Tax Code Information: What Is Irs Section 4975?

IRS Tax Code section 4975 imposes penalties on prohibited transactions involving retirement accounts and other employee benefit plans.

IRS section 4975 is about the improper use of certain employee benefit plans. It imposes tax penalties on "prohibited transactions" between the plans and "disqualified persons."

The plans covered by this section include individual retirement accounts and individual retirement annuities, certain stock bonus, pension, and profit-sharing plans, and certain medical and education savings accounts.

"Disqualified persons" have some specified relationship to the plan, and include fiduciaries, people providing services to the plan, employers whose employees are covered by the plan, and employee membership organizations whose members are covered. Certain relatives of disqualified persons are also disqualified, as are certain owners, shareholders, officers, directors, highly-compensated employees, partners, and joint-venturers of disqualified employers or employee membership organization.

Section 4975 says that as a general rule, disqualified persons may not:

-- Sell, exchange, or lease any property to or from a plan.

-- Borrow from or lend money to a plan.

-- Accept goods, services or facilities from a plan, or furnish them to a plan.

-- Use the income or assets of a plan for their own benefit.

-- If fiduciaries, deal with the income or assets of a plan in their own interests or for their own accounts.

There are numerous exemptions to the general rules:

1. You can apply for an individualized exemption which may be granted if it is administratively feasible, is in the interests of the plan, and protects the rights of the plan's participants and beneficiaries.



2. There are special rules for individual retirement accounts, Archer MSAs, and Coverdell education savings accounts.

3. In addition, section 4975 lists fifteen specific exemptions where the general rules concerning prohibited transactions do not apply. These are quite complex, and you should consult a tax advisor for more information. Here are a few examples, just to give you a sense of the scope of the exemptions:

-- A disqualified person who is a participant or beneficiary of a plan may obtain a loan from the plan IF the loan is available to all such participants or beneficiaries on a reasonably equivalent basis, is not made available to highly compensated employees, is made in accordance with specific provisions regarding such loans set forth in the plan, bears a reasonable rate of interest, and is adequately secured.

-- A disqualified person may provide office space or legal, accounting, or other services necessary for the establishment or operation of the plan IF no more than reasonable compensation is paid.

-- A disqualified person may receive any benefit to which he or she is entitled as a participant or beneficiary in the plan IF the benefit is computed and paid consistent with the terms of the plan as applied to all other participants and beneficiaries.

PENALTIES

Section 4975 lays out a two-tiered system of tax penalties imposed on disqualified persons who participate in prohibited transactions.

First, there is a tax of 15% of the amount of the transaction for each year, or part of the year, in the taxable period.

Second, if the prohibited transaction is not corrected within the taxable period, an additional tax of 100% of the transaction amount will be imposed.

-- This article is merely meant to provide a brief and hopefully readable overview of the IRS section, but does not constitute legal or professional advice. You should consult a tax attorney or other tax professional if you have any questions about this subject.

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