Pension plan loan was prohibited transaction.

• Author: Josephs, Stuart R.
• Position: Taxation

Gideon L. Medina was the president and sole shareholder of his professional medical corporation; his wife was the corporate secretary. Both spouses participated in the corporation's qualified employees' pension plan. On Dec. 1, 1986, the taxpayers borrowed $340,000 from the plan to acquire apartments; they executed a promissory note as follows:

* Interest at 10.5% per annum, payable annually.

* Any unpaid interest added to principal.

* All principal due eight years from the date of the note (or, if sooner, on sale of the apartments).

On Aug. 15, 1991, Dr. Medina assigned one of the apartment buildings to the plan "to ensure that the loan is paid if and when" the building is sold. The taxpayers did not file Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, for 1991-1997, nor did they make any payments to the plan under the promissory note.

The taxpayers conceded that they were disqualified persons but contended that they did not participate in a prohibited transaction in 1991-1997 because the loan was treated as a taxable distribution in 1986 under Sec. 72(p).

The Tax Court, in Medina, 112 TC No. 6 (1999), held that this loan was nevertheless a prohibited transaction under Sec. 4975. Because the taxpayers did not correct the prohibited transaction (within the meaning of Sec. 4975(f)(5)), they were liable for the two tiers of excise taxes imposed by Sec. 4975(a) and (b).

The "amount involved," which is the Sec. 4975 excise tax base, was the greater of interest paid (zero) or fair market value of the use of the loan proceeds, as reflected by the 10.5% interest rate. The Tax Court decided that, in...