3849. What are the exemptions to the prohibited transactions rules?Nuco Employeercline202010-08-31T22:00:00Z2014-08-17T20:17:00Z2014-08-17T20:17:00Z16302217231Microsoft143402021314prohibited transaction exemption PTE2005-01-19T00:00:00ZTaxFactsDefaultArticleSite Map/Retirement Plans/Pension And Profit Sharing/Taxation of Distributions/Prohibited Transactions116880450-00-tf1.xml452.00;#2262;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 1What are prohibited transactions? What is the tax penalty if a prohibited transaction takes place?81400.0000000000TaxFactsDefaultArticle2010-01-14T23:52:07ZSBMEDIA\moss-admin3849.01. What exemptions to the prohibited transactions rules are provided by the Internal Revenue Code? The IRC lists specific exemptions from the broad prohibited transaction rules. These include: (1)the receipt of benefits under the terms of the plan; (2)the distribution of the assets of the plan meeting allocation requirements; (3)loans available to all plan participants or beneficiaries under certain circumstances (see Q3849.02); (4)a loan to an employee stock ownership plan (Q 3717); and (5)the acquisition or sale of qualifying employer securities by an individual account profit sharing, stock bonus, thrift, savings plan, or employee stock ownership plan for adequate consideration and without commission.IRC Sec. 4975(d).Another statutory exemption is for the provision of office space or services necessary for the establishment or operation of the plan under a reasonable arrangement for no more than reasonable compensation.IRC Sec. 4975(d)(2). This exemption shields only the provision of services that would be prohibited transactions under (1), (3), and (4) above, not fiduciary self-dealing. Thus, if an insurance agent is not a fiduciary, the agent’s sale of insurance to a plan and receipt of a commission is within this statutory exemption. If an agent is a fiduciary (for example, if the trustee relies on his or her investment advice) receipt of a commission for sale of insurance or annuities to a plan may be a prohibited transaction.PTE 77-9 (Discussion of Major Comments); see also Treas. Reg. §54.4975-6(a)(5). Certain administrative exemptions (see Q3849.03) permit receipt of fees or commissions by fiduciaries in connection with the sale of insurance and annuity contracts to plans and the transfer of insurance contracts between plan and plan participants or employers. Under regulations issued on February 3, 2012, compensation paid to certain service providers will not be considered reasonable for purposes of the prohibited transaction exemption without complying with a fee disclosure mandate.77 Fed. Reg. 5655. The service providers covered by the mandate are fiduciaries, registered investment advisers, platform providers for participant directed defined contribution plans, and other indirectly compensated service providers such as an investment advisor to the plan. The initial compliance date for the required disclosures is July 16, 2011.Labor Reg. §2550.408b-2(c)(1)(vii). Failure to comply with the disclosure mandate will mean that compensation paid to the service provider no longer qualifies for the statutory prohibited transaction exemption.Except for the first two exemptions listed above, these statutory exemptions do not apply where a plan that covers owner-employees (1) lends assets or income, (2) pays any compensation for personal services rendered to the plan, or (3) except as described in the following paragraph, acquires property from or sells property to (x) an owner-employee (Q 3806) or an employee who owns more than 5 percent of the outstanding shares of an S corporation, an individual retirement plan participant, beneficiary, or sponsoring employer or association, as the case may be, (y) a family member of a person described in (x), or (z) a corporation controlled by a person described in (x) through ownership of 50 percent or more of total combined voting power of all classes of stock or 50 percent or more of total shares of all classes of stock of the corporation.IRC Sec. 4975(f)(6)(A).A transaction consisting of a sale of employer securities to an ESOP (Q 3719) by a shareholder-employee, a member of his or her family, or a corporation in which he or she owns 50 percent or more of the stock generally will be exempt from the prohibited transaction rules. For this purpose, a shareholder-employee is an employee or officer of an S corporation who owns or is deemed to own, under the constructive ownership rules of IRC Section 318(a)(1), more than 5 percent of the outstanding stock of the corporation on any day during the corporation’s taxable year.IRC Secs. 4975(f)(6)(B)(ii), 4975(f)(6)(C). For special rules applying to S corporation ESOPs that the IRS views as abusive, see Q 3725.The Pension Protection Act of 2006 created an exemption from the prohibited transaction rules for certain fiduciary advisers who provide investment advice under an eligible investment advice arrangement (Q 3705).IRC Secs. 4975(d)(17), 4975(f)(8). 3849.02. When is a plan loan exempted from the prohibited transactions rules? Loans made to plan participants and beneficiaries generally are exempted from the prohibited transaction rules if the loans: (1)are made available to all participants and beneficiaries on a reasonably equivalent basis, (2)are not made available to highly compensated employees (Q 3804) in an amount greater than the amount made available to other employees, (3)are made in accordance with specific provisions regarding such loans set forth in the plan, (4)bear reasonable rates of interest, and (5)are adequately secured.ERISA Sec. 408(b)(1); IRC Sec. 4975(d)(1); Labor Reg. §2550.408b-1.A reasonable rate of interest is one that provides the plan with a return commensurate with the interest rates charged by persons in the business of lending money for loans made under similar circumstances.Labor Reg. §2550.408b-1(e).Security for participant loans is considered adequate if it may reasonably be anticipated that loss of principal or interest will not result if default occurs.Labor Reg. §2550.408b-1(f)(1). The effect of this no loss requirement varies depending on the type of plan; a plan in which the investment experience of the plan’s assets is shared by all participants may require additional loan conditions, such as mandatory payroll deduction repayment on stated events or additional collateral. No more than 50 percent of the present value of a participant’s vested accrued benefit under a plan generally may be considered as security for the outstanding balance of all plan loans made to the participant.Labor Reg. §2550.408b-1(f)(2). Except in the case of directed investment loans, this loan exemption is not an exemption from the other fiduciary standards of ERISA. The prohibited transaction rules apply to a loan that does not meet the exemption requirements, even if it is treated and taxed as a distribution (Q 3825).Medina v. U.S., 112 TC 51 (1999). Loans from a qualified plan to S corporation shareholders, partners, and sole proprietors generally are exempt from the prohibited transaction rules (Q 3825),IRC Sec. 4975(f)(6)(B)(iii). although there are rules applying to certain S corporation ESOPs that the IRS views as abusive (Q 3725).The Tax Court determined that a loan between a plan and a corporation partially owned by a disqualified person did not constitute a prohibited transaction where the loan was approved by and made at the sole discretion of the plan’s independent bank trustee.Greenlee v. Comm., TC Memo 1996-378. A transfer of property to a plan in satisfaction of a participant loan was treated as a prohibited transaction where the borrower was a disqualified person.Morrissey v. Comm., TC Memo 1998-443.3849.03. What are the administrative exemptions to the prohibited transactions rules? Administrative Exemption: 84-24Prohibited Transaction Exemption 84-241984-2 CB 231 (formerly PTE 77-9, 1977-2 CB 428, as amended by 1979-1 CB 371). provides administrative relief in addition to the statutory provisions. It permits a life insurance agent, broker, or pension consultant and affiliates, including a fiduciary, who is a disqualified person (1) to receive sales commissions for insurance and annuity sales to a plan, or (2) to effect a transaction for the purchase of an insurance or annuity contract from an insurance company. The exemption also permits an investment company principal underwriter to effect a transaction for the purchase of an insurance or annuity contract. Furthermore, it allows the purchase of insurance or annuities from an insurance company that is a disqualified person. This class exemption is available only if certain conditions are met:First, the transaction must be effected in the ordinary course of business of the agent, broker, or consultant on terms at least as favorable to the plan as those that would be negotiated in an arm’s length transaction with an unrelated party. The total fees and commissions also must not be in excess of reasonable compensation, determined on a facts and circumstances basis.Second, the agent, broker, consultant, or insurance company may not act as a plan trustee (other than a nondiscretionary trustee who does not render investment advice with respect to any assets of the plan), plan administrator, a fiduciary authorized to manage, acquire, or dispose of plan assets on a discretionary basis, or an employer, any of whose employees are covered by the plan. PTE 84-24, as amended, extends the same relief to situations where an affiliate of the insurance agent or broker, pension consultant, or investment company principal underwriter is a trustee with investment discretion over plan assets that are not involved in the transaction.See Amendment to PTE 84-24, 71 Fed. Reg. 5887 (Feb.1, 2006).The term affiliates includes (1) any person controlled by or under common control with the agent, broker, consultant, or insurance company, (2) any officer, director, employee, or relative of or a partner in (but not of) the agent, broker, consultant, or insurance company, and (3) any corporation or partnership of which the agent, broker, consultant, or insurance company is an officer, director, or employee, or in which he or she is a partner.The transaction must be approved, in writing, by an independent fiduciary, who may be the employer. Prior to the sale, the agent, broker, or consultant must disclose to the independent fiduciary: (1)the nature of the affiliation between the agent and the insurer whose contract is being recommended; (2)any limitations on the agent’s ability to recommend insurance or annuity contracts; (3)the amount of sales commission, expressed as a percentage of gross annual premium payments for the first and renewal years; and (4)a description of any charges, fees, discounts, penalties, or adjustments that may be imposed in connection with the purchase, holding, exchange, termination, or sale of such contracts. Finally, the agent, broker, or consultant must retain records relating to the transaction for six years, but no filing is required with either the IRS or the Department of Labor. The records must be available for examination by those two federal agencies, plan participants, beneficiaries, and any employer or employee organization whose employees or members are covered by the plan.An insurance company that is a service provider or fiduciary solely because it sponsors a master or prototype plan need satisfy only the first set of conditions. An agent, broker, or consultant who is a fiduciary and who sells insurance in connection with the master or prototype plan must meet both sets of conditions.Administrative Exemption: 79-60Prohibited Transaction Exemption 79-6044 Fed. Reg. 59018. permits an insurance agent or broker who is the employer (or related, in certain ways listed below, to the employer) maintaining a plan to sell an insurance or annuity contract (including a contract providing only for the provision of administrative services) to the plan and receive a commission. A general agent who is the employer (or related to the employer in one of the listed ways) may receive override commissions on such sales by another agent.The following three conditions must be met for a transaction to come within this exemption. First, the agent or broker must be: (1)an employer with employees covered by the plan (including a sole proprietor who is the only plan participant); (2)a 10 percent or more partner of such an employer; (3)an employee, officer, or director (or an individual having powers or responsibilities similar to those of officers or directors), or a 10 percent or more stockholder of such an employer; (4)a 50 percent or more owner of the employer; or (5)a corporation or partnership that is 50 percent or more owned by a plan fiduciary, a person providing services to the plan, the employer, a 50 percent owner of the employer, or an employee organization with members covered under the plan. Second, the plan may pay no more than adequate consideration for the policy or contract. Finally, the total commissions received in each taxable year of the agent or broker as a result of sales under this exemption must not exceed 5 percent of the total insurance commission income received by the agent or broker in that taxable year. There are no record-keeping requirements.Administrative Exemption: 80-26Prohibited Transaction Exemption 80-261980-2 CB 323. permits a disqualified person other than another plan to make unsecured interest-free loans to a plan to pay ordinary operating expenses (including the payment of benefits and periodic premiums under an insurance or annuity contract) or, for a period no longer than three days, for a purpose incidental to the ordinary operation of the plan. The Department of Labor adopted a temporary amendment to PTE 80-26 to include interest-free loans made to plans affected by the 9/11 terrorist attacks.Temp. Amendments to PTE 80-26. 67 Fed. Reg. 9485 (Mar. 3, 2002). In 2006, the Department amended the regulation to eliminate the three-day limit, provided that if the loan is for longer than 60 days, the terms of the agreement are written.67 Fed. Reg. 17917 (April 7, 2006). An amendment proposed in 2013 would provide retroactive and temporary relief for certain guarantees of the payment of debits to plan investment accounts (including IRAs) by parties in interest to such plans as well as certain loans and loan repayments made pursuant to such guarantees.78 Fed. Reg. 31584.Administrative Exemptions: 92-5 and 92-63Prohibited Transaction Exemptions 92-5 and 92-657 Fed. Reg. 5019, 5189 (formerly PTEs 77-7 and 77-8, 1977-2 CB 423, 425). establish conditions for the transfer of life insurance and annuity contracts to and from plans. PTEs 92-5 and 92-6 extended the relief granted under PTEs 77-7 and 77-8 to owner-employees and to shareholders owning more than 5 percent of the outstanding stock in an S corporation. PTE 92-5 permits individual contracts to be transferred to a plan by participants or employers, any of whose employees participate in the plan. The plan generally must pay no more than the lesser of the cash surrender value of the contract or the value of the participant’s accrued benefit at the time of the transaction (or account balance, in the case of a defined contribution plan), and the contract must not be subject to any loan that the plan assumes. The DOL has stated that where participants transfer individual policies that have no cash surrender value, the transfer will not violate the prohibited transaction rules where the plan pays no consideration for the policies.DOL Adv. Op. 2002-12A.PTE 92-6 enables a plan to sell insurance contracts and annuities to a plan participant insured under the policies, a relative of such participant who is a beneficiary under the contract, an employer whose employees are covered by the plan, or another employee benefit plan for the cash surrender value of the contracts, provided certain conditions are met. In the absence of these exemptions, these transfers would be prohibited transactions.PTE 92-6 first was clarified in 1998 so that, if all of its other conditions are met, two or more relatives who are the sole beneficiaries under a contract may be considered a single relative and an individual life insurance contract may be read to include a contract covering the life of the participant and his or her spouse (if permitted by applicable state insurance law, other applicable law, and pertinent plan provisions). In addition, a sale of a partial interest in a life insurance contract qualifies as a sale of an individual life insurance contract if certain requirements are met with both the portion sold and the portion retained.See DOL Adv. Op. 98-07A.In 2002, PTE 92-6 was retroactively amended to permit transfers of life insurance contracts directly to life insurance trusts and certain other trusts.See 67 Fed. Reg. 56313. In addition, the DOL clarified that second-to-die policies covering spouses are included within the scope of PTE 92-6.DOL Adv. Op. 2006-03A (February 26, 2006).Planning Point: This expansion and liberalization by the Department of Labor adds trusts to the list of those to whom life insurance owned by a qualified plan can safely be sold. It is important to note that the exemption is conditioned on the fact that, but for the sale, the plan would have surrendered the life insurance contract. Furthermore, the plan must be paid what the policy is worth at the time it is sold. The preamble to PTE 77-8Citing Rev. Rul. 59-195, 1959-1 CB 18. (which was replaced by PTE 92-6), noted that, for federal income tax purposes, the value of an insurance policy is not the same as, and may exceed, its cash surrender value, and that a purchase of an insurance policy at its cash surrender value therefore may be a purchase of property for less than its fair market value. In 2004 guidance, the Treasury Department clarified that under new proposed regulations, any such bargain element will be treated as a distribution under IRC Section 402(a) as well as for other purposes of the IRC, including the limitations on in-service distributions from certain qualified plans and the limitations of IRC Section 415.See REG-126967-03, 69 Fed. Reg. 7384 (Feb. 17, 2004).The DOL also has extended the application of PTE 92-6 to the transfer of a second-to-die policy owned by a husband and wife from a self-directed profit sharing plan account, provided certain requirements are met. Generally, the requirements are that the participant must be the insured under the contract, the contract would be surrendered but for the sale by the plan, and the amount received by the plan as consideration must be at least equal to the amount necessary to put the plan back in the same position as if it had retained the contract, surrendered it, and made any distribution owed to the participant on his or her vested interest under the plan.DOL Adv. Op. 2006-03A (February 26, 2006).Administrative Exemption: 93-33 and 97-11Prohibited Transaction Exemption 93-3358 Fed. Reg. 31053. and Prohibited Transaction Exemption 97-1162 Fed. Reg. 5855. allow banks and brokerages, respectively, to offer no or low cost services based on account balances in IRAs and Keogh plans, if certain requirements are met: (1)the services offered must be those that could be offered under applicable state and federal law and that are available in the ordinary course of business to other customers who do not maintain an IRA or Keogh plan; (2)the eligibility requirements, based on the account value or the amount of fees incurred, must be as favorable as any such requirements imposed on any other account included in determining eligibility to receive such services; (3)the IRA or Keogh plan must be established for the exclusive benefit of the participant, his or her spouse, or their beneficiaries; (4)the investment performance of the IRA or Keogh plan must equal or exceed that of a like investment made at the same time by a customer ineligible to receive such low or no cost services. In addition, PTE 97-11 requires that the services offered by brokerages be the same as those offered to non-IRA or non-Keogh plan customers with like account values or like fees generated and that the combined total of all fees for the provision of services to the IRA or Keogh plan may not exceed reasonable compensation within the meaning of IRC Section 4975(d)(2).The Department of Labor subsequently adopted amendments expanding these exemptions to Coverdell education savings accounts and SIMPLE IRAs (Q 3641).See 64 Fed. Reg. 11042 and 64 Fed. Reg. 11044 (Mar. 8, 1999). PTE 97-11 was similarly amended to extend its provisions to Roth IRAs, assuming they are not part of an employee benefit plan covered by Title I of ERISA, other than an SEP or a SIMPLE IRA.See 67 Fed. Reg. 76425 (Dec. 12, 2002).