Excise tax on prohibited transactions

[Guest beth beaube]

I have a client company that made two invalid loans to two highly compensated employees. The employees have no ownership in the company and no other relationship with the company that would seem to make them "disqualified persons" as that term is defined in the Form 5330 (which is the form used to pay the applicable excise tax to the Service). Is an excise tax payable by the Company and not by the two employees? What about the individuals at the Company who may have been fiduciaries who participated in making the loans? It does not make much sense to me to have an excise tax paid on the same loan by more than one company/individual. I would like to simply have the company pay the excise tax on the two loans. I am rambling! Any response to any of the foregoing would be appreciated. Thanks.

[Guest Sherry Porter]

Please clarify what you mean by "invalid loan". If you do n ot have a prohibited transaction between a plan and a disqualified person, there is no excise tax under Code Section 4975. Section 4975 imposes a 15% excise tax (could be up to 100%) on the disqualified person for each prohibited transaction. However, if the persons receiving the loans were not disqualified persons as defined in Code Section 4975, then no PT and no excise tax. However, there are many other ways to screw up loans under a qualified plan. I would be happy to provide further guidance if you could elaborate on what you mean by an "invalid loan".

[Guest beth beaube]

The repayment term for loans was limited in the plan to five years. However, two loans were made to highly compensated individuals that had repayment terms of 15 years. Now that I look closer at this, I assume that, altough the loans were invalid loans as they did not follow the terms of the plan, the making of the loans did not constitute a prohibited transaction since they were not made to a "disqualified person." Though these individuals were hihgly compensated as that term is defined in Section 414, they do not meet the definition of highly compensated employeas set forth in Section 4975(e)(2)(H) which states that the highly compensated employee must be aerning 10% or more of yearly wages of the employer.

Thanks for your response.

[lkpittman]

Okay, let's say the individuals are not disqualified persons. If these 2 individuals are plan participants, the "loans" must meet the requirements of Sec. 72(p) (which includes the 5-year repayment rule, with an exception for certain home loans). If those requirements are not met, the "loan" is not a loan at all--it is considered a taxable distribution. It will either be a "deemed distribution" or an actual distribution (or offset, if the individuals are otherwise entitled to a distribution of their benefits under the plan) under the proposed regulations under Sec. 72(p).

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LKP

[Guest beth beaube]

Although the loans fell within the provisions of 72(p), the plan contained a prohibition against loans in excess of five years (even though Section 72(p) would allow such loans for mortgages). Thus, the making of the loan, though allowed under Section 72(p), was invalid under the terms of the Plan. We have corrected this (one person terminated employment and had a deemed distribution of the balance on the loan; the other person repaid the balance on his loan). I consulted with a VCR representative about the proper method of correction. The representative said it would be acceptable to simply allow an immediate repayment of the loan rather than to treat it as a deemed distribution.

After making the correction of the plan defect, I was looking at whether there was a prohibited transaction. It appears there is no prohibited transaction.

Thanks - you have been very helpful.