Prohibited transactions with retirement plans.

• Author: Martin, M. Jill

Who Is Liable and For How Much?

Both the Department of Labor (DOL) and the IRS are charged with enforcing laws that prevent conflicts of interest in dealings between certain individuals and/or organizations and retirement plans. While the focus of the legislation enforced by both has a common goal of preventing abuse in dealings between retirement plans and related parties, the terminology used to define the abusive actions and relationships differs. The Employee Retirement Income Security Act of 1974 (ERISA) seeks to prevent certain transactions between "parties-in-interest" and "employee benefit plans;"(1) the Code prohibits similar transactions between "disqualified persons" and "qualified plans."(2) In addition, both agencies impose different sanctions for violations of the laws they are called on to enforce. This dual treatment has led to considerable confusion on the part of tax practitioners and plan administrators.(3)

This article will look beyond the differences in terminology and answer the following questions. 1. What are "prohibited transactions?" 2. Who is disqualified from participating in prohibited transactions? 3. What exemptions apply and to whom do they apply? 4. What penalties are imposed on those who violate the rules?

Prohibited Transactions

Both ERISA and the Code forbid "disqualified persons"(4) and retirement plans from engaging in - the sale, exchange or leasing of any property; - the lending of money or other extension of credit; and - the furnishing of goods, services or facilities.

In addition, both forbid such persons from engaging in any transaction involving retirement plan assets or income for personal benefit.

Under both ERISA and the Code, there are two additional prohibitions applicable to "parties-interest" and "disqualified persons" who are also acting as fiduciaries of a retirement plan. A fiduciary cannot deal with the income or assets of a plan in his own interest or for his own account. A fiduciary cannot receive any consideration from any party dealing with the retirement plan with respect to a transaction involving the income or assets of the retirement plan.(5)

ERISA contains additional prohibitions limiting the percentage (not to exceed 10% of the fair market value (FMV) of the assets) of the plan assets that can be invested in the employer's securities. An employer security is any security issued by the sponsoring employer on an affiliate. It also contains a similar prohibition against investing in the employer's real property. Real property consists of any real property (including related personal property) leased from the plan to the sponsoring employer or an affiliate.(6)

Note: The Supreme Court recently decided that the transfer of real property in satisfaction of a contribution to a plan is a prohibited transaction. It does not matter whether the property is encumbered or unencumbered.(7)

Disqualified Persons

There are nine categories of disqualified persons. (Except as noted, the Code's definition of a disqualified person is identical to ERISA's definition of a party-in-interest.) A disqualified person is any person who is: 1. A fiduciary. 2. A person providing services to the plan. 3. An employer any of whose employees are covered by the plan. 4. An employee organization any of whose members are covered by the plan. 5. An owner, direct or indirect, of 50% or more of the voting stock or value of a corporation, the capital or profits of a partnership, or the beneficial interest of a trust, which is an employer under category 3 or an employee organization under category 4. 6. A member of the family of a person defined in categories 1, 2, 3 or 5. 7. A corporation, partnership, trust or estate of which (or in which) 50% or more of voting stock or total value, capital or profits, or beneficial interest is owned directly or indirectly by persons described in categories 1, 2, 3, 4 or 5. 8. An employee,(8) officer, director, 10%-or-more shareholder or a highly compensated employee of a person described in categories 3, 4, 5 or 7. 9. A 10%-or-more (in capital or profits) partner or joint venturer of a person described in categories 4, 5 or 7.

A fiduciary, as listed in category 1, is broadly defined and includes those persons designated as fiduciaries under ERISA Section 405. A fiduciary includes anyone who exercises any discretion or authority with respect to the management or administration of the retirement plan or its assets, or anyone who provides investment advice for a fee or other compensation.(9)

Family members (as listed in category 6) include a spouse, ancestor, lineal descendant and any spouse of a lineal descendant. While this list of relatives is very broad, it is not as broad as that in other Code sections. The list does not include brothers and sisters.

Note: The definition carries over to other categories of disqualified persons. When using attribution rules to determine...