  1. Ask for information on how and when a partnership’s FMV was determined.

    1. Ask whether there were sales of or offers for the partnership interests, secondary market trades or quotes, and whether the fiduciary used the general partner’s valuation.

    2. Determine the basis for the valuation of the partnership, in other words, if the partnership’s value was based on the original cost of the investment, or the capital account (reported on the Schedule K–1, which shows the partner’s pro rata share of the partnership’s income, losses, credits and deductions). These valuations may not reflect the FMV of the partnership.

  2. The fact that a partnership has had no earnings may indicate that the partnership is worthless. To determine whether the partnership had earnings, request the partnership’s K–1s. Depending on the circumstances, you may want to request K-1s for prior years.

Real Estate

  1. Plan ownership of real estate or mortgages may be valued incorrectly if based solely on their purchase prices.

  2. Under certain circumstances, if a plan owns a mortgage, it might need to be re-valued to reflect the current value of the encumbered real property.

    Example:

    If the FMV of property is lower than the indebtedness secured by the property, the value of the mortgage the plan holds should be marked down.

Examination Steps
  1. To determine the value of real estate, check the appraisal report, tax assessment document, and the property insurance policy.

  2. Compare the loan or mortgage balance to the appraised value of the property.

  3. The property’s best use is one criteria in valuing the asset. Determine what the property is actually used for. If the property’s best use is different than the property’s actual use, then the property may not have been properly valued.

Life Insurance Contracts

  1. Individuals who receive a distribution of property from a qualified plan must include its FMV in income (26 CFR 1.402(a)-1(a)(1)(iii)).

  2. 26 CFR 1.402(a)-1(a)(1)(iii) also provides that in the case of a distribution of a life insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection, or any interest in one of those contracts, the policy cash value and all other rights under the contract (even including any supplemental agreements to the contract) and whether or not they are guaranteed, are included in determining the fair market value of the contract.

  3. Q&A-10 of Notice 89-25, 1989-12 IRB 68, described a qualified plan distribution of a life insurance policy with a value substantially higher than the cash surrender value stated in the policy. The notice concluded that the practice of using cash surrender value as fair market value is not appropriate when the total policy reserves (including life insurance reserves (if any) computed under IRC 807(d), together with any reserves for advance premiums, dividend accumulations, etc.) more accurately approximate the policy’s FMV.

  4. Since Notice 89-25 was issued, life insurance contracts have been marketed that are structured in a way which results in a temporary period during which neither a contract’s reserves nor its cash surrender value represent the contract’s FMV.

    Example:

    Some life insurance contracts may offer large surrender charges and other charges that aren’t expected to be paid because they’re expected to be eliminated or reversed in the future (under the contract or under another contract exchanged for the first contract). But, this future elimination or reversal isn’t always shown in the contract’s reserve calculation. If this contract is distributed before the charges are eliminated or reversed, both the cash surrender value and the reserve under the contract could significantly understate the contract’s FMV. Therefore, in some cases, it wouldn’t be appropriate to use either the net surrender value (i.e., the contract’s cash value after reduction for any surrender charges) or, because of the unusual nature of the contract, the contract’s reserves to determine its FMV.

  5. Rev. Proc. 2004-16 provided a safe harbor to determine the fair market value of variable and non-variable contracts to apply the rules under the proposed regulations under IRC 402(a) but was modified by and superseded by Rev. Proc. 2005-25.

  6. Rev. Proc. 2005-25 modified and superseded Rev. Proc. 2004-16. It provides two safe harbor formulas that, if used to determine the value of an insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection that is distributed or otherwise transferred from a qualified plan, will meet the definition of FMV for IRC 402(a) purposes.

  7. These safe harbor formulas also meet the definition of FMV for IRC 402(b) purposes and the definition of vested accrued benefit for IRC 402(b)(4)(A).

  8. Rev. Proc. 2005-25 applies to distributions, sales, and other transfers made from an exempt employee’s trust on or after February 13, 2004, and to non-exempt employees’ trusts under IRC 402(b) for periods on or after February 13, 2004. Taxpayers may rely on the Rev. Proc. 2005-25 safe harbors for periods before May 1, 2005. Taxpayers may also rely on the safe harbors in Rev. Proc. 2004-16 for periods on or after February 13, 2004, and before May 1, 2005.

Examination Steps
  1. Determine whether a life insurance policy distributed by a plan is valued properly:

    1. For a non-variable life insurance contract - compare the premiums paid with the contract’s value. Generally, the value of a non-variable life insurance contract should be close to the premiums paid under the contract accumulated at a reasonable rate of interest (at least 2 or 3%) less reasonable cost of insurance charges (generally, except for very high ages, less than $5,000 per $1 million of death benefit) less reasonable policy expenses (generally, less than $1,000 per $1 million of death benefit).

    2. For a variable life insurance contract, consider the actual investment return. Generally the value of a variable life insurance contract should be close to the premiums paid under the contract accumulated at the actual investment return rate earned by the contact (which can vary widely because the premiums paid under these contracts are generally invested in mutual fund like instruments) less reasonable cost of insurance charges (generally, Rev. Rul. except for very high ages, of less than 5,000 per $1 million of death benefit) less reasonable policy expenses (generally, less than $2,000 per $1 million of death benefit).

    3. Protect the statute of limitations on the related Form 1040, U.S. Individual Income Tax Return, resulting from any adjustments to the recipient's taxable income. See IRM 4.71.4, Employee Plans Examination of Returns, Discrepancy Adjustments.

Effects of Improper Valuation

  1. Defined contribution plan assets must be revalued at least annually, Rev. Rul. 80-155. If Rev. Rul. 80–155 requirements are not met, the plan is not qualified.

  2. If assets are valued more frequently than annually in a way that favors distributions to HCEs, it could result in prohibited discrimination under IRC 401(a)(4).

  3. Improperly valuing qualified plan assets can cause a plan to exceed the IRC 415 limits.

    Example:

    A plan sponsor contributed undervalued property to the ABC Co. Profit Sharing Plan. In the plan year of the contribution, the annual additions to participant accounts based on the improper valuation are within the limits of IRC 415. ABC later received an independent appraisal of the property. The annual additions based on FMV of the contributed property exceeded the participants’ IRC 415(c) limits.

    Example:

    DEF Co. 401(k) plan sold property at more than its FMV. The allocation of trust earnings to participants’ annual additions based on the sale at more than FMV could cause the participants to exceed their IRC 415(c) limits.

  4. If the plan sells or buys assets at a value other than FMV, it may be a prohibited transaction if a disqualified person is involved.

  5. In extreme cases, a plan may violate the exclusive benefit rule in IRC 401(a)(2) if it engages in a prohibited transaction in which it buys property for more than FMV.

Funding and Deductions

  1. Contributing property to a plan may be allowed if it is covered by a prohibited transaction exemption.

  2. Generally, a cash contribution is made to the plan, but it doesn’t have to be paid in cash to be deductible under IRC 404.

  3. If an employer contributes overvalued property to the plan:

    1. They may have deducted an amount in excess of the IRC 404 limit.

    2. If contributed to a money purchase pension plan, the plan might not satisfy the minimum funding standards of IRC 412.

Prohibited Transactions

  1. A plan may acquire and hold qualifying employer securities and qualifying employer real property IRC 4975(d)(13)and ERISA 408(e)).

  2. A plan’s acquisition of qualifying employer securities or qualifying employer real property is exempt under IRC 4975(d)(13) only if the securities or real property is acquired for "adequate consideration" as defined under ERISA 3(18). This requires a proper valuation. See IRM 4.72.11, Employee Plans Technical Guidance, Prohibited Transactions.

Examination Steps

  1. Evaluate a plan’s purchase of employer securities and employer real property. Determine if it complies with the prohibited transaction exemption requirements and the exclusive benefit requirements.

  2. If a contribution of property to a plan is covered by a prohibited transaction exemption, determine whether an employer exceeded the contribution or deduction limitations by contributing undervalued property to a qualified defined contribution plan. The IRC 4972 excise tax may apply.

  3. Determine whether an improper valuation has caused the plan to violate IRC 415.

ESOP Issues

  1. ESOPs must satisfy the annual valuation requirements of Rev. Rul. 80–155 for defined contribution plans. However, in a transaction between an ESOP and a disqualified person (as defined in IRC 4975(e)(2)), the value must be determined as of the date of the transaction. See 26 CFR 54.4975-11(d)(5).

  2. ESOPs have special valuation rules in certain circumstances. See IRM 4.72.4, Employee Plans Technical Guidance, Employee Stock Ownership Plans (ESOPs).

Independent Appraiser Rules

  1. An ESOP is not a qualified plan unless an independent appraiser values employer securities that are not readily tradable on an established securities market, for activities carried on by the ESOP (IRC 401(a)(28)(C)).

  2. An independent appraiser’s valuation is not required for employer securities that are readily tradable on an established securities market per 26 CFR 1.401(a)(35)-1(f)(5), Notice 2011-19, 2011-11 IRB 550.

  3. An independent appraiser’s valuation is required for employer securities that aren’t readily tradeable on an established securities market but only for securities acquired after December 31, 1986.

  4. An appraiser is independent if he/she satisfies the requirements under IRC 170(a)(1) for a "qualified appraiser." 26 CFR 1.170A-13(c)(5) requires a "qualified appraiser" to make a declaration on the appraisal summary that the appraiser:

    1. Holds himself/herself out to the public as an appraiser or performs appraisals on a regular basis.

    2. Is qualified to make appraisals of the type of property being valued; and describes his/her qualifications pursuant to 26 CFR 1.170(A)-13(c)(3)(ii)(F).

  5. An appraiser is not independent if he/she is:

    1. The taxpayer that maintains the ESOP (or a member of the controlled group of corporations that includes the taxpayer).

    2. A party to the transaction in which the ESOP acquired the property.

    3. Employed by the taxpayer maintaining the ESOP (or any entity described in subparagraphs a) or b), above).

    4. Regularly used by any entity described above and doesn’t perform a majority of his/her appraisals for entities other than those described above.

      Example:

      Employer X has an ESOP and uses a large, national accounting firm for its auditing and tax requirements. The accounting firm proposes to use its valuation division to perform an appraisal for the ESOP. The valuation division is qualified to perform appraisals of the property and holds itself out to the public as an appraiser. Is the accounting firm’s valuation division an independent appraiser for purposes of IRC 401(a)(28)(C)?
      Yes, as long as the accounting firm’s valuation division performs a majority of its appraisals for entities other than Employer X or its related entities, it is an independent appraiser.

  6. A valuation of employer securities by an independent appraiser is required for any activities carried on by the plan. These activities include the contribution of employer securities to an ESOP, the purchase of employer securities by an ESOP and distributions to participants.

    1. Employer securities are not necessarily required to be valued by IRC 401(a)(28)(C) as of the date of the plan activity. The plan can generally use the most recent annual valuation the independent appraiser did on the plan’s valuation date.

    2. Plan activities requiring valuations also include a participant’s offer of employer securities to the employer under a right of first refusal, a participant’s exercise of a put option to sell shares to the employer and the allocation of assets to participants’ accounts, 26 CFR 54.4975-11(d)(5).

    3. A participant’s diversification election under IRC 401(a)(28)(B) is a plan activity that requires a valuation by an independent appraiser.

    4. IRC 401(a)(35) requires defined contribution plans to provide employees the freedom to divest publicly traded employer securities.

Examination Steps

  1. Review Form 5500 to see if a current appraisal of employer securities was made immediately before such stock was contributed to or purchased by an ESOP for the plan year.

    1. If the answer is "no," determine if the plan has a valuation problem and if the plan may be disqualified.

    2. If the answer is "yes," check Form 5500 to see if the appraisal was made by an unrelated third party. If the answer is "no," determine if the plan has a valuation problem and if the plan may be disqualified.

  2. Make sure the appraiser is an "independent appraiser" per IRC 401(a)(28)(C).