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Part 1: What are Prohibited Transactions and Disqualified Persons?

Updated: Aug 12

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

"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.

Exemption

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.

Disqualified Person

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."


Watch for next week's post: Part 2: Taxes Imposed on, and How to Correct, a Prohibited Transaction. It can be found here.

Source: https://www.irs.gov/publications/p560#en_US_2019_publink10009043

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