What Is A 401k Prohibited Transaction?
According to the Internal Revenue Manual (IRM), a 401k prohibited transaction is a financial exchange of value in which a disqualified person engages in. The disqualified person must then reverse the transaction and pay a tax. Potentially, this tax can be up to 100% of the amount in question!
So who is a disqualified person? Put simply, it’s anyone who has any control or management responsibilities over a 401k plan.
Disqualified persons can include any of the following:
- Unions and their officials
- Plan Fiduciaries (anyone who gives advice or has any authority or control over the 401k plan including administration services)
- Lawyers and accountants to the plan and it’s fiduciaries
- 401k plan service providers
- Employer or employee organizations
- Anyone with a 10% or more interest in the plan
- Family members related to anyone who may be a disqualified person
If you’re even remotely managing or advising or administering a 401k plan – or if you’re a family member of someone who is – you’re very likely a disqualified person.
So What Is A Prohibited Transaction?
Prohibited transactions include:
- a transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person;
- any act of a fiduciary by which plan income or assets are used for his or her own interest;
- 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;
- the sale, exchange, or lease of property between a plan and a disqualified person;
- lending money or extending credit between a plan and a disqualified person; and
- furnishing goods, services, or facilities between a plan and a disqualified person.
Disqualified persons CANNOT benefit financially in any way from use (or misuse) of their relationship to the 401k plan.
Penalties For Prohibited Transactions
If you participate in a prohibited transaction it must be reversed. You must also pay an excise tax.
The initial tax is 15% for each year in the taxable period. If the transaction isn’t reversed, an additional penalty of 100% of the amount involved is owed.
If more than one person participates in the transaction, multiple people may be responsible for the entire tax! So if you don’t realize what you’re getting in to – and are simply going along with another disqualified person – you may be on the hook for 100% of the penalty!
The amount of the penalty is the greater of the money and value of any property given or received. The taxable period used to calculate the amount starts on the day the IRS mails the notice of deficiency. It ends when they assess the tax penalty or when the correction of the transaction is complete.
Prohibited 401k Transactions Summary
Don’t ever use your position as someone with any control over a 401k plan to benefit financially. The law is very broad on this, and the penalties are also very severe.
Not only will you have to fix the situation, but you’ll potentially be on the hook for a 100% tax!