Prohibited Transactions

     Prohibited Transaction (PT) rules were created to protect the interest of plan participants by prohibiting transactions between the plan and persons who may have conflicts of interest with the Plan. The approach used by the Employee Retirement Income and Security Act (ERISA) and the Internal Revenue Code (IRC), is the listing of specific relationships referred to as disqualified persons in the IRC and party-in-interest by ERISA. Any transaction with a disqualified person and the plan would be a prohibited transaction even though the transaction might, in fact, be beneficial to the plan participants unless there is a specific exemption granted by the Department of Labor (DOL). The result of a prohibited transaction is the imposition of an excise tax on the disqualified person.

     There are many potential surprises for the uninformed in this arena. For example, a contribution to a Defined Benefit Pension Plan (DB) in kind rather than cash in considered a PT in that such a transaction is analogous to the sale of the property to the plan [See Commissioner vs. Keystone Consolidated Industries, Inc. (1993)]. Fortunately, if a plan engages in a PT, the plan is not disqualified unless the facts are such that the plan can be deemed to no longer be for the exclusive benefit of the plan participants.

     Therefore, in general, Loren D. Stark Company, Inc. requests that clients inquire as to the availability of an investment which would appear to be unusual or too good to be true. Note: See our paper on bonding requirements wherein the concept of non-qualifying assets has evolved relative to required independent plan audits. Some fact situations which may appear to be too good to be true are in fact permissible. (See our paper on Eligible Individual Account Plans.) Other fact situations may be so complicated such that the first impression is that the facts were created to disguise a PT. Look at the following facts:

assets of the family members who own 99% of the FLP Units. The        Corporate General Partner (GP) owns 1% of the FLP.

 has significant adverse interest to demonstrate lack of control by the family. The GP employs the family patriarch (P) to help manage the FLP, and P owns 9% of the GP.

means of a Trust agreement with a disinterested third party as the Trustee (T).

believes that the purchase of FLP units will give him the least potential personal liability and accomplish his objectives. However, T wants to know if the DB’s purchase of FLP units is a PT. Or, is the FLP a disqualified person (party-in-interest)?

A PT is a transaction between the Plan and a disqualified person. Disqualified persons as set forth in IRC Sec. 4975(e)(2) are the following:

a. A fiduciary, meaning any person maintaining control of the

assets, rendering advice for a fee or who has discretionary responsibility for administration for the plan;

b. person providing services to the plan;

c. An employer whose employees are covered by the Plan; The

GP sponsors the Plan. GP is not a control group with the FLP. Although the proposed regulations under IRC 414(m)(5) have been withdrawn, it would seem that any attempt to take the posture that the GP and the FLP were an Affiliated Service Group (ASG) and, therefore, a disqualified person would be unsuccessful;

d. An employee organization any of whose members are covered

 by the plan;

e. An owner, direct or indirect, of 50% or more of voting power,

 profits interest, or beneficial interest c) or d) above;

f. A member of the family of a) through e) above;

g. A corporation or partnership of which 50% or more of voting

power or profit interest or beneficial interest is owned by the following:

1) The Trustee (i.e., fiduciary)

2) b. above

3) c. above

4) d. above

5) e. above

h. an officer, director, a 10% or more shareholder, an employee

 earning 10% or more of the total wages of:

1) Trustee (i.e., fiduciary)

2) a. through g. above

i. a 10% or more partner of c. through g. above.

     Any attempt to cause the given facts to fit the definition of a disqualified person fall short of the mark. In Swanson vs. Commissioner (1996) the IRS was unsuccessful in establishing a PT when a corporation created by a self-directed Individual Retirement Account (IRA), transacted business with a corporation owned by the IRA beneficiary. We are aware of the facts in this case because the taxpayer successfully sued for reimbursement of litigation costs after a summary judgment in favor of the taxpayer in the PT case. The IRS should have little incentive to pursue a PT from our facts. If the facts are more straight forward, one should easily determine whether a transaction would be a PT.