Michael A. Webb, vice president, Cammack Retirement Group, answers:
Good question, since the term “prohibited transaction” is actually quite complex. The IRS Website provides a simplified definition, as follows:
“Prohibited transactions are certain transactions between a retirement plan and a disqualified person. If you are a disqualified person who takes part in a prohibited transaction, you must pay a tax.
“Prohibited transactions generally include the following transactions:
- A disqualified person’s transfer of plan income or assets to, or use of them by or for his or her benefit;
- A fiduciary’s act by which he or she deals with plan income or assets in his or her own interest;
- A fiduciary’s receipt of consideration for his or her own account in a transaction that involves plan income or assets from any party dealing with the plan; and
- Any of the following acts between the plan and a disqualified person: Selling, exchanging, or leasing property; lending money or extending credit; and furnishing goods, services or facilities.”
Doesn’t sound bad so far? The Experts agree, but a problem arises when you look up the definition of “disqualified person”, which is a key component of the definition of a prohibited transaction. Unfortunately, this definition is NOT a brief and straightforward one! IRS Publication 560 defines a “disqualified person” as follows:
“You are a disqualified person if you are any of the following:
1. A fiduciary of the plan.
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. Any direct or indirect owner of 50% or more of any of the following.
a. 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 that is an employer or employee organization described in (3) or (4).
b. The capital interest or profits interest of a partnership that is an employer or employee organization described in (3) or (4).
c. The beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization described in (3) or (4).
6. A member of the family of any individual described in (1), (2), (3), or (5). (A member of a family is the spouse, ancestor, lineal descendant, or any spouse of a lineal descendant.)
7. A corporation, partnership, trust, or estate of which (or in which) any direct or indirect owner described in (1) through (5) holds 50% or more of any of the following.
a. 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.
b. The capital interest or profits interest of a partnership.
c. The beneficial interest of a trust or estate.
8. An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10% or more shareholder, or highly compensated employee (earning 10% or more of the yearly wages of an employer) of a person described in (3), (4), (5), or (7).
9. A 10% or more (in capital or profits) partner or joint venturer of a person described in (3), (4), (5), or (7).
10. Any disqualified person, as described in (1) through (9) above, who is a disqualified person with respect to any plan to which a section 501(c)(22) trust is permitted to make payments under section 4223 of ERISA.”
Confused yet? Though we suspect that you are, the Experts can tell you, however, that your recordkeeper is indeed a “disqualified person” as is any person who provides services to your retirement plan.
As for the rest of the definition, if there is any doubt as to whether a particular transaction is a prohibited transaction, counsel with specific expertise in this area should be consulted. The good news is that not all aspects of the definition are complex; for example, if the transaction relates to any benefit to which the disqualified person is entitled as a participant in the plan (e.g. loans or withdrawals from the participant’s account balance—assuming they comply with the Code and the terms of the plan) is NOT a prohibited transaction if the benefit is provided on the same terms that it would be provided to other participants/beneficiaries.
Thank you for your question!
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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