Prohibited transactions are specific types of retirement plan errors that result in excise taxes and could also result in civil penalties and personal liability. Responsible parties include plan sponsors, officers, trustees, plan administrators and other fiduciaries. Prohibited transactions generally involve misuse of plan assets and/or self-dealing (transactions with a “party in interest”). Several specific prohibited transactions can be fixed through the Department of Labor’s (DOL) Voluntary Fiduciary Correction Program (VFCP).
Many well-intentioned transactions can be prohibited transactions. If you have the participants’ best interest in mind when making an investment or selling a plan asset, that may not be enough. You also often need to ensure the transaction does not involve a party in interest. The rules are complex. If you aren’t sure, consult an outside expert to help you determine if the transaction is proper.
Parties in Interest
In addition to prohibiting general misuse of plan assets, the prohibited transaction rules prohibit self-dealing with plan assets. The definition of a party in interest is basically what defines the “self” in self-dealing. Parties in interest is a broad category that includes:
plan administrators, officers, trustees, custodians, attorneys, or employees of the employee benefit plan (including plan fiduciaries) or their family members;
Family members are defined broadly (spouse, lineal descendants and spouses of lineal descendants) and constructive ownership rules also apply to determine ownership (for example, stock owned by a trust is considered as owned by the beneficiaries of the trust).
In addition to prohibiting misuse of plan assets, the law generally prohibits parties in interest from benefiting financially from the plan. Parties in interest are prohibited from receiving the income or assets of the plan (with certain exceptions) and from dealing with the income or assets of a plan in his own interests or for his own account. The following specific transactions between a plan and a party in interest are prohibited:
A simple example of a prohibited transaction would include the plan purchasing assets in real estate from an officer of the plan sponsor. The investment could be an incredible opportunity for the plan and create enormous sums of money. It’s still a prohibited transaction. Several other common prohibited transactions are covered by the VFCP, described below.
Fiduciary Errors and Prohibited Transactions Covered by the VFCP
The DOL’s VFCP covers only certain fiduciary violations/prohibited transactions and provides methods to correct each. The prohibited transactions that can be fixed by the VFCP are:
* Note that these loan errors require filers to use the IRS’s Employee Plans Compliance Resolution System (EPCRS) to fix the error and then file the compliance statement with DOL’s VFCP.
For each error, the regulations set forth the proper process to correct the error. No matter which type of error, in order to file with the VFCP, you must:
If the DOL is satisfied with the correction, it will issue a no-action letter. Persons using the VFCP must fully and accurately correct violations. Incomplete or unacceptable applications may be rejected. If rejected, applicants may be subject to enforcement action, including assessment of civil monetary penalties.
Penalties are assessed by both the DOL and the Internal Revenue Service (IRS) against the party in interest. The maximum penalty is 5% of the amount involved for each year or part thereof during which the prohibited transaction continues. If the transaction is not corrected within 90 days after notice from the DOL (or such longer period as DOL may permit), the penalty may not exceed 100%. If a no action letter is issued under the VFCP, no civil penalties will apply.
The IRS imposes an excise tax equal to 15% of the amount involved with respect to the prohibited transaction for each year (or part thereof) in the initial period. In any case in which a 15% initial tax is imposed and the transaction is not corrected within a certain period, the tax is equal to 100% of the amount involved. In certain VFCP cases, the IRS will waive the excise tax.
Excise Tax Relief
The following prohibited transactions, once corrected through VFCP, will not be subject to the excise tax:
Finding or discovering errors is often the most difficult part of the corrections process. Errors often occur precisely because a process or person is not being closely monitored or because parties in interest are not aware of the rules. Regularly reviewing plan procedures, consulting with outside experts and establishing policies is the best way to catch errors quickly and prevent errors from occurring. Once an error is discovered, timely discussing the errors with outside experts will help ensure the correction is not costly for the plan.