Part 2: Taxes Imposed on, and How to Correct, a Prohibited Transaction.
Updated: Apr 23, 2021
In case you missed it, here is our post from last week: Part 1: What are Prohibited Transactions and Disqualified Persons?
The following information was pulled directly from IRS Publication 560 (2019), Retirement Plans for Small Business:
Tax on Prohibited Transactions
"The initial tax on a prohibited transaction is 15% of the amount involved for each year (or part of a year) in the tax period. If the transaction isn't corrected within the tax period, an additional tax of 100% of the amount involved is imposed. For information on correcting the transaction, see Correcting a prohibited transaction , later.
Both taxes are payable by any disqualified person who participated in the transaction (other than a fiduciary acting only as such). If more than one person takes part in the transaction, each person can be jointly and severally liable for the entire tax.
The amount involved in a prohibited transaction is the greater of the following amounts.
· The money and fair market value of any property given.
· The money and fair market value of any property received.
If services are performed, the amount involved is any excess compensation given or received.
The tax period starts on the transaction date and ends on the earliest of the following days.
· The day the IRS mails a notice of deficiency for the tax.
· The day the IRS assesses the tax.
· The day the correction of the transaction is completed.
Payment of the 15% Tax
Pay the 15% tax with Form 5330.
Correcting a Prohibited Transaction
If you are a disqualified person who participated in a prohibited transaction, you can avoid the 100% tax by correcting the transaction as soon as possible. Correcting the transaction means undoing it as much as you can without putting the plan in a worse financial position than if you had acted under the highest fiduciary standards.
If the prohibited transaction isn't corrected during the tax period, you usually have an additional 90 days after the day the IRS mails a notice of deficiency for the 100% tax to correct the transaction. This correction period (the tax period plus the 90 days) can be extended if either of the following occurs.
· The IRS grants reasonable time needed to correct the transaction.
· You petition the Tax Court.
If you correct the transaction within this period, the IRS will abate, credit, or refund the 100% tax."