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When considering making investments to the plan, the IRS and Dept of Labor have limits on whom you can enter into a transaction with.
IRC 4975(c)(1 )(A) defines a prohibited transaction as a sale, exchange or lease of any property between a plan and a disqualified person.
IRC 4975(e)(1 )(F) defines a plan as any trust, plan, account or annuity that is exempt from tax under 501 (a), or was ever determined by the Secretary to be so exempt.
IRC 4975(e)(2)(C) defines a disqualified person as an employer, any of whose employees are covered by the plan.
IRC 4975(e)(2)(E)(i) defines a disqualified person as an owner, direct or indirect, of 50% or more of the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation which is an employer described in 4975(e)(2)(C).
IRC 4975(a) imposes a tax on a prohibited transaction equal to 15% of the amount involved in the transaction.
IRC 4975(b) imposes a tax equal to 100% of the amount involved in any case where a prohibited transaction is not corrected within the taxable period,as defined at 4975( f)..
IRC 4975(d)(13) provides an exemption from prohibited transaction consideration for any transaction which is exempt from ERISA 406, by reason of ERISA 408(e), which addresses certain transactions involving employer stock.
IRC 4975(f)(2) defines the taxable period as the period beginning with the date on which the prohibited transaction occurs and ending on the earlier of the dates on which a) a notice of deficiency with respect to the tax imposed by 6212(a) is mailed, b) the date on which the tax imposed by 4975(a) is assessed, or c) the date on which correction of the prohibited transaction is completed.
IRC 4975(f)(5) defines correction as the undoing of the transaction, to the extent possible, such that the plan is restored to a financial position not worse than it would have been absent the transaction.
ERISA 408(e), and ERISA Reg, 2550,408 (e) promulgated there under, provides an exemption from ERISA 406 for acquisitions or sales of qualifying employer securities, subject to a requirement that the acquisition or sale must be for "adequate consideration,"
Except in the case of a "marketable obligation", adequate consideration for this purpose means a price not less favorable than the price determined under ERISA 3(18), ERISA 3(18) provides in relevant part that, in the case of an asset other than a security for which there is no generally recognized market, adequate consideration means the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations.
An exchange of company stock between the plan and its employer-sponsor would be a prohibited transaction, unless the requirements of ERISA 408(e) are met. IRS
examiners have been provided with a single sheet of paper, signed by a purported valuation specialist. This appraisal "certifies" that the value of the enterprise stock is a sum certain, the amount of which approximates the amount of available proceeds from the individual's tax deferred retirement account. These appraisals are questionable. Because the valuation usually approximates available funds, consideration needs to be given to whether inherent value in the plan-acquired entity actually exists.
Examples to help you examine your situation:
Loans to Companies in which You have an Interest
An Owner of a public accounting firm is the trustee of the firm's 401(k) plan and is accountable for investing the plan's assets. The Owner decides that the plan can loan money to a series of companies in which the Owner owns less than 50%. The loans interest rate was 12%, and will provide an interest stream for the plan.
Because the Owner does not own 50% or more of the companies to which the plan will be loaning money, the Owner figures the transactions are not prohibited transactions.
The IRS represented the opposite opinion. The IRS applied 4975(c)(1)(D) and (E) of the Internal Revenue Code and claimed that the Owner was involved in prohibited transactions. The IRS claimed that the "loans were transfers of the plan's assets that benefited" the Owner under Sec. 4975(c)(1)(D) of the Code, and that the loans were dealings with the plan's assets in the Owner's own interest under sec. 4975(c)(1)(E) of the Code.
The IRS contended that the Owner was a disqualified person with respect to the plan in two capacities: (a) A fiduciary of the Plan (sec. 4975(e)(2)(A)), and (b) the 100-percent Owner of the employer sponsoring the plan. The IRS positioned that the Owner benefited from the loans -- the loans enabled the borrowers--all companies in which the Owners owned interests--"to operate without having to borrow funds at arms length from other sources."
The Tax Court agreed with the IRS that the loans were prohibited transactions under section 4975(c)(1)(D),
The Tax Courts position was :
" The fact that the transaction would qualify as a prudent investment when judged under the highest fiduciary standards is of no consequence. Furthermore, the fact that the plan benefits from the transaction is irrelevant. Good intentions and a pure heart are no defense."
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