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Prohibited Transactions Law & Cases
IRA Qualifications and General Rules
IRC § 408 (e)(2)(A) Consequences of PT, distribution of account.
IRC § 408(e)(2)(A)Disqualification and distribution of IRA money when a prohibited transaction occurs.
Roth IRA Qualifications and General Rules
IRC § 408A(d)(2)(A) Roth IRAs and distribution
Prohibited Transaction Rules
IRC 4975 The primary code section for prohibited transactions.
IRC § 4975 (a), IRC § 4975 (b) PT consequences when a disqualified person other than the IRA owner engages the account in the PT.
IRC § 4975 (b) If an additional 100% penalty is assessed as opposed to distribution, the time period to correct the PT is the tax year in which the PT occurred.
IRC § 4975 (c)(1) Self Dealing Prohibited Transaction definition
IRC § 4975 (c)(1)(B) Extension of credit prohibited transaction.
IRC § 4975 (c)(3) Consequences of PT, distribution of account.
IRC § 4975 (d)(10) Reasonable compensation exception to PT. Broker commission may be “reasonable compensation”. Should not be relied on as it has not been tested in court nor specifically endorsed by the IRS or DOL.
IRC § 4975 (e)(2) Lists persons disqualified to an IRA.
IRC § 4975 (e)(2)(A) IRA Account owner is disqualified person as a Fiduciary.
IRC § 4975 (e)(2)(F), IRC § 4975 (e)(6) Family members as a disqualified person.
IRC § 4975 (e)(2)(G) 50% or more of a beneficial interest of a trust or unincorporated business enterprise.
IRC § 4975 (e)(2)(H) An officer, director, or 10% or more shareholder, or highly compensated employee (earns 10% or more of the company’s wages) of a company owned by the IRA owner or disqualified persons.
Prohibited Transaction Consequences
IRC § 6501(a) Statute of Limitations for prohibited transaction.
IRC § 6501(c)(1),(2),(3) An indefinite statute-of-limitations applies when there has been a false return, a willful attempt to evade tax, or when no return was ever filed.
IRC § 6501(e)(1), IRS Tax Exempt and Government Entities, Chapter 11 Statute of Limitations, Training 4213-021 (Rev. April 2002).
IRC § 6662 Accuracy Related Penalty applied when there is no reasonable position for not reporting and paying tax. Penalty is 20% on amount that should have been paid.
Cases and Opinions
PER SE PROHIBITED TRANSACTIONS
|Citation: Harris v. Comm’r, T.C. Memo 1994-22.|
|Case Facts: IRA owner purchased a home with his IRA and used it as his personal residence. The Tax Court ruled that the purchase was a prohibited transaction since the property was to be used by the IRA owner.|
|Citation:In re Hughes, 293 B.R. 528 (M.D. Fl. Bankr. Ct. 2003).|
|Case Facts: IRA owner loaned money from his IRA to himself. The loan from the IRA was a transaction with a disqualified person (IRA owner) and the Court ruled that it was a prohibited transaction.|
|Citation: DOL Advisory Opinion 06-09A|
|Case Facts: IRA owner planned to enter into a promissory note investment with a company owned 87% by the IRA owner’s son-in-law. DOL ruled that it would be a prohibited transaction because the IRA investment would be a transaction with a disqualified person (company owned 50% or more by son-in-law who is a disqualified person).|
|Citation: Ellis v. Commissioner, T.C. Memo 2013–245 (2013), citing, S. Rept. No. 93–383 (1974)|
|Case Facts: Statutory History to the Prohibited Transaction Rules|
|Citation: DOL Advisory Opinion 11-04A|
|Case Facts: IRA purchased note and deed of trust from bank. The note and deed of trust was for a property where the IRA owner personally lived, and the IRA owner was personally the borrower on the note. The IRA’s purchase of the note and deed of trust was not a per se prohibited transaction since the bank was not a disqualified person to the IRA. However, all subsequent loan payments from the IRA owner on the note owned the IRA would be “transactions” with “disqualified persons” and are prohibited transactions.|
|Citation: DOL Advisory Opinion 93-33A|
Case Facts: IRA owner’s purchase of a school from a company founded, controlled, and managed by the IRA owner’s daughter and son-in-law is a prohibited transaction since the purchase is a transaction with a company controlled 50% or more by disqualified persons (daughter and son in-law).
|Citation: D.E.W. Plumbing v. Domestic Mortgage, Case 1:10-CV-2593-TWT (U.S. Dist Ct. N.D. Georgia, 2012)|
Case Facts: Retirement plan owner directed his company plan to loan money into a company owned by the retirement plan owner and his two children. The court held that the loan was a transaction with a company owned 50% or more by disqualified persons (plan owner and two children).
|Citation: In re Daniels, 452 B.R. 335 (Bankr.D.Mass Ct. 2011).|
Case Facts: Retirement plan owner purchased investment property with plan and leased the property to the plan owner’s son and daughter-in-law who paid rent to the plan. This was a prohibited transaction as the lease and rent was a transaction with a disqualified person (plan owner’s son and daughter-in-law).
|Citation: Morrissey v. Commissioner, TC 1998-443 (U.S.T.C. 1998).|
Case Facts: Retirement plan owner loaned money from plan to himself. The loans and subsequent repayments were transactions (loan and re payment) between disqualified persons (plan owner).
|Citation: Wood v. Comm’r, 95 T.C. 364 (U.S.T.C. 1990).|
Case Facts: Retirement plan owner/trustee sold/transferred real and personal property he personally owned to his retirement plan. The transfer of property to the plan was a transaction by a disqualified person (plan owner).
|Citation: Rutland v. Commissioner, 89 T.C. 1137 (1987).|
Case Facts: Retirement plan fiduciaries and officers of a company plan sold property from themselves personally to the plan. The plan paid cash for the real property and agreed to a note for the balance of the purchase price. The sale of the personally owned property to the plan and the note for the balance of the purchase was a prohibited transaction.
|Citation: Janpol v. CIR, 101 T.C. 518 (1993).|
Case Facts: The second prohibited transaction from Janpol occurred when the retirement plan owners loaned money from themselves personally to the plan. This was a prohibited transaction, as there was a loan between a disqualified person and a plan.
EXTENSION OF CREDIT PROHIBITED TRANSACTION
|Citation: Rutland v. Commissioner, 89 T.C. 1137 (1987)|
|Case Facts: Personal extension of credit between a plan and a disqualified person. A loan from the IRA to the disqualified person.|
|Citation: Zacky v. Commissioner, T.C.M. 2004-130 (2004).|
Case Facts: Retirement plan owner loaned money from his plan to himself personally to pay off a personal car loan and to pay personal real property taxes. The loans were prohibited transactions as they were extensions of credit from a plan to a disqualified person.
|Citation: Janpol v. CIR, 101 T.C. 518 (1993).|
Case Facts: Retirement plan owners guaranteed loans from a bank to the retirement plans. The Tax Court held that such guarantees were an extension of credit from a disqualified person to a plan.
|Citation: ERISA ADVISORY OPINION 90-23A (no online link)|
Case Facts: Two attorneys requested approval of a transaction from the Department of Labor (“DOL”) in which they would form a new entity and fund it with their self directed IRAs. The new entity would obtain a loan for the purchase of real estate and the self directed IRA owners would sign a personal guarantee. The DOL ruled that the guarantees would be an extension of credit from IRA owners to a disqualified person (company entirely owned by their IRAs).
|Citation: ERISA ADVISORY OPINION 2006-09A|
Case Facts: IRA owner’s son-in-law and daughter owned 95% of a corporation. IRA owner wanted to lend money as an investment to the corporation. DOL ruled that the loan would be a prohibited transaction as the company was owned 50% or more by disqualified persons (son-in-law and daughter), and the loan would be an extension of credit.
|Citation: In Re Daley, 2013 U.S. App LEXIS 12138 (6th Cir. June 17, 2013).|
Case Facts: IRA owner signed documents with his broker whereby his IRA was subject to a lien against any amounts that the IRA owner personally owed to the bank. The Court ruled that this lien language did not constitute a prohibited transaction since the IRA owner did not have any other personal obligations to the bank, and as a result, the language did not burden the IRA or result in an actual extension of credit from the IRA to the IRA owner. This overruled a lower court ruling finding that there was a prohibited transaction.
Case Facts: Two Roth IRA’s owned a company which acquired an existing business as part of the acquisition there was financing to the Roth IRA owned company., The Roth IRA owner’s personally guaranteed the financing and the Tax Court found an extension of credit prohibited transaction.
Citation: DOL Opinion Letter 2006-01A
|Case Facts: Not a self dealing prohibited transaction when a company in which an IRA has invested engages in a transaction with that IRA owner.|
|Citation: DOL Opinion Letter 88-018A (no online link)|
|Case Facts: Promissory Note from self directed IRA to a company in which the self directed IRA owner owned less than 50% of the company, not an extension of credit PT.|
SELF DEALING PROHIBITED TRANSACTIONS
|Citation: DOL Advisory Opinion 2011-04A|
Case Facts: IRA sought to purchase promissory note from third-party bank. The borrower to the note, however, was the IRA owner personally. The DOL stated that the existence of an outstanding note between the IRA and the IRA owner personally would be a self dealing prohibited transaction.
|Citation: DOL Advisory Opinion 2006-01A, 29 C.F.R. 2509.75-2(a)|
Case Facts: IRA owned 49% of an LLC that in turn leased a property to a company majority owned by the IRA owner. Even though the IRA owned less than 50% of the LLC and was therefore not a disqualified person, the DOL stated that since the intent of the LLC at formation was to then lease property to a company majority controlled by the IRA owner, that the investment would constitute a per se prohibited transaction and self dealing prohibited transaction since it would be for the benefit of a company majority owned by the IRA owner. The DOL relied on 29 C.F.R. 2509.75-2(a) in reaching this conclusion, which states that a retirement plan engages in a prohibited transaction when it invests into a company and when that company has an arrangement to then invest with a disqualified person.
|Citation: DOL Advisory Opinion 82-08A|
Case Facts: Four siblings each owned 45%, 40%, 10%, and 5% of a company. The siblings wanted to make a loan investment from their IRAs to the company. Because siblings are not disqualified persons, the company was not a disqualified person under the rules, and as a result, there was no per se or extension of credit prohibited transaction. However, the DOL reasoned that because of the significant ownership interests of the siblings, who are disqualified to their own IRAs, the loan investments would be a self dealing prohibited transaction.
|Citation:DOL Advisory Opinion 89-03A (no online link)|
|Case Facts: An officer and 1% shareholder of a publicly traded company wanted to invest his self directed IRA into the company for shares equaling less than 1%. The DOL stated that the investment would not constitute a per se prohibited transaction because of the IRA owner’s small ownership stake but withheld opinion on whether the purchase would constitute a self dealing prohibited transaction and cautioned the IRA owner on the issue without expressing an opinion.|
|Citation: DOL Advisory Opinion 90-20 (no online link)|
|Case Facts: Company sought opinion as to whether its employees could purchase shares of its parent holding company with their self directed IRAs. DOL stated that such stock purchases of employee’s IRA would not constitute a per se or self dealing prohibited transaction. DOL cautioned that purchases of stock for employees who are also officers or directors may cause a self dealing prohibited transaction but refused to express a final opinion as to such.|
|Citation:DOL Advisory Opinion 2000-10A|
|Case Facts: IRA owner and family members owned over 50% of an investment partnership, though only about 20–25% was owned by disqualified family members. IRA owner wanted to invest his self directed IRA into the investment partnership and would reorganize the ownership such that following the investment, his IRA would own 39.38% and disqualified persons to his IRA would own about 11%. The partnership would be managed by an unrelated third party. The DOL ruled that this would not result in a per se prohibited transaction and did not find a self dealing prohibited transaction at the time of the IRA investment, though they did say it was possible one could arise later because of the involvement of the IRA and disqualified persons.|
|Citation: TAM 9208001 (IRS, Technical Advice Memorandum) (not published)|
Case Facts: A disqualified person caused a retirement plan to loan money to a limited partnership where the disqualified person was a 7.5% partner. The IRS wrote that this was a self dealing prohibited transaction.
|Citation: TAM 9119002 (IRS, Technical Advice Memorandum) (not published)920800|
Case Facts: A disqualified person and plan owner caused his company plan to loan money to Company Y. The plan owner was a 39% owner of Company Y. According to the facts, the IRS ruled that there was no evidence to refute the assumption that the plan owner participated in the decision to make the loan to Company Y. As a result, the IRS reasoned that because of the plan owner’s participation in making the loan with Company Y and because the plan owner benefited as a significant owner of Company Y, the loan was a self dealing prohibited transaction.
|Citation: Lowen v. Tower Asset Management, Inc., 829 F.2d 1209 (2nd Cir. 1987)|
Case Facts: A disqualified person to the plan caused the plan to invest in companies where the disqualified person would receive commissions and fees for services. The Court ruled that this was a self dealing prohibited transaction because the disqualified person would receive financial benefit for the plan’s investments in the companies.
|Citation: Flahertys Arden Bowl, Inc. v. Commissioner, 115 T.C. 269 (2000), affirmed per curiam, 271 F.3d 763 (8th Cir. 2001).|
Case Facts: A disqualified person caused his retirement plans to loan money to a business substantially owned (over 50%) by the disqualified person. The Court ruled that this was a self dealing prohibited transaction since the disqualified person’s business was benefitting from the investment. This also constituted a per se prohibited transaction.
|Citation: PLR 8717079, Department of Labor Private Letter Ruling. No online link available see Private Letter Ruling (PLR)|
Case Facts: IRA owner was a manager and a member of the board of directors of Company. The IRA owner also owned less than 1% of the stock of company. The IRA owner proposed to invest his IRA into Company to buy one hundred shares, which purchase would result in the IRA owner still owning less than 1% between him personally and his IRA. The IRS ruled that this would not be a per se prohibited transaction but reserved to say whether or not it would be a self dealing prohibited transaction.
|Citation: PLR 8009091, Department of Labor Private Letter Ruling. No online link available see Private Letter Ruling (PLR)|
Case Facts: IRA owner was a director of Corp A and a former employee of Corp A. Corp B owns 35% of Corp A and the IRA owner was the president of Corp B. The IRA owner proposed to purchase 5% of the shares of Corp A. The DOL ruled that the purchase would not be a prohibited transaction as Corp A was not a disqualified person to the IRA owner. The DOL cautioned that a self dealing prohibited transaction may occur though, if the “plan’s acquisition of the stock insures your [IRA owner’s] reelection as a director of Corp A or benefits you in your position as president of Corp B.”
Citation: Rollins v. Commissioner, T.C. Memo 2004-260.
Case Facts: Rollins was trustee of a retirement plan that invested into companies where he and his wife were owners but did not own 50% or greater. While there was not a per se prohibited transaction, the court found a self dealing prohibited transaction because Rollins benefitted from the transactions by being a significant owner (approx. 30%) in some of the companies that received loan investments from the retirement plans. Rollins was also the officer of the companies that received the loans and signed on the notes for the companies.
Case Facts: Prohibited transaction case. See link.
Case Facts: Prohibited Transaction case. See link.
Citation: DOL Opinion Letter 88-018A (no online link)
Case Facts: Prohibited transaction case. Discussed in SDIRA Handbook.
Citation:140 T.C. 12 (2013)
|Case Facts: Accuracy-Related Penalty on taxes not paid by the IRA owners personally following a PT in their IRA.|
Disqualified / Not Disqualified Persons Table
|Disqualified Persons – Your IRA may NOT engage in a transaction with these persons.||NOT Disqualified – Your IRA MAY engage in a transaction with these persons.|
|IRA Owner||Non family members or employees|
|Children||Step parent (to un-adopted child) or un-adopted step child|
|Spouses of Children||Aunts and Uncles, Nieces and Nephews, and cousins.|
|Grandchildren and their spouses||In-laws of the IRA owner|
|Parents and grandparents||Brothers and Sisters|
|Companies (corps, LLCs, LPS, partnerships, trusts) where you or family above own or control 50% or more||Companies the IRA owner and other disqualified persons own and control less than 50%|
|Certain Officers, Directors, or Highly Compensated Employees of companies where the IRA owner owns or controls 50% or more||Everyone else not listed to the left and not disqualified in IRC § 4975 (e)(2)|
Misc. IRS Forms, Publications, Treasury Regulations For Prohibited Transactions
IRS Form 1099-R IRA custodian files this form when a PT occurs and distribution of IRA is reported.
1099-R Instructions Pg. 4 Reasons for distribution as a PT.
IRS Form 5329 or IRS Form 5330 is the applicable return that is filed to declare a prohibited transaction and to pay any applicable taxes and penalties. IRS Form 5329 is what is filed if the IRA engaged in a prohibited transaction with the IRA owner or other fiduciary. IRS Form 5330 is what filed if the IRA engaged in a prohibited transaction with a disqualified person who was not a fiduciary.
IRS, Instructions for Form 5329, Additional Taxes on Qualified Plan (Including IRAs), pg. 2. (2012), IRS, Instructions for Form 5330, Return of Excise Taxes Related to Employee Benefit Plans (Rev. April 2009).
IRS Form 8606 is used to determine and declare the taxable portions for these amounts. Income and Gains, subject to tax.
IRS Publication 590 (2013 Pg. 51) Prohibited Transactions
IRS Publication 590, Distributions, pg. 40 (2013) Taxes due from the IRA distribution depend on the IRA owner’s personal tax situation.
IRS Publication 598 for distribution-rule exceptions if you have a special circumstance or hardship on how the 10% penalty is applied.
Treasury Reg. §1.408A-6, Q&A-1(b) Roth IRAs and distribution
Treasury Reg. §1.408A-6,Q&A-5(b) The 5 year Roth IRA qualified distribution rule does not come into play when analyzing whether there is a 10% early withdrawal penalty.
Retirement Plan FAQs Regarding Plan Investments, Q: 5, (Rev. 11-21-2013) IRS, Retirement Plans. If the taxable year has passed, the IRS allows a prohibited transaction to be corrected within 90 days after the IRS mails a notice of deficiency, alleging the prohibited transaction.
Internal Revenue Manual, 220.127.116.11 Prohibited Transactions (8/13/2013) IRS agents are instructed to treat all prohibited transactions as if the 3 year rule applied in order to minimize issues with taxpayers who may claim they are subject to the 3 year rule.
IRS Tax Exempt and Government Entities Manual, Chapter 11 Statute of Limitations, Training 4213-021, pg. 5. (Rev. April 2002) In order to pursue prohibited transactions past the 3 year statute of limitations, an IRS revenue agent must obtain approval from IRS Area Counsel.