Prohibited Transaction - practical effect?

[Belgarath]

This kind of stuff used to happen eons ago when there were more pooled plans, but I haven't seen it in a long time.

Pooled account. Plan apparently didn't have a checking account. Check for (x) sent to the Trustee, for a distribution to a terminated participant.

Trustee deposited it into the EMPLOYER checking account and simultaneously wrote a check to the terminated participant for the appropriate amount, and submitted the 20% withholding to the IRS.

Yeah, it's a PT, but what is the penalty? There is zero loss or gain to any party involved, and no "amount involved" if one were to try to pay a 15% excise tax anyway. What do folks do with this on a practical level, rather than a theoretical level? Or is there an exemption for this that I'm missing?

[Mike Preston]

This still happens.  As I recall, when queried at conferences governmental representatives reference the PTE dealing with short term loans.  

[RatherBeGolfing]

On a practical level, it still happens all the time with pooled plans.  Most of the time its because the financial institution will not issue a third party check so they issue it to the trustee who then issues the check to the participant. 

With an explanation, I have never had a problem with it on audit.

[CuseFan]

agreed, as long as the tax withholding and reporting are done properly and the checks are timely issued so there's no float benefit to the employer, should be no problem.

[Luke Bailey]

The short-term loan to plan PTE specifically covers loans to pay benefits.

[Mike Preston]

Luke, are you saying that the specificity mentioned argues for its applicability or against?

[Luke Bailey]

Definitely for its applicability, Mike. I just reviewed the terms of the exemption, PTE 80-26, and as far as I can see, it fits this situation well. Note that (a) there should be some provision in the plan document permitting the loan, at least obliquely (because the loan must be "in accordance with the [plan's] terms or written modifications thereof..."), and (b) the loan would become a PT (or need to be recharacterized as a contribution, I guess) if it went over 60 days without being memorialized in a formal loan document.

[Mike Preston]

7 minutes ago, Luke Bailey said:

Definitely for its applicability, Mike. I just reviewed the terms of the exemption, PTE 80-26, and as far as I can see, it fits this situation well. Note that (a) there should be some provision in the plan document permitting the loan, at least obliquely (because the loan must be "in accordance with the [plan's] terms or written modifications thereof..."), and (b) the loan would become a PT (or need to be recharacterized as a contribution, I guess) if it went over 60 days without being memorialized in a formal loan document.

Wonderful!

[Belgarath]

Thanks for the input.

[ESOP Guy]

I thought an PTE 80-26 loan was a loan to the plan the original question says it was a loan to the sponsor.  Am I missing something here?  

[Luke Bailey]

ESOP Guy, you are right about the direction of the loan in PTE 80-26. Rereading the question, I think you are probably also right that at least several of us misread it, but now I'm confused. (I guess I was confused before, but now am confused differently.) Maybe Belgarath can go through the sequence of events with more detail. The question says that the plan may not have a checking account, but then seems to have the plan writing a check. Also, the time period between each step could be important.

[RatherBeGolfing]

55 minutes ago, Luke Bailey said:

ESOP Guy, you are right about the direction of the loan in PTE 80-26. Rereading the question, I think you are probably also right that at least several of us misread it, but now I'm confused. (I guess I was confused before, but now am confused differently.) Maybe Belgarath can go through the sequence of events with more detail. The question says that the plan may not have a checking account, but then seems to have the plan writing a check. Also, the time period between each step could be important.

Many financial companies will not issue third party checks/payment, they will only issue a checks/payment to the trustee.  If the plan does not have a checking account with check writing capability, those payments to the trustee are often deposited to the sponsor's operating account Which then issues the payment to the participant.

So the plan pays the sponsor who then pays the participant.  Usually, the payment to the participant is made as soon as the sponsor gets the assets from the plan.  There is no gain to the sponsor in terms of interest or earnings, it is merely a conduit.  The alternative is for the plan to open and maintain a checking account which will usually mean fees and/or minimum balances.  I see this a lot with pooled plans where there is very little turnover.  They might have to process a distribution every 2-3 years.

[Belgarath]

Luke - it is same day. Or at worst the next day.

"Trustee deposited it into the EMPLOYER checking account and simultaneously wrote a check to the terminated participant for the appropriate amount, and submitted the 20% withholding to the IRS. "

[jpod]

If structured properly going forward, I think you can use 80-26:  Employer makes the payment on behalf of the Plan using employer money, and AFTER THAT (can be a nanosecond after that) the employer is repaid by the Plan.  If employer doesn't want to do that then open up a checking account in the name of the Plan/Trustees. 

[Luke Bailey]

Maybe this is more like an agency arrangement than a loan? The employer receives the money that is going to go to the plan participant from the plan's trust, deposits the funds into its own general account, and pays the same amount of money to the participant on behalf of the plan. That practice seems to raise a silly tax issue (i.e., could an IRS agent having a really bad day allege that the participant did not receive the funds from the plan), but I'm not sure that would be a PT even without PTE 80-26. However, I wonder if the DOL could have concerns with this practice with respect to the requirement to hold plan assets in trust. Suppose it's not a nanosecond, but a day or two, and during that day or two the employer goes belly up? The participant does not receive the check, at least not for awhile as things are sorted out in the bankruptcy, and the plan definitely does not have the money. If this is common practice, I guess it is possible that the financial institutions that do this have thought it through, but I do find it a little puzzling. I would be interested to see whether the practice is the subject of any self-serving protective provisions in the financial institution documents.

In the situation where the employer pays first, using its check, and then is reimbursed from the trust, you would have a clear PTE 80-26 loan, and there would also be no risk that the funds would be lost in a bankruptcy.

[Peter Gulia]

RBG and others in this conversation, I hope you can answer a point of my curiosity:

 

When a plan’s fiduciary is reluctant to open a separate bank account for the plan’s trust, does that happen because the fiduciary perceives that the employer would bear the fees of the plan’s account?

 

[RatherBeGolfing]

39 minutes ago, Fiduciary Guidance Counsel said:

RBG and others in this conversation, I hope you can answer a point of my curiosity:

 

When a plan’s fiduciary is reluctant to open a separate bank account for the plan’s trust, does that happen because the fiduciary perceives that the employer would bear the fees of the plan’s account?

 

No, its more along the lines of an unnecessary expense to the plan.  They either have to have certain balance in the account that could be invested elsewhere, or they have to pay monthly fees for an account that might not be used for several years.  

 

[Peter Gulia]

RBG, thank you for this helpful information.