Prohibited Transaction Or Not???

[Guest Mitch]

Would like to get your reaction/thoughts related to the following. Assume a DB plan in VCR. Several defects have resulted in "overpayments" and "underpayments" from the plan. These defects affect practically every participant in the plan (both HCEs and NHCEs.) We do not intend to collect the overpayments because we probably will not convince anyone to repay and it would be too much of a headache. Also, the plan is significantly overfunded and we (the employer) have proposed not to "repay" the overpayments to the plan because of the overfunding (BTW it appears the IRS is not going to challenge this).

Here's the issue: A sizable portion of the overpayments were made to individuals that were participants in a nonqualified supplemental pension plan (this plan made up benefits that could not be paid from the qualified DB plan because of 415 limits, comp limits, etc.) For example, a person's total benefit is 200K of which only 150K could be paid from the DB plan because of 415, comp. limits, etc.; the remainder of 50K would be paid from the nonqualified plan. However, the DB plan was actually paying the entire 200K. Hence our defect. A question has been raised as to whether the payment of 50K from the qualified plan is a prohibited transaction. The argument is that a PT involves the intentional OR inadvertent use or retention of plan assets by a party in interest. Also, it has been suggested that you could call this a loan from the plan to the employer because the plan has discharged an obligation (the $50K) of the employer. Thus, the PT excise taxes would be reduced because the amount involved would be the interest on the loan. But what is the interest rate? Based on a literal reading of PT laws/rules I can see where one might get to the conclusion that this is a PT. On the other hand I never dreamed that the PT rules were designed to capture these types of transactions. If so, then could you argue that every overpayment from any qualified plan is a PT? What is your opinion? Has anyone seen the IRS call this a PT?