- 4.72.11 Prohibited Transactions
- 22.214.171.124 Overview
- 126.96.36.199.1 Technical Overview
- 188.8.131.52.2 Relationship Between Exclusive Benefit and Prohibited Transaction
- 184.108.40.206.3 Exclusive Benefit Rule
- 220.127.116.11.4 Relationship Between Assignment or Alienation and Prohibited Transaction
- 18.104.22.168.5 Examination Steps
- 22.214.171.124.6 Excise Taxes
- 126.96.36.199 Identifying Prohibited Transactions
- 188.8.131.52.1 Disqualified Person
- 184.108.40.206.1.1 Examination Steps
- 220.127.116.11.2 Application of IRC 4975
- 18.104.22.168.2.1 Examination Steps
- 22.214.171.124 Prohibited Transactions
- 126.96.36.199.1 Sale, Exchange or Leasing of Property
- 188.8.131.52.2 Loans Between Plan and Disqualified Person Who Is a Participant or Beneficiary
- 184.108.40.206.2.1 Loans from 401(k) Plan to Entities Partially Owned by the 401(k) Plan Sponsor
- 220.127.116.11.2.1.1 Examination Steps
- 18.104.22.168.2.2 Loans From Plan to Disqualified Person (Other than Participant Loans)
- 22.214.171.124.2.2.1 Examination Steps
- 126.96.36.199.3 Furnishing Goods or Services or Usage of Facilities
- 188.8.131.52.3.1 Department of Labor Service Provider Disclosures Under Section 408(b)(2)
- 184.108.40.206.3.2 Examination Steps
- 220.127.116.11.4 Direct or Indirect Transfer of Income or Assets
- 18.104.22.168.5 Fiduciary Self Dealing
- 22.214.171.124.5.1 Investments of Plan Assets in Account
- 126.96.36.199.5.2 Insurance Purchase From Related Companies
- 188.8.131.52.5.3 Examination Steps
- 184.108.40.206.6 Third Party Dealing by Fiduciary
- 220.127.116.11.6.1 Examination Step
- 18.104.22.168.7 Acquisition of Employer Securities or Employer Real Property
- 22.214.171.124.7.1 Eligible Plans
- 126.96.36.199.7.2 Qualifying Employer Securities and Qualifying Employer Real Property
- 188.8.131.52.7.2.1 Qualifying Employer Real Property
- 184.108.40.206.7.2.2 Adequate Consideration
- 220.127.116.11.7.2.3 No Commission
- 18.104.22.168.7.2.4 Examination Steps
- 22.214.171.124.7.3 Terminated Plans
- 126.96.36.199.7.3.1 Disposition of Qualifying Employer Securities
- 188.8.131.52.7.4 Disposition of Qualifying Employer Real Property
- 184.108.40.206.7.4.1 Disposition of Employer Real Property or Employer Securities Not Qualifying
- 220.127.116.11.7.4.2 Disposition of Other Plan Assets
- 18.104.22.168.7.5 Wasting Trusts
- 22.214.171.124.7.6 Examination Steps
- 126.96.36.199 Prohibited Transactions Tax
- 188.8.131.52.1 First Level Tax
- 184.108.40.206.2 Amount Involved First Level
- 220.127.116.11.2.1 Excess Compensation
- 18.104.22.168.2.2 Use of Money or Property
- 22.214.171.124.2.3 Less than FMV Received
- 126.96.36.199.3 Amount Involved Second Level
- 188.8.131.52.3.1 Correction
- 184.108.40.206.3.1.1 Correction Involving Use of Money or Property
- 220.127.116.11.3.1.2 Correction Involving Use of Money or Property by a Plan
- 18.104.22.168.3.1.3 Correction of Sales of Property by a Plan
- 22.214.171.124.3.1.4 Resale Prior to End of Taxable Period
- 126.96.36.199.3.1.5 Correction of Sale of Property to a Plan
- 188.8.131.52.3.1.6 Resale by Plan
- 184.108.40.206.3.1.7 Compensation Paid
- 220.127.116.11.3.1.8 Less than FMV Received
- 18.104.22.168 Transactions Identified on Form 5500
- 22.214.171.124.1 Examination Steps
- 126.96.36.199 Statute of Limitations
- Exhibit 4.72.11-1 List of Granted Class Exemptions
- Exhibit 4.72.11-2 Relationship Between Employer and Disqualified Person
- Exhibit 4.72.11-3 Relationship Between Non-corporate Employer and Disqualified Person
- Exhibit 4.72.11-4 Computation of the Amount Involved and the IRC 4975(a) Excise Tax for a Continuous Prohibited Transaction
- Exhibit 4.72.11-5 Computation of the Amount Involved and the IRC 4975(a) Excise Tax for a Continuous Prohibited Transaction with Repayments
- 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
Part 4. Examining Process
Chapter 72. Employee Plans Technical Guidelines
Section 11. Prohibited Transactions
December 17, 2015
(1) This transmits revised IRM 4.72.11, Employee Plans Technical Guidance, Prohibited Transactions.
(1) Revised, clarified and reorganized content throughout.
Robert S. Choi
Director, Employee Plans
Tax Exempt and Government Entities
This IRM provides guidance for Employee Plans (EP) agents to help identify prohibited transactions during the examination of a qualified pension or profit-sharing plan.
The purpose of these guidelines is to assist the examining specialist to determine the issues to raise with respect to certain areas for which it was believed guidelines would be helpful. The techniques identified herein may be modified based on examination issues encountered. These guidelines are not intended to be all-inclusive. It is not expected that the guidance presented in these guidelines will be relevant in every examination.
These guidelines are not intended to be and should not be treated as a comprehensive statement of precedent or of the Service’s legal position on the issues herein presented.
The information in this IRM is also written to provide guidelines for prohibited transactions and:
Computation of applicable excise taxes
Exclusive benefit requirements under IRC 401(a)
Assignment and alienation provisions under IRC 401(a)(13)
IRC 4975 imposes a nondeductible excise tax on the amount involved for each prohibited transaction that occurs in a year. See IRC 275(a)(6). The disqualified person (DP) who participated in the prohibited transaction pays the excise tax. See IRC 4975(a).
The legislative history to the Employee Retirement Income Security Act of 1974 (ERISA) indicates that Congress believed the sanction of an excise tax was desirable in many instances in lieu of disqualifying plans under the prohibited transaction rules of IRC 503. IRC 503(b):
Governs whether a transaction that was entered into prior to January 1, 1975, constitutes a prohibited transaction.
Continues to apply to IRC 414(d) governmental plans and to those church plans that don’t make an election under IRC 410(d) to be covered by ERISA. See IRC 4975(g)(2) and (3).
For a plan to be qualified (and the related trust tax-exempt) at any time prior to satisfying its liabilities for its employees and their beneficiaries, it must be impossible to divert the trust’s corpus or income other than for the exclusive benefit of the employees and their beneficiaries. See IRC 401(a)(2).
A proposed disqualification of a plan for an exclusive benefit violation involving fiduciary action per ERISA, Title I, Subtitle B, Part 4 is subject to mandatory technical advice under Rev. Proc. 2015-2. See IRM 4.71.13, Technical Assistance and Technical Advice Requests.
There are special rules for multiemployer plans. See IRM 4.72.14, Employee Plans Examination Guidelines - Multiemployer Plans.
A trust isn’t a qualified trust under IRC 401 unless the plan of which it is a part provides that benefits under the plan may not be assigned or alienated. See IRC 401(a)(13).
The exclusive benefit rule of IRC 401(a) doesn’t conflict with the prohibited transaction provisions of IRC 4975. A DP may engage in a prohibited transaction and at the same time cause a violation of the exclusive benefit rule. Therefore, a trust officer, etc., can’t claim that the imposition of an IRC 4975 excise tax prevents the application of the exclusive benefit rule.
If a transaction violates the exclusive benefit rule, you must consider revoking the trust’s qualified status.
If you invoke revocation, the prohibitions and sanctions of IRC 4975 continue to apply to the disqualified plan. See IRC 4975(e)(1)(G) and IRM 4.71.3, Unagreed Form 5500 Examination Procedures and EP Exam Closing Agreements.
Generally any transaction described in IRC 4975(c) between the plan and the employer or other persons related to the plan or the employer (i.e., a DP) constitute a prohibited transaction under IRC 4975. In some cases, these transactions may be exempt from IRC 4975 taxes because of a statutory or an administrative exemption. However, even though a transaction may be exempt from IRC 4975 taxes, it must still meet the exclusive benefit and the assignment or alienation requirements.
A trust’s investment policies must be for the exclusive benefit of the employer’s employees or their beneficiaries is a qualification requirement under IRC 401(a).
Consider these four factors to determine whether a trust’s investment policies are for the exclusive benefit of the employees/beneficiaries (Rev. Rul. 69-494 as incorporated into ERISA 404):
The cost of an investment must not exceed its fair market value (FMV) at the time of its purchase.
A fair return commensurate with the prevailing rate must be provided.
The investment must be sufficiently liquid to permit distributions per the plan terms.
The safeguards and diversity that a prudent investor would adhere to must be present.
Also consider these other issues for investments:
The use or diversion of the trust’s corpus or income.
Whether there is a reversion of the trust’s corpus or income to the employer.
For IRC 401(a), a custodial account under IRC 401(f) is treated as if it were a trust and a custodian is treated as a trustee. See Winger's Department Store v. Commissioner, 82 T.C. 869 (1984), for a discussion of the IRS's post-ERISA enforcement authority.
The assignment or alienation rule of IRC 401(a)(13) doesn’t conflict with the prohibited transaction provisions of IRC 4975. As a result, imposing the IRC 4975 excise tax doesn’t prevent the IRS from applying the assignment or alienation provisions of IRC 401(a)(13).
Not more than 10 percent of any benefit payment made to any participant who is receiving benefits under the plan is for defraying plan administration costs.
There is a qualified domestic relations order per IRC 414(p).
A loan meets the requirements of IRC 4975(d)(1).
There is a federal tax levy or a federal tax lien.
Inspect the Form 5500 series return to determine the nature of investments. Also inspect the trust balance sheet and statement of receipts and disbursements to determine if their dollar amounts agree with the Form 5500 return amounts.
If the employer establishes the trustees’ investment powers and duties in the trust document, determine whether the trustees are following the trust instrument.
If the trust document is silent as to investment powers or in situations that go beyond the document, determine whether the investments meet the law governing investments by employee trusts.
For plans covered by Title I of ERISA, as described in DOL regulation 2510.3–3, state law doesn’t apply after January 1, 1975.
Plans not covered by Title I, such as "one-participant" plans covering only (i) sole proprietor and her/his spouse, or (ii) partners and their spouses and corporate plans whose sponsoring corporation is wholly owned by an individual or her/his spouse and the plan covers only the owner and the owner’s spouse, continue to be subject to state trust investment law.
Inspect the trust receipts and disbursements to detect:
Disbursements of funds that are contrary to IRC 401(a)(2).
Payments made to the employer/sponsor.
Be alert to the diversion of trust assets or income for purposes other than for the exclusive benefit of the employees for whom the funds were originally allocated.
Review the plan and/or trust documents and be alert for payments made to the employer/sponsor that violate the plan and/or trust provisions.
Complete Form 6212-B, Examination Referral Checksheet B, for all full scope and focused EP exams involving plans under DOL jurisdiction. See IRM 188.8.131.52, EP Group Procedures – Making Referrals to the Department of Labor (DOL), and IRM 184.108.40.206, Referrals to the Department of Labor.
If you determine that a prohibited transaction has occurred and Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, hasn’t been filed, solicit one.
If the taxpayer files a return, process it in accordance with IRM 220.127.116.11, Processing Agreed Forms 5330.
If the taxpayer refuses to file the return, process the case in accordance with IRM 18.104.22.168, Unagreed Cases.
A prohibited transaction means any direct or indirect transaction described in IRC 4975(c)(1) between the plan and a DP.
If a prohibited transaction falls within one of the statutory exemptions under IRC 4975(d), the excise tax may not apply.
In addition, there are two types of administrative exemptions that may be granted under IRC 4975(c)(2):
The term "disqualified person," as defined in IRC 4975(e)(2), covers a range of people including:
Unions and their officials
Fiduciaries and persons providing services to a plan such as lawyers and accountants
A disqualified person may also be someone whose relationship to the plan may not be immediately apparent. You’ll have to diligently investigate relationships of:
A service provider
The employer or employee organization involved
Persons who have a 50 percent or more interest
A member of the family as defined in IRC 4975(e)(6) of any individual described in IRC 4975(e)(2)(A), (B), (C) or (E)
Individuals with a 10 percent or more interest
The term "fiduciary" is specifically defined in IRC 4975(e)(3). The term fiduciary includes any person who does any of the following:
Exercises any discretionary authority or control in managing the plan
Exercises any authority or control over the trust’s assets
Renders investment advice concerning plan assets for which he/she receives direct or indirect compensation
Has any discretionary authority or responsibility for plan administration
If a prohibited transaction has occurred, determine whether the transaction took place (directly or indirectly) between the plan and a person (entity) described in IRC 4975(e)(2). See Exhibit 4.72.11-2, Relationship Between Employer and Disqualified Person and Exhibit 4.72.11-3, Relationship Between Non-corporate Employer and Disqualified Person.
IRC 4975 excise tax provisions apply to the following plan types:
A tax-exempt trust under IRC 401(a) (which is part of a plan).
A tax-exempt plan under IRC 403(a).
An IRC 408(a) Individual Retirement Account (IRA) or an IRC 408(b) Individual Retirement Annuity (IRA) (including Roth IRAs). However, if the individual for whom the IRA was established or the IRA’s beneficiary engages in a prohibited transaction with respect to the IRA, the sanction is the loss of the tax-exempt status of the IRA as of the first day of the taxable year in which the prohibited transaction occurs. See IRC 408(e)(2)(A).
Any of the above, even after they cease to be qualified. See IRC 4975(e)(1)(G).
The excise tax provisions of IRC 4975 don’t apply to:
A governmental plan within the meaning of IRC 414(d)
Those church plans that do not make an election under IRC 410(d) to be covered by ERISA
A tax sheltered annuity under IRC 403(b)
Due to the complexity of this area, use an analytical approach to determine whether a prohibited transaction has occurred for which the excise tax applies:
Determine whether there has been a prohibited transaction per IRC 4975(c)(1).
If a prohibited transaction has occurred, determine whether the trust or DP has received an IRC 4975(c)(2) administrative exemption.
If a prohibited transaction has occurred and the IRC 4975(c)(2) exemption hasn’t been granted, determine whether the prohibited transaction meets any of the statutory exemptions of IRC 4975(d) or IRC 4975(f)(6)(B)(ii).
If a prohibited transaction has occurred and any of the exemptions in IRC 4975(c)(2), IRC 4975(d) or IRC 4975(f)(6)(B)(ii) applies, don’t pursue the prohibited transaction because it’s exempt.
Exclusive benefit requirements
Assignment and alienation requirements
IRC 72(p) loan provisions
If a prohibited transaction has occurred and any of the exemptions in paragraph (d) don’t apply, pursue the issue with your group manager’s approval.
The following transactions (whether direct or indirect) between a plan and a DP result in a prohibited transaction subject to IRC 4975 excise tax unless there’s an applicable statutory or administrative exemption:
Sale, exchange or lease of any property
Loans or extensions of credit
Furnishing of goods, services or facilities
Transfer to, or use by or for the benefit of, a DP of any income or assets of a plan
Dealings by a fiduciary with the income or assets of the plan for her/his own interest or account
Receipt by a fiduciary of any consideration, from a party dealing with the plan in connection with a transaction involving income or assets of the plan
The sale, exchange or leasing of property (directly or indirectly) between a DP and the plan constitutes a prohibited transaction whether the transaction was made from the DP to the plan or from the plan to the DP. See IRC 4975(c)(1)(A).
If a DP transfers real or personal property to a plan, that transfer constitutes a sale or exchange such as to make the transfer a prohibited transaction if:
The property is subject to a mortgage or lien which the plan assumes.
The plan takes the property subject to a mortgage or similar lien which was placed on the property by a DP within 10 years prior to the transfer. See IRC 4975(f)(3).
This type of transfer of real or personal property most often arises when the employer contributes property instead of cash.
For contributions of unencumbered property, in Commissioner v. Keystone Consolidated Industries, Inc., 508 U.S. 152 (1993), the U.S. Supreme Court held that an employer’s contribution of unencumbered property to a defined benefit plan to satisfy the employer’s funding obligation to that plan is a sale or exchange within the meaning of IRC 4975(c)(1)(A) and, therefore, a prohibited transaction.
An ordinary blind purchase or security sale doesn’t constitute a prohibited transaction when neither the buyer, seller nor the agent of either, knows the identity of the other parties.
If a prohibited transaction falls within one of the following, the excise tax may not apply:
If the plan holds securities subject to a privilege to convert those securities to other securities (e.g., from bonds to stock), the plan may exercise that privilege if it receives adequate consideration under the conversion. See IRC 4975(d)(7).
Pooled Investments: A plan may purchase or sell an interest in a common or collective trust fund or a pooled investment fund maintained by a DP which is a bank or trust company supervised by a state or federal agency or between a plan and a pooled investment fund of an insurance company qualified to do business in a state if the bank or other entity receives no more than reasonable compensation for the purchase or sale or for the pooled fund’s investment management. Also, the transaction must be expressly permitted by the plan instrument or by a plan fiduciary, independent of the bank, trust company, or insurance company, who has authority to manage and control the plan assets.
A plan may acquire, sell or lease qualifying employer securities or qualifying employer real property, under certain conditions. See IRC 4975(d)(13) and IRM 22.214.171.124.7, Acquisition of Employer Securities or Employer Real Property.
The direct leasing of any property other than qualifying employer real property between a plan and a DP is prohibited.
Any contract, or reasonable arrangement, made with a DP for office space which is deemed necessary for establishing or operating a plan may be statutorily exempt from the prohibited transaction excise taxes if no more than reasonable compensation is paid for such lease (IRC 4975(d)(2))
Inspect the plan records to determine whether there have been any sales, exchanges or leases of property. If these transactions have occurred, request back-up documents to determine if the transaction is prohibited. Documents you may examine to determine whether a prohibited transaction has occurred include, but aren’t limited to:
Lease and rental agreements
If equipment is used in the employer’s business, check to see whether the plan owns the equipment and leases it to the employer.
A common transaction is a sale-leaseback. In this situation, the DP sells property to the plan, then the plan leases the property to the DP. If you discover an equipment lease to the employer, determine how the plan acquired the equipment. Generally, a sale (including a sale-leaseback) between the plan and a DP, in the absence of an administrative exemption, constitutes one or more prohibited transactions.
If the plan leases office space from a DP, it must meet the conditions of IRC 4975(d)(2) for it to qualify for the statutory exemption.
The terms of the lease must be as favorable to the plan as the plan might have obtained in an arm's-length transaction with an unrelated third person. Compare the leased space with any commercially leased space in the same building or obtain comparability data on similar office space from the local board of realtors.
The length of the lease must be reasonable (especially in relationship to leases on similar property).
The lease must be necessary for the plan’s establishment or operation.
Check to see if an administrative exemption exists if you discover a prohibited lease. See Exhibit 4.72.11-1, List of Granted Class Exemptions.
A loan to a disqualified person is a prohibited transaction unless it is a loan to a participant or beneficiary that meets the conditions of the statutory exemption for loans or is a loan for which the DOL has granted an administrative exemption.
A plan loan to a participant or beneficiary who is a DP is permissible if the loan:
Is adequately secured
Is available on a reasonably equivalent basis to all participants or beneficiaries in the plan
Bears a reasonable rate of interest
Is not made available to highly compensated employees (HCEs) (per IRC 414(q)) in greater amounts than to other employees
Is made according to specific plan provisions
The rules under IRC 72(p) and IRC 72(t) may also apply. For example:
Plans which use the participant’s account balance as security for a loan may simply offset that amount if the participant defaults on the loan. This offset could result in an impermissible pension plan distribution.
The participant’s account balance may not be adequate security if it’s less than the loan amount.
Offsets in a profit-sharing plan or a stock bonus plan may be permissible if the plan permits early distribution. However, evaluate all distributions to make sure the total amount of the distribution and the taxable amount are correctly reported on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
See IRM 4.72.4, Employee Stock Ownership Plans (ESOPs) for examination guidelines that cover ESOP loans.
If a disqualified person causes his/her wholly-owned company’s 401(k) plan, of which he/she is the sole trustee and administrator, to loan money to entities in which that individual owns minority interests, the loans may be prohibited transactions. See Joseph R. Rollins v. Commissioner, T.C. Memo 2004-260.
Determine whether loans are made according to specific plan/trust provisions.
Determine whether loans to participants are adequately secured. Usually, plans permit the participant’s vested accrued benefit to be used for the collateral.
Verify that the interest rate is reasonable:
Determine whether the plan loans’ interest rates and other conditions are comparable to the terms of similar commercial loans in the relevant community.
Check the overall rate of return on the plan's investments. When a large percentage of the plan's assets are invested in participant loans, the overall rate of return may be unreasonable.
To determine whether loans are available on a reasonably equivalent basis to all plan participants, determine whether the loan amount to one person is a substantial portion of plan assets. If so, there’s a potential that loans haven’t been made available on a reasonably equivalent basis to other employees. See Esfandiar Kadivar v. Commissioner, T.C. Memo. 1989-404.
Verify that loans to highly compensated employees don’t exceed any plan limits on participant loans.
Determine whether loans were made available to HCEs more frequently than to nonhighly compensated employees.
Check whether loans to HCEs are made in amounts greater than the amounts made available to other employees. See Esfandiar Kadivar v. Commissioner, T.C. Memo. 1989-404.
Ask about administrative practices for the loan program, including how participants are informed about the program and the history of loan applications and their disposition.
E Company's defined contribution plan allows participant loans and uses an employee's vested accrued account balance as collateral. The plan's most recent Form 5500, Annual Return/Report of Employee Benefit Plan, reports loans totaling $125,000. During your audit, you discover the loans were made to HCEs. Because the loans were made only to HCEs, it appears that loans may be made available to highly compensated employees more frequently than to nonhighly compensated employees. Therefore, although these are participant loans, they are loans to disqualified persons that don't meet the requirement that loans must not be available to HCEs in amounts greater than to other employees. (See IRC 4975(d)(1)(B)). Therefore, they are prohibited transactions per IRC 4975(c)(1)(B).
Determine if the plan granted a disqualified person an extension of the loan’s term. If so, the loan extension is a separate transaction that, itself, must meet the criteria for an exemption. An extension on a loan which is not exempt is a second prohibited transaction occurring at the time the loan was due and the extension granted.
Direct or indirect loans or other extensions of credit are prohibited between the plan and a disqualified person (IRC 4975(c)(1)(B)).
Consider the potential for nonexempt prohibited loans for employers experiencing financial difficulties or in a recessionary industry or region. Review the answer to Form 5500-SF, Annual Return/Report of Small Employee Benefit Plan and Schedule I, Financial Information - Small Plan, that asks "Were there any non-exempt transactions with any party-in-interest?"
When you discover a prohibited transaction, check the DOL annually granted individual administrative exemptions. Many of them are for loan transactions. If there’s an exemption, make sure it covers your plan’s specific transaction and that all of the conditions of the exemption are met.
Inspect the plan’s records to determine whether it has direct or indirect loans between disqualified persons and the plan. If yes, review a copy of the loan agreement to identify the parties to the loan.
Direct or indirect furnishing of goods, services, or facilities between a plan and a disqualified person is prohibited (IRC 4975(c)(1)(C)).
Consider these prohibited transaction exemptions when you discover a plan and a DP are directly or indirectly furnishing goods, services or facilities:
DOL may have granted an administrative exemption under IRC 4975(d)(2).
If the plan enters into a contract or reasonable arrangement with a DP for office space or services needed to establish or operate the plan, such as legal or accounting, and the plan pays no more than reasonable compensation for the office space or service, the excise tax may not apply.
A bank or other financial institution acting as a plan fiduciary may provide additional banking services to the plan if it charges no more than reasonable compensation for its additional services, and has adopted adequate internal safeguards to ensure the services are provided per sound banking practice. See IRC 4975(d)(6).
A DP may serve as a plan fiduciary in addition to serving as an officer, employee, agent or other representative of a DP (e.g., the employer which sponsors the plan), without being liable for the excise tax. See IRC 4975(d)(11).
The excise tax doesn’t apply when a fiduciary receives reasonable compensation for services rendered to the plan if the services are necessary to establish and/or operate the plan. See IRC 4975(d)(10).
The fiduciary can’t receive double compensation, i.e., a fiduciary can’t receive full-time pay from the employer or union sponsoring the plan and also receive additional compensation from the plan for providing fiduciary services to the plan. A fiduciary may receive reasonable reimbursement for expenses actually incurred while he/she provides services to the plan.
The DOL issued regulations under section ERISA 408(b)(2) that require certain service providers (CSPs) (primarily, those who provide financial services and bundled record keeping services) to furnish detailed disclosures on fees and certain other information to plan fiduciaries as a condition to satisfying the “reasonable contract or arrangement” requirement. If the CSP doesn’t comply with the disclosures, then the payment of fees in exchange for services between the plan and the service provider doesn’t qualify for the prohibited transaction exemption under IRC 4975(d)(2). See 29 CFR 2550.408b‐2(c).
The DOL regulation requires CSPs to give the responsible fiduciaries information so they can:
Assess reasonableness of total compensation, both direct and indirect, paid to the CSP, its affiliates and/or subcontractors.
Identify potential conflicts of interest.
Satisfy reporting and disclosure requirements under ERISA Title I.
The DOL regulation applies to:
ERISA-covered defined benefit plans
Defined contribution plans
The DOL regulation doesn’t apply to:
Simplified Employee Pensions
Savings Incentive Match Plan for Employees
IRC 403(b) plans
The disclosure requirements apply to service providers who expect to receive $1,000 or more of direct or indirect fees for services to the plan.
The DOL regulation applies to covered service providers including:
ERISA fiduciary service providers to a covered plan or to a "plan asset" vehicle in which such plan invests
Investment advisers registered under federal or state law
Record-keepers or brokers who make designated investment alternatives available to the covered plan (e.g., a "platform provider" )
Inspect plan records to determine whether there has been any direct or indirect furnishing of goods or services or using facilities between the plan and a disqualified person. Inspect plan receipts and disbursements because it doesn’t matter in which direction the goods, services or use of facility takes place.
Inspect the trust’s balance sheet to see if the plan owns any property which might be involved in this type of prohibited transaction. If the plan owns real or personal property, verify that a DP doesn’t occupy or use this property.
A disqualified person is prohibited from, directly or indirectly, transferring or using for his/her benefit, the income or assets of a plan (IRC 4975(c)(1)(D)).
However, IRC 4975(d) grants certain statutory exemptions for a DP transferring to, or using plan income or assets. The excise tax doesn’t apply if a prohibited transaction falls within one of the following:
If a DP is a participant in the plan, he/she may receive plan benefits as long as the benefits are computed and paid in a manner consistent with the plan provisions as applied to all other participants and beneficiaries. See IRC 4975(d)(9).
If a plan terminates, it may make distributions to all plan participants (some of whom may be DPs) without there being a prohibited transaction if distributions are made per plan provisions and don’t violate the asset allocation rules in ERISA 4044. Also, excess assets caused by actuarial surplus may revert to the employer if the conditions in ERISA 4044(b) aren’t violated. See IRC 4975(d)(12).
If the employer doesn’t timely pay the 401(k) employee’s elective deferrals to a qualified plan, then a prohibited transaction has taken place and the employer is subject to excise taxes under IRC 4975. See Rev. Rul. 2006-38 for a detailed explanation.
The DOL has advised the IRS that the failure to remit employee contributions to an employee benefit plan may constitute a crime under 18 U.S.C. 664 which provides, in relevant part, that anyone who unlawfully and willfully converts any of an employee benefit plan’s moneys, funds, or other assets to her/his own use or to the use of another, is subject to the fines and/or imprisonment as provided for under the provisions of Title 18.
Inspect the plan receipts and disbursements journal to determine whether any plan income or assets have been transferred to, or used by or for the benefit of, a DP.
If the result is yes, examine source documents (checks, loan agreements, security buy-sell statements, stock quotations, etc.) to verify the nature, circumstances and ultimate effect of the transaction.
Inspect the employer’s disbursements journal to determine whether the IRC 401(k) elective deferrals were segregated and transmitted timely to the plan.
If the IRC 401(k) elective deferrals weren’t timely transmitted to the plan, a prohibited transaction has occurred.
See Rev. Rul. 2006-38 for an example and full description of how to calculate the amount involved for a prohibited transaction excise tax for not timely paying elective deferrals to a qualified plan.
See IRM 4.71.5, Employee Plans Examination of Returns - Form 5330 Examinations.
A fiduciary may not act by dealing with the income or assets of the plan in her/his own interest or for her/his own account (IRC 4975(c)(1)(E)).
A statutory exemption exempts self dealing from being a prohibited transaction for any contract or reasonable arrangement the plan makes with a DP for office space, or legal, accounting, or other services necessary for the plan’s establishment or operation, if no more than reasonable compensation is paid (IRC 4975(d)(2)).
Fiduciaries and other DPs may provide services to the plan if the arrangement meets the requirements of the exemption (26 CFR 54.4975-6).
The statutory exemption is limited by IRC 4975(f)(6).
Under ERISA, the definition of fiduciary goes beyond those persons traditionally recognized as plan fiduciaries, such as plan trustees. The term "fiduciary" includes any person who:
Exercises any authority or control on managing or disposing plan assets.
Has or exercises discretionary authority, control or responsibility for plan administration.
Renders investment advice to the plan for a fee or any other direct or indirect compensation.
Under ERISA, persons who give advisory or consulting services to the plan, such as insurance agents or stockbrokers, may be fiduciaries to the plan although not formally named as one.
An indirect benefit to a fiduciary includes a benefit to someone in whom that fiduciary has an interest that would affect her/his fiduciary judgment.
A fiduciary hires her/his son to provide administrative services to the plan for a fee. Although the son’s providing services to the plan is a prohibited transaction in and of itself, it may be exempt from excise tax if it meets the conditions of IRC 4975(d)(2). However, the fiduciary’s action in causing the plan to pay a fee to her/his son is a separate prohibited transaction under IRC 4975(c)(1)(E) which is not exempt under IRC 4975(d)(2). Both this prohibited transaction and the one discussed in IRM 126.96.36.199.6, Third Party Dealing by Fiduciary, apply only to fiduciaries. ERISA’s parallel provisions to IRC 4975(c)(1)(E) and (F) are ERISA Title I sections 406(b)(1) and (3) respectively.
A bank or similar financial institution supervised by the United States or a state may, as the plan fiduciary, invest plan assets in its own depository accounts which bear a reasonable rate of interest if the:
Plan covers only employees of the financial institution, its affiliates or both.
Investments are expressly allowed by plan provisions or by a fiduciary (other than the financial institution) expressly empowered by the plan to instruct the trustee to make these investments. See IRC 4975(d)(4).
A plan may purchase life or health insurance or annuities from an insurance company, or companies, if each company is the employer maintaining the plan, or wholly owned by the employer or by another DP, but only if:
The total consideration the wholly-owned insurer receives from all plans for which it’s a DP is five percent or less of the total premiums and annuity considerations not including premiums of annuity considerations written by the employer maintaining the plan written by such insurers that year.
Each insurer is qualified to do business in the state.
The plan pays no more than adequate consideration for the insurance or annuities. See IRC 4975(d)(5).
Examine the receipts and disbursements journal and related source documents for any transaction involving income or assets which might (directly or indirectly) benefit a fiduciary who used any of her/his fiduciary authority, control or responsibility to cause the plan to enter into the transaction.
Look for a prohibited transaction when an investment manager can generate additional fees on her/his own authority. If an investment management fee structure is based on managing a certain portion of the plan’s assets and the investment manager can charge additional fees for those same assets for additional services, there may be a prohibited transaction.
"Sweep fees" : An investment manager’s fee may be a certain percentage of the value of assets he manages. If the investment manager provides a service and all uninvested assets as of the close of business are "swept" into an overnight money fund, there may be a prohibited transaction if his fee includes any additional fee for this service based on the value of the funds swept. This arrangement, of course, motivates the investment manager to maximize the funds available for the sweep fee rather than making longer term investments.
Another type of fiduciary self-dealing is when the employer has an arrangement with a plan service provider and the employer receives certain benefits from the service provider as a result of the plan’s business.
The Form 5500 asks for information about the plan’s payments to service providers, plan administrative expenses and terminated service providers. If administrative expenses seem unusually high in relation to plan assets, or if it appears that the plan administrator has been dissatisfied with the service provider, investigate further for the problems described above.
Fiduciary self-dealing transactions doesn’t necessarily involve the employer or plan administrator in a prohibited transaction.
If during a plan audit, you discover the investment management contract shows that the investment manager is charging multiple fees, the investment manager may have engaged in a prohibited transaction. Scrutinize the investment manager’s charges to determine if the multiple fees are reasonable. If they are unreasonable, examine the investment manager’s contracts with other plans in an attempt to discover other prohibited transactions that he/she engaged in. To do this, request the service provider’s client list. If necessary, issue a summons to obtain that list.
If a fiduciary who is a DP receives any consideration for her/his own personal account from any party dealing with the plan in connection with a transaction involving the income or assets of the plan, it is a prohibited transaction. See IRC 4975(c)(1)(F).
The general area addressed by this prohibited transaction is "kickbacks."
There are no statutory exemptions for "kickbacks." Very common payments not normally considered a "kickback," such as commissions on the purchase/sale of insurance/securities are considered prohibited transactions.
A plan and a DP are prohibited from directly or indirectly selling, exchanging or leasing property(IRC 4975(c)(1)(A)). Therefore, these transactions are prohibited:
Sale of securities or real property between an employer and a plan
Leasing of property to the employer by the plan
See IRM 188.8.131.52.1, Sale, Exchange or Leasing of Property.
A statutory exemption exists for plans to acquire, sell or lease certain employer securities or real property (IRC 4975(d)(13)). See ERISA 408(e).
A plan’s acquisition or holding of employer securities or employer real property isn’t a prohibited transaction, but if the plan acquires property from, or sells it to a DP, it is a prohibited transaction.
ERISA 407(a), administered by the DOL, generally prohibits plans from acquiring or holding employer securities or employer real property (defined in ERISA 407(d)(1) and (2)) but does permit plans to acquire or hold 10 percent or less of its assets in qualifying employer securities or qualifying employer real property (as defined in ERISA 407(d)(4) and (5)) or in any combination of these types of property. Generally, eligible individual account plans are exempt from this limitation. See IRM 184.108.40.206.7.1, Eligible Plans, and ERISA 407(d).
To meet the requirements of ERISA 408(e), four requirements must be met:
Plan must be an eligible individual account plan
Securities or real property must be qualifying
Acquisition must be for adequate consideration
No commission may be charged for the acquisition
Remember that not all of the statutory exemptions in IRC 4975(d) may apply to a given transaction because IRC 4975(f)(6) notes that some exemptions don’t apply to owner-employees.
Defined benefit plans and most money purchase plans may not acquire qualifying employer securities or qualifying employer real property exceeding 10 percent of their assets.
Money purchase plans that existed on September 2, 1974 and invested primarily in employer securities may invest in qualifying employer securities or qualifying employer real property exceeding 10 percent of their assets.
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 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.
The IRC 4975 excise taxes apply only to prohibited transactions between a plan and a DP. Because ERISA Title I sections 406 and 407 are more broad in their prohibited transaction application than the Internal Revenue Code, there might be a prohibited transaction under Title I for which the IRS can’t impose the IRC 4975 excise tax.
A prohibited transaction under Title I can result from acquisitions from third parties and from holding securities or real property in excess of the prescribed limits.
However, real property the employer acquired through a non-cash contribution to satisfy a funding obligation is considered a sale or exchange and is a prohibited transaction. See IRM 220.127.116.11.1, Sale, Exchange or Leasing of Property, for the discussion on Commissioner v. Keystone Consolidated Industries, Inc. (the Keystone case). In Interpretive Bulletin 94–3, 59 F.R. 66735 (December 28, 1994), the DOL applied the holding in Keystone to defined contribution plans and welfare plans as well as to defined benefit plans.
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 their assets if the plan terms specifically permit the acquisition of these investments.
However, if an individual account plan’s benefits 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."
Therefore, 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).
Generally, a plan may not acquire any employer securities or employer real property that is not "qualifying."
An employer security is a security issued by the employer (or an affiliate) whose employees are covered by the plan. See ERISA 407(d)(1) and ERISA 407(d)(7).
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 on the definition of qualifying employer security.
A marketable obligation is any of the below items that meets certain requirements that ensure the obligation is acquired at a price not unfavorable to the plan:
A marketable obligation isn’t qualifying unless immediately after the acquisition of the obligation:
The plan holds no more than 25 percent of the aggregate amount of the outstanding debt issue.
At least 50 percent of the aggregate amount of the issue is owned by persons independent of the issuer.
No more than 25 percent of the assets of the plan are invested in obligations of the employer or an affiliate of the employer.
B Corporation has an eligible individual account plan which 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.
A marketable obligation isn’t qualifying unless purchased:
On a national securities exchange
From an underwriter
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)
Defined benefit plan or money purchase pension plan purchases of stock or an interest in a publicly traded partnership on or after December 17, 1987 isn’t qualifying under ERISA 407(f)(1) unless immediately following the acquisition of the stock:
The plan holds no more than 25 percent of the aggregate amount of stock of the same class issued and outstanding at the time of the acquisition.
Persons independent of the issuer hold at least 50 percent of the aggregate amount of stock of the same class of stock.
After January 1,1993, for Title I purposes only, the employer securities owned (not merely acquired) by defined benefit and money purchase plans, must meet certain requirements. See ERISA 407(d)(5) and 407(e).
Employer real property is defined in ERISA 407(d)(2) as real property (and related personal property) a plan owns and leases to an employer (or an affiliate of the employer) of employees covered by the plan.
This term is often confused with property that an employer owns. Employer owned property leased to the plan is not exempt under ERISA provisions for the acquisition and holding of qualifying employer real property.
Company C reports on its defined contribution plan’s Form 5500 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.
Qualifying employer real property is defined in ERISA 407(d)(4) as parcels of employer real property that:
Are geographically dispersed (there must be more than one property).
Are suitable (or adaptable without significant cost) for more than one use (even if such property is leased to only one lessee).
Insofar as their acquisition or retention is concerned, comply with ERISA, Title I, Subtitle B, Part 4 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.
Eligible plans that acquire or hold qualifying employer securities or qualifying employer real property must also ensure that the acquisition, sale, or lease is for adequate consideration (i.e., FMV). This means the plan paid the price that a third party independent of the issuer would pay for the property.
For employer securities (or employer real property) for which there is a generally recognized market, the market determines the adequacy of consideration.
In almost all other instances, this requires an appraisal from a party independent of the employer.
D Corporation’s defined contribution plan 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.
No commission may be charged for a transaction involving the acquisition, sale or lease of employer securities or employer real property to or from a DP.
Determine whether the employer property is:
Compare the amount listed on Form 5500 for the question about employer securities or real property with the amount listed in the statement of assets and liabilities for corporate debt and equity instruments and/or real estate and mortgages.
Determine the total percentage of the plan’s assets invested in employer securities or real property. Compare the amount reported on Form 5500 in the prohibited transactions with the amount of total assets listed for the plan. 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.
Defined contribution plan, determine whether the plan is an "eligible individual account plan."
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.
Determine whether the plan document specifically permits the plan to acquire and hold qualifying employer securities and qualifying employer real property.
Make sure that benefits payable under the individual account plan aren’t taken into account in determining the benefits payable to any participant under any of the employer’s defined benefit plans.
If the employer property is securities, determine:
That the plan purchased qualifying employer securities per the criteria under ERISA 408(e). See IRM 18.104.22.168.7, Acquisition of Employer Securities or Employer Real Property.
Whether the plan purchased nonpublicly traded securities without an independent appraisal 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 22.214.171.124.7.2.2, Adequate Consideration.
If the employer property is real property, determine:
That the plan purchased qualifying employer real property per the criteria under ERISA 407(d)(4). See IRM 126.96.36.199.7.2.1, Qualifying Employer Real Property.
Whether there are at least two parcels of employer real property.
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.
Whether there was an independent appraisal of the property before the acquisition if there was a sale or exchange of employer real property. See IRM 188.8.131.52.7.2.2, Adequate Consideration.
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.
Plans are permitted to dispose of qualifying employer securities upon termination by offering the property to the employer at FMV. However, 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.
Upon plan termination, the plan may sell qualifying employer real property to the employer or place it on the market as the plan fiduciaries deem appropriate.
The plan may not sell any employer securities or employer real property to the employer with that are not qualifying to begin with upon plan termination. This sale is not a correction within the meaning of 26 CFR 53.4941(e)–1(c), and therefore, would constitute a second prohibited transaction. See Rev. Rul. 81–40.
All plan assets must be distributed as soon as administratively feasible after the plan sponsor adopts an amendment to terminate the plan.
Generally, a distribution not completed within one year after the date of plan termination is presumed not to have been made as soon as administratively feasible. See Rev. Rul. 89–87.
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.
Review the Form 5500 filed for the current plan year and the two previous plan years, and determine whether any plan assets were sold to a DP prior to the plan’s termination.
For employer securities or employer real property reported by the plan, determine:
How they were disposed of prior to termination
Whether a third party appraisal was obtained in those cases where there was no recognized market for the securities
Whether an independent third party appraised the real property
Whether the real property was sold to the employer or an affiliate
Any potentially non-exempt loans were reported on the Form 5500.
An extension was given on any prior loans involving a substantial portion of the plan’s assets.
Determine whether there was a net loss to the plan before the plan termination. A loss may indicate an underlying prohibited transaction involving a sale of assets to a DP for less than FMV or a previous purchase of assets from a DP at an inflated price.
IRC 4975(a) and (b) impose a two level, nondeductible excise tax on each prohibited transaction a DP enters into (other than a fiduciary acting only as a fiduciary). Pending final regulations being issued under IRC 4975, calculate the excise tax on prohibited transactions the same way as the excise tax on self-dealing transactions for private foundations. Because the terms "amount involved" and "correction" have not changed, we use the private foundation regulations 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.
An excise tax is imposed on a DP (other than a fiduciary acting only as such) for each prohibited transaction with the plan.
When a fiduciary participates in a prohibited transaction, in a capacity other than as a fiduciary, he/she is to be treated as a DP subject to an excise tax.
The excise tax imposed on the DP is 15 percent of the "amount involved" in the prohibited transaction for each year or partial year in the taxable period.
Find additional information and examples for calculating the excise tax 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.
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 DP. 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.
The second tier excise tax can be abated if the prohibited transaction is corrected during the taxable period (IRC 4961).
If more than one DP is liable for the first or second level excise tax, then all of them are jointly and severally liable for the excise tax.
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:
The IRS mails the Notice of deficiency under IRC 6212 for the IRC 4975(a) tax.
The IRS assesses the IRC 4975(a) tax.
The prohibited transaction is corrected.
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 IRS doesn’t mail a notice of deficiency because there is a waiver of the restriction on assessment and collection of a deficiency (executed Form 870-A), or because the deficiency is paid, the end of the taxable period is either the date of the:
The "amount involved" under IRC 4975(f)(4) is generally the greater of the below amounts for the property given or received:
The amount of money
The FMV for first level excise tax purposes is measured as of the date of the prohibited transaction.
See these IRMs for detailed descriptions of how to determine the amount involved:
IRM 184.108.40.206.2.1, Excess Compensation
IRM 220.127.116.11.2.2, Use of Money or Property
IRM 18.104.22.168.2.3, Less than FMV Received
Generally, services exempted from being prohibited transactions because they are in the statutory exemptions in IRC 4975(d)(2) and (10) aren’t subject to the excise tax unless the compensation is deemed to be excessive. In this case, the "amount involved" is the excessive compensation.
When the use of money or other property is involved, the "amount involved" is the greater of the two amounts below for the period for which the money/property is used:
Plan leases a building to a DP: the "amount involved" is the greater of the two amounts below for the period the DP uses the building (See 26 CFR 53.4941(e)-1(b)(2)(ii)) :
The amount of rent received by the plan from the DP
The fair rental value of the building
On January 1, 2014, the plan borrowed $100,000 from the employer, a DP, at six percent interest and the prevailing rate in the financial community for similar loans at that time was 10 percent. The "amount involved" is $10,000 ($100,000 loan x 10 percent interest rate). The amount of the first level excise tax for 2014 is $1,500 (15 percent x $10,000).
The following table reflects how the "amount involved" is determined when the plan acquires property for an amount other than fair market value (FMV):
If an otherwise protected PT (by statutory or administrative exemption or transitional rule) doesn’t meet the exemption or rule’s conditions because the plan: Then, if the parties in good faith, determined FMV, the "amount involved" is the difference between the FMV and the amount the plan Paid more than FMV for property transferred Paid Received less than FMV for property received Received Received less than a reasonable interest rate for loans Received
A good faith effort is made when the:
Person making the valuation is:
Not a disqualified person
Competent to make the valuations
Not in a position to derive an economic benefit from the value used.
Valuation method is a generally accepted one for valuing comparable property for purposes of arm's-length business transactions.
To determine the "amount involved" for the second level excise tax, use the first level excise tax guidelines except that the "amount involved" is the highest FMV during the taxable period. This provision ensures the person subject to the excise tax won’t postpone correcting a prohibited transaction to earn income on the transaction.
The FMV used to determine the "amount involved" for the second level excise tax isn’t necessarily the same as the FMV used to correct a prohibited transaction per IRM 22.214.171.124.3.1, Correction.
Correcting a prohibited transaction means undoing the transaction to the extent possible. The plan’s resulting financial position 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 for which the first level excise tax is imposed if the correction is completed before IRS mails the notice of deficiency. However, the main significance of a correction is to avoid the second level 100 percent excise tax in IRC 4975(b).
When a prohibited transaction is corrected:
Undoing the prohibited transaction does not constitute another prohibited transaction.
You must use the higher of the FMV of the property given or received, either at the date of:
Each prohibited transaction
The FMV for "correction" is not necessarily the same as the FMV for "amount involved." See IRM 126.96.36.199.2, "Amount Involved First Level."
However, the IRS 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, PPA 06, section 612, effective after August 16, 2006, applies only to certain transactions involving securities and commodities, and generally provides a 14-day correction period. See IRC 4975(d)(23) and IRC 4975(f)(11).
If a DP uses a plan’s money or property, correction includes, but is not limited to, terminating that use. In addition, the DP must pay to the plan the excess, if any, of both:
The FMV (greater of the value at the time of: i) the prohibited transaction or ii) correction) for using the money or property over the amount DP paid for using it until termination.
The amount that the DP would’ve paid for the period of using the property, if he/she didn’t terminate use, over the FMV (at the time of correction) for the use for that period.
If a plan uses a DP’s property, correction includes, but is not limited to, terminating that use. In addition, the DP must pay to the plan the excess, if any, of both:
The amount he/she received from the plan over the FMV (lesser of the value at the time of: i) the prohibited transaction or ii) correction) for using the money or property until the time of termination.
The FMV at time of correction for using the money or property (for the period the plan would’ve used the money or property if termination had not occurred), over the amount that the plan would’ve paid after termination for use in that period.
When a plan sells property to a DP for cash, undoing the transaction includes, but is not limited to, rescinding the sale.
The amount the plan returns to the DP is limited to the lesser of: i) the cash the plan received or ii) the FMV of the property the DP received.
The FMV the plan must return is the lesser of the FMV on the date of: i) the prohibited transaction or ii) the sale.
The DP must also return to the plan any net income derived from using the property if it exceeds any income the plan derived during the taxable period from using the cash received from the original sale, exchange or transfer to the DP.
If, prior to the end of the taxable period, the DP resells the property in an arm's-length transaction to a bona fide purchaser other than the plan or another DP, the original sale doesn’t have to be rescinded. See IRM 188.8.131.52.3.1.3, Correction of Sales of Property by a Plan.
The DP must pay to the plan the excess, if any, of the greater of:
The FMV of the property on the date of correction, (the date the DP pays money to the plan).
The amount the DP realized from the arm’s-length sale, over the amount which the plan would’ve returned to the DP.
The DP must pay to the plan any net profits he/she realized by property use during the taxable period.
When a DP sells property to a plan for cash, undoing the transaction includes, but is not limited to, rescinding the sale when possible. To avoid placing the plan in a position worse than it would be if the transaction didn’t have to be rescinded, the amount the DP received under the rescission is the greatest of:
Cash paid to the disqualified person.
FMV of the property at the time of the original sale.
FMV of the property at the time of rescission.
In addition to rescission, the DP must pay to the plan any net profits he/she realized after the original sale for consideration he/she received from the sale if income during the taxable period exceeds the income the plan derived during the same period from the property.
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 DP, no rescission is necessary.
The DP must pay to the plan the excess, if any, of the amount the DP would’ve paid to the plan if rescission had been required over the amount which the plan realized on the resale of the property.
The DP is required to pay to the plan any net profits he/she realized over the plan’s income.
If a plan pays compensation to a DP for his/her performance of personal services that are reasonable and necessary to carry out the plan provisions, correction requires the DP paying back any amount considered excessive to the plan. The plan doesn’t have to terminate the DP’s employment.
For prohibited transactions described in IRM 184.108.40.206.2.3, Less than FMV Received, correction occurs if the DP pays the plan 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 from the date of the prohibited transaction to the date of correction.
The Form 5500 series return contains several questions 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 ERISA Title I that, in most cases, is parallel to a DP. The questions on the Form 5500 series returns are designed to identify potential problem areas.
Plans investing in employer securities or employer real property
Exchanges or leases of property
Relationships between plan fiduciaries and service providers
The purchase of non-publicly traded securities without a third party appraisal
If the Form 5500 series return lists a transaction with a party-in-interest/DP, investigate to determine if the transaction is a prohibited transaction. For a transaction between the plan and a DP to be a prohibited transaction, it must be one of the transactions in IRC 4975(c)(1) that is neither:
Statutorily exempt under IRC 4975(d)
Administratively exempted under IRC 4975(c)(2)
Potential prohibited transactions may not be identified on the Form 5500 series return because the plan administrator:
Incorrectly interpreted the definition of party-in-interest/DP
Believes the transaction is exempt
Doesn’t realize that the transaction is a party-in-interest transaction
Is unaware of the transaction
The three-year statute of limitations commences on the date the administrator files the Form 5500 series return and the prohibited transaction is sufficiently disclosed. See IRC 6501(l)(1).
If the filed Form 5500 doesn’t disclose the prohibited transaction, the six-year statute period applies. The IRS may assess the excise tax at any time within six years after the later of the date the Form 5500 series return was filed or due.
The Form 5500 series return is the return for the plan only. The excise tax on a prohibited transaction is assessed against the DP and is reported on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans. See IRM 220.127.116.11.2, Statute of Limitations for Forms 5330 and IRM 18.104.22.168.2, Securing Consents for Forms 5330.
Extending the statute of limitations for Forms 5500/1041 with Form 872-H, Consent to Extend the Time to Assess Tax on a Trust, does not extend the statute of limitations for any prohibited transaction.
The statutory period is different for a "continuing" transaction (e.g., a loan or lease), than for a "discrete" transaction (e.g., a sale).
In a continuing transaction, the prohibited transaction is deemed to recur on the first day of the DP’s each subsequent taxable year. The Form 5500 series return filing starts the statute running only for transactions occurring in the year for which the return is filed. Therefore, for a continuing prohibited transaction, determine the statute expiration for each subsequent tax year if the prohibited transaction hasn’t been corrected.
In a discrete transaction, you only need to determine the statute of limitations 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.
If the Form 5500 series return inadequately discloses a prohibited transaction, the statute of limitations is generally six years rather than the normal three years. However, to protect the interests of the government, protect the six-year statute, to the extent possible, as if it were a three-year statute.
A prohibited transaction of a continuing nature may occur when the plan and the DP are on different years. If the transaction isn’t corrected before the end of the plan year that overlaps the DP’s tax year, then the DP engaged in two prohibited transactions within the year and must file at least two Form 5330 returns.
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 DP’s tax year is the calendar year. The 2013 Form 5500 timely and adequately reported prohibited transaction. The DP must file a Form 5330 for calendar year 2012 and another Form 5330 for calendar year 2013, if he/she didn’t correct the transaction on or before December 31, 2012. No Form 5330 is due if IRS assessed the IRC 4975(a) excise tax or mailed the notice of the IRC 4975(a) excise tax by December 31, 2012. Either of these actions would cause the taxable period to end.
Assuming that the taxable period has not ended, there is:
One prohibited transaction in calendar year 2012 (the initial prohibited transaction)
One prohibited transaction in calendar year 2013 (the second year of the first taxable period pyramiding of the initial prohibited transaction)
Because both 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 plan year end June 30, 2013. If the Form 5500 return was filed timely without extensions and with adequate disclosure, the statute of limitations doesn’t end until January 31, 2017, for Forms 5330 due in 2012 and 2013.
When necessary, solicit Form 872, Consent to Extend the Time to Assess Tax. Make sure you properly prepare the consent. Type "excise tax" on the Kind of tax line and extend the statute for the appropriate length of time. The DP must sign the extension. If more then one DP is involved in the transaction, secure a separate extension from each DP. Each DP is considered jointly liable for the excise tax and the correction.
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.
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 2012, 6.25 percent for 2013 and 8 percent for 2014. 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, 2012. No interest was paid on the loan until December 31, 2014. On December 31, 2014, a payment of the principal amount of the loan ($40,000) plus all accrued interest ($6,058.15) 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, 2014. The prime interest rate on short term business loans was 3.25 on April 1, 2012, January 1, 2013 and January 1, 2014.
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 %|
|1.||April 1, 2012 - 3.25 % + 2 % = 5.25 %|
|2.||January 1, 2013 - 3.25 % + 2 % = 5.25 %|
|3.||January 1, 2014 - 3.25 % + 2 % = 5.25 %|
|Date||Principal||Interest Rate||Time||Amount Involved|
|(initial loan + unpaid accrued interest)|
|(initial loan + unpaid accrued interest)|
Computations of Tax
|2012 Taxable Year ||2013 Taxable Year ||2014 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||------||-------||$2,297.44|
|Times the Tax Rate|| x .15 |
| x .15 |
| x .15 |
|1st Level Tax||$ 236.68||$564.11||$908.72|
|Total All Years = $1,709.51|
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, 2012. (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, 2012, January 1, 2013 and January 1, 2014. As a result, the fair market rates were 5.25 percent on April 1, 2012, January 1, 2013 and January 1, 2014. Under the terms of the borrowing, payments of principal and interest were due on the first day of each month (beginning May 1, 2012) with final payment due on March 31, 2014. 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, 2014.
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 %|
|1.||April 1, 2012 - 5.25 %|
|2.||January 1, 2013 - 5.25 %|
|3.||January 1, 2014 - 5.25 %|
|Date||Principal||Interest Rate||Time||Amount Involved|
|* $240,000 - $80,000 (eight timely payments of principal of $10,000 each during the 2012 taxable year + eight timely payments of interest)|
** $160,000 - $120,000 (12 timely payments of principal of $10,000 each during the 2013 taxable year + 12 timely payments of interest)
Computations of Tax
|2012 Taxable Year||2013 Taxable Year||2014 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|
|Times the Tax 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|
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, 2012. (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, 2012, was 3.25 percent, the prime interest rate on January 1, 2013, was 3.25 percent and the prime interest rate on January 1, 2014, 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 first day of each month beginning May 1, 2012. The amount of each monthly payment applied towards the principal was set at $10,000. All payments of principal and interest through December 2013 were timely. No payments were made after that date. On March 31, 2014, 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.
Second tier tax
|Date||Principal||Higher Interest Rate||Time||Amount Involved|
|$18,385.02||x 100 % = $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)
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.