Company in severe cash-crunch is considering asking key executives to

[Guest BA Gates]

We are currently in a severe cash-crunch and are considering asking key executives to take loans of $25,000 or more from their plan accounts to reloan to the firm for 90 days at a rate of 10% which will be paid directly by the firm back into their plan accounts. First is this legal and, if so, are there tax consequences?

[MoJo]

The prohibited transaction rules say that it is a prohibited transaction for the plan and a party in interest (or disqualified person) to, either "directly or indirectly" extend credit....

[KIP KRAUS]

Let’s see now. If I was a key executive in a company and I decided to take a loan from my 401(k) plan for $25,000, and if at my discretion I decided to invest it with my employer for a return of 10% after 90 days, I think I might do that. However, if I did I would want my employer to write me a check for the principal and interest at the end of the 90-day period, and then I’d pay off my 401(k) loan. Seems like an arms length transaction to me.

I’m not sure what would prohibit me from lending my money to my employer or anyone else. Who would object?

[MoJo]

Arms length is irrelevant - it is the act that causes the prohibited transaction. the question is one of linkage - can it be traced to some action of the employer in causing the PT to occur. If it occurred as distinct transactions (ie, an exec took a loan, and then made a loan to the company) that's one thing. It's quite another for the employer to ask the execs to take 401(k) loans to loan to the company, and then to make the payments right back to the plan. If the employer merely asked the execs for a loan, and allowed the execs to decide where to get the money from, it'd probably be a different story.

[Guest mo again]

I recently ran across a case with a similar fact pattern, FIRSTIER BANK, N.A., OMAHA v. ZELLER,CA 8,17 EBC 2313, February 16, 1994, 92-3595 (U.S. Court of Appeals Eighth Circuit). In that case, I believe the court said the loans were permissible, but you would need to follow its logic in arriving at that conclusion.

[KIP KRAUS]

Mojo:

That was exactly my point. There's more than one way to skin a cat.

[MoJo]

Oh most certainly it can be done (and is done many times); however, usually one doesn't advertise it, and to the extent there is any employer "pressure" to do this, I would think the execs would have a clear case under ERISA if (or when) the employer defaults on those loans.....

[david rigby]

And of what value would that "clear case" be? If the ER is defaulting on the loan(s), then the ER is probably defaulting on everything else and is bankrupt. Not much for the employee to go after.

Might be a case where the exec should review their resume.

[MoJo]

Jail time for revenge. Misuse of employee benefit money is a federal felony (Leavenworth). The DOL is always looking for examples.....

[Kirk Maldonado]

I seem to recall that there is a subsequent court decision that concludes, contary to the decision in Firstier Bank, N.a., Omaha V. Zeller, that there is no prohibited transaction in these circumstances.

[Guest mo again]

Actually, Kirk, although I may have read it or remembered it incorrectly, I believe that the disposition of FIRSTIER BANK, N.A., OMAHA v. ZELLER was that there was no PT.

[Jon Chambers]

Somewhat on point, had a client once who terminated plan, distributed assets, agreed with key execs to take taxable distributions, lend proceeds to company for 60 days, company agreed to repay at end of 60 days so execs could do a rollover (this was before mandatory 20% withholding). Amazingly, the scheme worked. Another way to skin the cat.