Part 1: What are Prohibited Transactions and Disqualified Persons?
Updated: Apr 23, 2021
Next week's post will be: Part 2: Taxes Imposed on, and How to Correct, a Prohibited Transaction. It can be found here.
Many years ago, the government instituted legislation that encouraged taxpayers to save for retirement by permitting special retirement accounts, including, but not limited to, Self-Directed Solo 401(k)s, as a means to save money and enjoy tax deferral benefits. To ensure that the benefits are preserved until retirement, however, the tax law does not allow the Self-Directed Solo 401(k) account holder to take any personal benefit before he or she reaches the age of retirement. Interactions that violate this statute are known as “Prohibited Transactions.”
The following information was pulled directly from IRS Publication 560 (2019), Retirement Plans for Small Business:
"Prohibited transactions are transactions between the plan and a disqualified person that are prohibited by law. (However, see Exemption next.) If you are a disqualified person who takes part in a prohibited transaction, you must pay a tax (discussed later).
Prohibited transactions generally include the following transactions.
1. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person.
2. Any act of a fiduciary by which he or she deals with plan income or assets in his or her own interest.
3. The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets.
4. Any of the following acts between the plan and a disqualified person.
a. Selling, exchanging, or leasing property.
b. Lending money or extending credit.
c. Furnishing goods, services, or facilities.
Certain transactions are exempt from being treated as prohibited transactions. For example, a prohibited transaction doesn't take place if you are a disqualified person and receive any benefit to which you are entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries. For other transactions that are exempt, see section 4975 and the related regulations.