4.72.11  Prohibited Transactions (Cont. 1)

4.72.11.3 
Prohibited Transactions

4.72.11.3.7 
Acquisition of Employer Securities or Employer Real Property

4.72.11.3.7.1  (12-17-2015)
Eligible Plans

  1. Defined benefit plans and most money purchase plans may not acquire qualifying employer securities or qualifying employer real property exceeding 10 percent of their assets.

    Exception:

    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.

    Example:

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

  2. The 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.

    1. 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.

    2. 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 4.72.11.3.1, 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.

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

    1. 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."

    2. 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).

4.72.11.3.7.2  (12-17-2015)
Qualifying Employer Securities and Qualifying Employer Real Property

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

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

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

  2. 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:

    • Bond

    • Debenture

    • Note

    • Certificate

    • Other evidence of indebtedness

      Note:

      See ERISA 407(e).

  3. A marketable obligation isn’t qualifying unless immediately after the acquisition of the obligation:

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

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

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

    Example:

    B Corporation 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.

  4. A marketable obligation isn’t qualifying unless purchased:

    1. On a national securities exchange

    2. From an underwriter

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

  5. 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:

    1. 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.

    2. Persons independent of the issuer hold at least 50 percent of the aggregate amount of stock of the same class of stock.

  6. 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).

4.72.11.3.7.2.1  (12-17-2015)
Qualifying Employer Real Property

  1. 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.

    Note:

    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.

    Example:

    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.

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

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

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

    3. Insofar as their acquisition or retention is concerned, comply with 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.

4.72.11.3.7.2.2  (12-17-2015)
Adequate Consideration

  1. 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.

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

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

    Example:

    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.

4.72.11.3.7.2.3  (12-17-2015)
No Commission

  1. 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.

4.72.11.3.7.2.4  (12-17-2015)
Examination Steps

  1. Determine whether the employer property is:

    • Real property

    • Securities

  2. 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.

  3. 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:

    1. 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.

    2. Defined contribution plan, determine whether the plan is an "eligible individual account plan."

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

      2. Determine whether the plan document specifically permits the plan to acquire and hold qualifying employer securities and qualifying employer real property.

      3. 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.

  4. If the employer property is securities, determine:

    1. That the plan purchased qualifying employer securities per the criteria under ERISA 408(e). See IRM 4.72.11.3.7, Acquisition of Employer Securities or Employer Real Property.

    2. 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 4.72.11.3.7.2.2, Adequate Consideration.

  5. If the employer property is real property, determine:

    1. That the plan purchased qualifying employer real property per the criteria under ERISA 407(d)(4). See IRM 4.72.11.3.7.2.1, Qualifying Employer Real Property.

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

      Note:

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

    3. 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 4.72.11.3.7.2.2, Adequate Consideration.

4.72.11.3.7.3  (12-17-2015)
Terminated Plans

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

4.72.11.3.7.3.1  (12-17-2015)
Disposition of Qualifying Employer Securities

  1. 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.

4.72.11.3.7.4  (12-17-2015)
Disposition of Qualifying Employer Real Property

  1. 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.

4.72.11.3.7.4.1  (12-17-2015)
Disposition of Employer Real Property or Employer Securities Not Qualifying

  1. 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.

4.72.11.3.7.4.2  (12-17-2015)
Disposition of Other Plan Assets

  1. For plan mergers or consolidations, each participant’s account balance after the transaction must be equal to or greater than each participant’s account balance prior to the transaction. See IRC 414(l).

4.72.11.3.7.5  (12-17-2015)
Wasting Trusts

  1. All plan assets must be distributed as soon as administratively feasible after the plan sponsor adopts an amendment to terminate the plan.

  2. 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.

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

    Note:

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

4.72.11.3.7.6  (12-17-2015)
Examination Steps

  1. 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.

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

    1. How they were disposed of prior to termination

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

    3. Whether an independent third party appraised the real property

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

  3. Determine whether:

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

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

  4. 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.

4.72.11.4  (12-17-2015)
Prohibited Transactions Tax

  1. 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.

    Note:

    The validity of 26 CFR 141.4975–13 was upheld in Rutland v. Commissioner, 89 T.C. 1137 (1987). The Rutland case also reaffirms the holding in Lambos. See IRM 4.72.11.3.7.2.4, Examination Steps.

4.72.11.4.1  (12-17-2015)
First Level Tax

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

  2. 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.

    1. 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.

    2. 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.

      Note:

      Do not prorate the excise tax for a discrete transaction for partial periods.

4.72.11.4.1.1  (12-17-2015)
Second Level Tax

  1. If the prohibited transaction is not corrected within the taxable period an excise tax of 100 percent of the "amount involved" is imposed on the 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.

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

4.72.11.4.1.2  (12-17-2015)
Liability

  1. 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.

4.72.11.4.1.3  (12-17-2015)
Taxable Period

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

    1. The IRS mails the Notice of deficiency under IRC 6212 for the IRC 4975(a) tax.

    2. The IRS assesses the IRC 4975(a) tax.

    3. The prohibited transaction is corrected.

  2. A prohibited transaction occurs on the date on which the terms and conditions of the transaction and the liabilities of the parties have been fixed. When 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:

    • Waiver filing

    • Deficiency payment

4.72.11.4.2  (12-17-2015)
Amount Involved First Level

  1. 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

    • FMV

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

    Example:

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

  3. See these IRMs for detailed descriptions of how to determine the amount involved:

    1. IRM 4.72.11.4.2.1, Excess Compensation

    2. IRM 4.72.11.4.2.2, Use of Money or Property

    3. IRM 4.72.11.4.2.3, Less than FMV Received

4.72.11.4.2.1  (12-17-2015)
Excess Compensation

  1. 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.

    Example:

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

4.72.11.4.2.2  (12-17-2015)
Use of Money or Property

  1. 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:

    • Amount paid

    • FMV

  2. 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

    Example:

    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).

    Example:

    The plan leased its building to a DP for $10,000 a year and the fair rental value was $11,000. The "amount involved" for the IRC 4975(a) is $11,000. However, if the fair rental value was $9,000 the "amount involved" would be $10,000.

4.72.11.4.2.3  (12-17-2015)
Less than FMV Received

  1. 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

    Note:

    See 26 CFR 53.4941(e)-1(b)(2)(iii).

  2. A good faith effort is made when the:

    1. 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.

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

    Example:

    Assume a good faith effort was made to determine FMV value. The amount paid in the transaction was $5,000 and the FMV was determined to be $5,500. The "amount involved" would be $500. If a good faith effort wasn’t made, the "amount involved" would be $5,500.

4.72.11.4.3  (12-17-2015)
Amount Involved Second Level

  1. 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.

  2. 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 4.72.11.4.3.1, Correction.

4.72.11.4.3.1  (12-17-2015)
Correction

  1. 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).

  2. When a prohibited transaction is corrected:

    1. Undoing the prohibited transaction does not constitute another prohibited transaction.

    2. You must use the higher of the FMV of the property given or received, either at the date of:

      • Each prohibited transaction

      • The correction

    3. The FMV for "correction" is not necessarily the same as the FMV for "amount involved." See IRM 4.72.11.4.2, "Amount Involved First Level."

      Note:

      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).

4.72.11.4.3.1.1  (12-17-2015)
Correction Involving Use of Money or Property

  1. 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:

    1. 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.

    2. 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.

4.72.11.4.3.1.2  (12-17-2015)
Correction Involving Use of Money or Property by a Plan

  1. 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:

    1. 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.

    2. 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.

4.72.11.4.3.1.3  (12-17-2015)
Correction of Sales of Property by a Plan

  1. When a plan sells property to a DP for cash, undoing the transaction includes, but is not limited to, rescinding the sale.

    1. 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.

    2. The FMV the plan must return is the lesser of the FMV on the date of: i) the prohibited transaction or ii) the sale.

    3. 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.

4.72.11.4.3.1.4  (12-17-2015)
Resale Prior to End of Taxable Period

  1. 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 4.72.11.4.3.1.3, Correction of Sales of Property by a Plan.

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

    1. The FMV of the property on the date of correction, (the date the DP pays money to the plan).

    2. The amount the DP realized from the arm’s-length sale, over the amount which the plan would’ve returned to the DP.

  3. The DP must pay to the plan any net profits he/she realized by property use during the taxable period.

4.72.11.4.3.1.5  (12-17-2015)
Correction of Sale of Property to a Plan

  1. 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:

    1. Cash paid to the disqualified person.

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

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

  2. In addition to rescission, the 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.

4.72.11.4.3.1.6  (12-17-2015)
Resale by Plan

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

    1. 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.

    2. The DP is required to pay to the plan any net profits he/she realized over the plan’s income.

4.72.11.4.3.1.7  (12-17-2015)
Compensation Paid

  1. 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.

4.72.11.4.3.1.8  (12-17-2015)
Less than FMV Received

  1. For prohibited transactions described in IRM 4.72.11.4.2.3, 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.

4.72.11.5  (12-17-2015)
Transactions Identified on Form 5500

  1. 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.

    Example:

    Form 5500 series returns schedules H and I request data on:

    • Plans investing in employer securities or employer real property

    • Plan loans

    • Sales

    • Exchanges or leases of property

    • Relationships between plan fiduciaries and service providers

    • The purchase of non-publicly traded securities without a third party appraisal

4.72.11.5.1  (12-17-2015)
Examination Steps

  1. 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)

  2. Potential prohibited transactions may not be identified on the Form 5500 series return because the plan administrator:

    1. Incorrectly interpreted the definition of party-in-interest/DP

    2. Believes the transaction is exempt

    3. Doesn’t realize that the transaction is a party-in-interest transaction

    4. Is unaware of the transaction

4.72.11.6  (12-17-2015)
Statute of Limitations

  1. 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).

    Note:

    See IRM 4.71.9.5.1, Statute of Limitations for Forms 5500/1041, and IRM 4.71.9.5.2, Statute of Limitations for Form 5330, for a more detailed discussion.

  2. 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.

    Note:

    Because we’re required to get TE/GE Division Counsel’s (Area Counsel) written approval when pursuing a statute of limitations beyond three years, take the most conservative approach and protect the three-year statute, if possible, even if a six year statute appears to apply.

  3. 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 4.71.9.5.2, Statute of Limitations for Forms 5330 and IRM 4.71.9.6.2, Securing Consents for Forms 5330.

  4. 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.

  5. The statutory period is different for a "continuing" transaction (e.g., a loan or lease), than for a "discrete" transaction (e.g., a sale).

    1. 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.

    2. 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.

  6. 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.

    Note:

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

  7. 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.

    Example:

    A prohibited transaction of a continuing nature occurred in C Corporations’ profit-sharing plan on July 31, 2012. The plan year and the trust are on a fiscal year, July 1 to June 30. The 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)

      Note:

      Because no correction on or before December 31, 2012, calendar year 2013 is also the first year of the taxable period for the second prohibited transaction (deemed to occur on January 1, 2013).


    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.

    Note:

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

  8. 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.

Exhibit 4.72.11-1 
List of Granted Class Exemptions

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

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

Exhibit 4.72.11-2 
Relationship Between Employer and Disqualified Person

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

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

Facts
The disqualified person, a calendar year taxpayer who is not a participant or beneficiary of the plan, borrowed $40,000 from the plan's trust. The interest rate on the loan is 5.75 percent for 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 %




Initial Tax    
  Date Principal Interest Rate Time Amount Involved
1. 4/1/2012 $40,000.00 5.25 % 275/366 $1,577.87
2. 1/1/2013 $41,577.87 5.25 % 1 $2,182.84
    (initial loan + unpaid accrued interest)
3. 1/1/2014 $43,760.71 5.25 % 1 $2,297.44
    (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
Total $1,577.87 $3,760.71 $6,058.15
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

Note:

Templates are available to provide assistance in computing excise tax. See IRM 4.72.11 Exhibit 4 at IRM 4.72 - Employee Plans Technical Guidelines Exhibits for an example of the IRC 4975 excise tax template for this example.

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

Facts
A disqualified person, a calendar year taxpayer who was not a participant or beneficiary of the plan, borrowed $240,000 from the trust of a calendar year, profit-sharing plan on April 1, 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 %
Initial Tax
  Date Principal Interest Rate Time Amount Involved
1. 4/1/2012 $240,000 5.25 % 275/366 $9,467.21
2. 1/1/2013 $160,000* 5.25 % 1 $8,400.00
3. 1/1/2014 $40,000** 5.25 % 90/365 $517.81
* $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
Total $9,467.21 $17,867.21 $18,385.02
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

Note:

Templates are available to provide assistance in computing excise tax. See IRM 4.72.11 Exhibit 5 at IRM 4.72 - Employee Plans Technical Guidelines Exhibits for an example of the IRC 4975 excise tax template for this example.

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

Facts
A disqualified person, a calendar year taxpayer who was not a participant or beneficiary of the plan, borrowed $240,000 from the trust of a calendar year, profit-sharing plan on April 1, 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  
1. 4/1/2012 $240,000 5.25 % 275/366 $9,467.21  
2. 1/1/2013 $160,000* 5.25 % 1 $8,400.00  
3. 1/1/2014 $40,000** 5.25 % 90/365 $517.81  
          $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)

Note:

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

Note:

Templates are available to provide assistance in computing excise tax. See IRM 4.72.11 Exhibit 6 at IRM 4.72 - Employee Plans Technical Guidelines Exhibits for an example of the IRC 4975 excise tax template for this example.


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