Grace period ends Aug. 21, 1995 for waiving penalties on property contributions to qualified retirement plans.
However, the Court did not expressly address in-kind contributions to such plans in excess of amounts necessary to reduce the sponsor's funding obligation for the year in which the contribution is made or contributions to other types of plans. (See also Tax Trends, "Sup. Ct.: Contribution of Unencumbered Property to Defined Benefit Plan Was a Sale or Exchange," TTA, Aug. 1993, at 536, and Tax Clinic, "Property Contributions to Pension Plans Are Prohibited, But What About Profit-Sharing Plans?" TTA, Oct. 1993, at 653.)
DOL's interpretation of
Supreme Court's decision
Defined benefit plans: Since in-kind contributions are credited to the plan's funding standard account, they reduce the employer's or sponsor's funding obligation to the plan. Therefore, unless a statutory or administrative exemption applies, these contributions would be prohibited transactions - even if the contribution's value exceeds the funding obligation for the plan year in which the contribution is made (since those contributions would result in credits against funding obligations that might arise in the future).
Defined contribution and welfare plans: In-kind contributions to a plan that reduce the employer's or sponsor's obligation to make a contribution measured in terms of cash amounts would be prohibited transactions (unless an exemption applies).
Example 1: A profit-sharing plan requires the employer to make annual contributions "in cash or in kind" equal to a given percentage of the employer's net profits for the year. An in-kind contribution used to reduce this obligation would constitute a prohibited transaction in the absence of an exemption; the amount of the contribution obligation is measured in terms of cash amounts (a percentage of profits), even though the plan's terms permit in-kind contributions.
Conversely, a transfer of unencumbered property to a welfare benefit plan that does not relieve the employer or sponsor of any present or future obligation to make a contribution measured in terms of cash amounts would not constitute a prohibited transaction. The same principles apply to defined contribution plans not subject to minimum funding requirements.
Example 2: A profit-sharing or stock bonus plan, by its terms, is funded solely at the discretion of the sponsoring employer and the employer is not otherwise obligated to make a contribution measured in terms of cash amounts. A contribution of unencumbered real property would not be a prohibited sale or exchange between the plan and the employer. However, if the same employer had made an enforceable promise to make a contribution measured in terms of cash amounts to the plan, a subsequent contribution of unencumbered real property made to offset such an obligation would be a prohibited sale or exchange. (See Pension and Welfare Benefits Administration (PWBA) Interpretive Bulletin 94-31, 12/28/94.)
Observation: An employer with a discretionary profit-sharing plan that intends to contribute property should do so without first establishing the amount of the contribution to be made (since that might create a prohibited transaction). On the other hand, this approach may not be advisable because it could cause nondeductible contributions (exceeding the percentage limitations) or insufficient contributions (below these limitations). Nondeductible contributions are subject to a 10% excise tax under Sec. 4972.
The Department of Labor (DOL) has the authority to interpret whether a transaction is prohibited under Sec. 4975 (pursuant to Reorganization Plan No. 4 of 1978).
IRS's conditions for waiving
penalties on such prohibited
The IRS recognizes that many employers have made contributions of unencumbered property (other than cash or its equivalent) to qualified retirement plans in satisfaction of obligations to those plans. These employers may have erroneously concluded that, because the property was not subject to a mortgage or similar lien, such contributions were not prohibited transactions.
Therefore, the Service will not impose late filing or late penalties if the conditions discussed below are met. However, interest generally will be due on any unpaid excise tax.
1. By Aug. 21, 1995, Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, is filed for each tax year in the taxable period and the employer pays the 5% excise tax on the amount involved. "ANNOUNCEMENT 95-14" should be typed on the top of Form 5330. 2. The transaction is corrected. Correction includes (but is not limited to) requiring rescission of the sale when possible. However, to avoid placing the plan in a position worse than that it would be in if rescission were not required, the amount received by the plan from the employer pursuant to rescission shall be the greatest of - the extinguished obligation; - the property's fair market value (FMV) at the time of the contribution; or - the property's FMV at the time of the rescission.
In addition to rescission, the employer must pay to the plan any net profits it realized from the diminution of the obligation exchanged for the contributed property.
Unless the Form 5330 reporting the prohibited transaction indicates that the necessary correction has taken place, the IRS will issue a deficiency notice for the second-tier 100% excise tax. This deficiency will be abated if correction is made by the end of the correction period, i.e., 90 days after the date of mailing of the deficiency notice (plus any extensions that may apply).
A prohibited transaction does not occur if a plan acquires qualifying employer securities or qualifying employer real property if
- the acquisition is for adequate consideration; - no commission is charged; and - the plan is an eligible individual account plan, or (for other plans) - the total FMV of such qualifying employer securities and real property held by the plan does not exceed 10% of the FMV of the plan's assets.
This exception does not apply to a plan benefiting an owner-employee that acquires property from the owner-employee or related parties (specified in Sec. 4975(d)).
Independent of the application of the prohibited transaction rules, plan fiduciaries must determine that accepting in-kind contributions is consistent with the Employee Retirement Income Security Act of 1974's (ERISA) general standards of fiduciary conduct. It is the DOL's view that accepting an in-kind contribution is a fiduciary act. ERISA requires that fiduciaries discharge their duties to a plan solely in the interests of the participants and beneficiaries, for the exclusive purpose of providing benefits and defraying reasonable administrative expenses, and with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. In addition, fiduciaries generally must diversify plan assets to minimize the risk of large losses.
Accordingly, the plan fiduciaries must act "prudently," "solely in the interest" of the plan's participants and beneficiaries, and with a view to the need to diversify plan assets when deciding whether to accept in-kind contributions. If accepting an in-kind contribution is not "prudent," not "solely in the interest" of the plan's participants and beneficiaries, or would result in an improper lack of diversification of plan assets, the responsible fiduciaries would be liable for any losses resulting from such a breach of fiduciary responsibility, even if such a contribution does not constitute a prohibited transaction. In this regard, a fiduciary should consider any liabilities pertaining to in-kind contributions to which the plan would be exposed as a result of accepting such contributions (PWBA Interpretive Bulletin 94-3).
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|Author:||Josephs, Stuart R.|
|Publication:||The Tax Adviser|
|Date:||May 1, 1995|
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