February 16, 2021

Retirement Plan Management – Prohibited Transactions

From time-to-time issues arise in the administration of an employee benefit plan. It is bound to happen given the sheer number of rules and regulations plan sponsors must adhere to. To facilitate resolution the IRS has established the Employee Plans Compliance Resolution System where plan sponsors can go to resolve open issues including prohibited transactions. This happens when a transaction occurs between a plan and a disqualified person. Such transactions can arise from plan loans to certain participants and even fiduciary self-dealing. Regardless of the type, once identified it is important to resolve the issue quickly.  To help clients, prospects, and others, Wilson Lewis has provided a summary of the key information below.  

What is a Prohibited Transaction?

It is defined as any transaction between a retirement plan and a disqualified person that is prohibited by law. This can include loans between the plan and a participant that is prohibited, loans from a 401(k) plan to entities partially owned by a plan sponsor, fiduciary self-dealing when an employer fails to pay 401(k) contributions, and excess compensation issues to name a few.

 Generally speaking, a prohibited transaction can include any of the following:

• A transfer of plan income or assets to or use of them by or for the benefit of a disqualified person.
• Any act of a fiduciary in which plan income or assets are used for their own interest.
• The sale, exchange, or lease of property between a plan and a disqualified individual.
• The receipt of consideration by a fiduciary for their account from any party with the plan in a transaction that involves plan income or assets.
• Lending money or extending credit between the plan and a disqualified individual.
• The furnishing of goods, services, or facilities between a plan and disqualified individual.

Who is a Disqualified Person?

Most often a disqualified person is a plan fiduciary, plan service provider, an employer or employer organization with employees covered by the plan.  

Taxes on Prohibited Transactions

When a prohibited transaction has been identified the disqualified person must pay an initial tax on the transaction of 15% of the amount involved for each year in the taxable period. If the transaction is not corrected within the taxable period, an additional 100% excise tax is assessed.

The transaction amount is determined by evaluating the greater of the money and fair market value of any property given and the money and fair market value of any property received. In cases where services are performed, the amount involved is defined as any excess compensation given or received.

The taxable period starts on the transaction date and ends on the earliest of the following:

• The day the IRS mails a tax deficiency notice.
• The day of tax assessment.
• The day the correction of the transaction is completed.

Correcting Prohibited Transactions

A disqualified individual can avoid the 100% tax by correcting the error as soon as possible. IRS guidance states the correction must undo as much of the transaction as possible without placing the plan in a worse financial position than if the error had not occurred.

Contact Us

Once a prohibited transaction has occurred it creates unique challenges for the plan sponsor and participant. For this reason, it is important to review plan operations to ensure appropriate safeguards are implemented. In the event, such a transaction does occur it is best to resolve it as soon as possible. If you have questions about the information outlined above or need assistance with another plan issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.