third party loan from a profit sharing plan

[Guest le190]

I have a client who is an owner-participant in his own company's profit sharing plan. the company is an s-corp. if he unelects s-corp status, is he permitted to make a 'third party loan' from the assets in his account to his brother-in-law's company? if so, do the standard IRS loan rules apply to this type of loan? Can he set his own interest rate, say 7%? does anyone have this experience to pass on? any help is greatly appreciated.

[Dave Baker]

Playing with fire there. On the face of it such a loan would not be a prohibited transaction within the meaning of the tax code because it would be a loan between a plan and the brother-in-law of the person who owns the plan sponsor ... the brother-in-law is not a "disqualified person" (nor would a sister be).

But the trouble-maker is the fact that the plan's trustee, who makes the decision whether to invest the plan's assets in the form of a loan, is acting in a way that arguably benefits himself personally (his sister will certainly think better of him for making the capital available). It's that "dealing" with plan assets in his own "interest" that could cause the IRS to accuse the trustee of having caused the plan to enter into a prohibited transaction, no matter how favorable the interest rate is for the plan.

[Guest le190]

Ok. Thanks, Dave. To clarify my original question, the bank who sponsors the prototype plan document is the trustee of the plan. And the assets that would be loaned would be only those in my client's own participant account. Also, (if this even matters)the plan is participant-directed, with respect to investment funds. Thanks again.

[Kathy]

I would still be VERY CAREFUL!!! If the plan is self directed, will this invesment (the loan to the brother-in-law) be available to all participants? If the guy is a really good credit risk, the others may want to get in on it as well. Could it be discrimintory to make such a great investment opportunity available to an HCE only? If the accounts are not self directed then the loan would have to be a general asset of the trust or you might have an alienation problem. Furthermore, the IRS and the DOL have slightly different definitions of disqualified person so look very carefully at both.

Sounds dangerous to me.

[imchipbrown]

Brother-in-law loan sounds like a dodge around not being able to borrow yourself (auditor's mindset). If I hit the nail, think twice!

Why are sole-p and S-corpers second class citizens in this loan fandango? Besides the regs, of course.

This is another part of pension planning that needs fixing.

[This message has been edited by Chip Brown (edited 01-20-99).]