Demutualization Proceeds - Form 5330 Correction

[Guest ERISAMOM]

Does anyone know how to characterize and report deliquent contributions of demutualization proceeds to a pension plan on Form 5330? Insurance company distributed demutualization shares to the company instead of the pension plan in late 2001. The company didn't realize shares belonged to plan. After discovering the error, the company returned the shares (which have appreciated significantly in value) plus dividends paid on shares into plan. The plan ended up with shares that increased 57% over the last three years. The plan is not under audit.

I spoke with a very helpful guy at the DOL, who advised us to make full correction (return appreciated shares and dividends) and document our correction. I realize we need to file Form 5330s with the IRS to report the prohibited transaction(s). I think the prohibited transactions would be the prohibited use of property (the shares) or an improper extension of credit (deemed loan). But I'm not sure how the IRS would view this. My concern is that the IRS could view this as a deemed tranfer of assets between the plan and company instead of the company's improper use of plan assets (or deemed loan). I can't seem to get guidance from the IRS on this point. Until I figure out how the IRS will view this, it is hard to figure out the excise tax, since the "amount involved" differs depending on whether the IRS views this as (1) a deemed transfer of assets from the plan to the company (in which case the "amount involved" would be the value of the shares on the date the shares were distributed to the company in 2001 (the excise tax would then be due for each year until corrected) or (2) use of property or extension of credit (in which case the "amount involved" would be the fair market value of use of property (or reasonable interest rate in case of a loan) for each of 2001, 2002, 2003 and 2004 (subject to the usual pyramiding). If it is treated as an improper use of property (deemed loan), is the "amount involved" the appreciation of the stock in each period (since the appreciation is what was actually "earned" and it is higher than would be yielded under either the plan's average interest rate, the federal underpayment of tax rate or afr for below market loans). I'm really struggling with how to characterize the type of prohibited transaction (transfer of assets vs. use of property (deemed loan)) and if it is a deemed loan, how to calculate the amount involved.

Sorry for such a long winded (and clear as mud) message. Would greatly welcome any thoughts!

[J. Bringhurst]

We had the same issue with a client and filed Form 5330 on their behalf as an improper extension of credit...as to the calculation of the amount involved (the fair market use of the money)....we actually used the rate that the company would have gotten from a commercial lender for a similar loan...I think that we have typically used the other rates that you mentioned as rates to use in calculating earnings on a borrowed amount (such as late deferrals)....rather than the rate used to calculate the amount involved for further use in calculating the excise tax....I think they're really two different concepts...please let me know if you disagree since there doesn't seem to be much guidance out there....

[Guest kmvr]

How did you ever resolve this problem? We have an identical situation and are debating whether we should treat the failure to deposit the proceeds as an interest free loan between the plan and plan sponsor. If we do so, what interest rate should we use for purposes of calculating the excise tax?