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Pension plan loan was prohibited transaction.

Gideon L. Medina was the president and sole shareholder of his professional medical corporation; his wife was the corporate secretary. Both spouses participated in the corporation's qualified employees' pension plan. On Dec. 1, 1986, the taxpayers borrowed $340,000 from the plan to acquire apartments; they executed a promissory note as follows:

* Interest at 10.5% per annum, payable annually.

* Any unpaid interest added to principal.

* All principal due eight years from the date of the note (or, if sooner, on sale of the apartments).

On Aug. 15, 1991, Dr. Medina assigned one of the apartment buildings to the plan "to ensure that the loan is paid if and when" the building is sold. The taxpayers did not file Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, for 1991-1997, nor did they make any payments to the plan under the promissory note.

The taxpayers conceded that they were disqualified persons but contended that they did not participate in a prohibited transaction in 1991-1997 because the loan was treated as a taxable distribution in 1986 under Sec. 72(p).

The Tax Court, in Medina, 112 TC No. 6 (1999), held that this loan was nevertheless a prohibited transaction under Sec. 4975. Because the taxpayers did not correct the prohibited transaction (within the meaning of Sec. 4975(f)(5)), they were liable for the two tiers of excise taxes imposed by Sec. 4975(a) and (b).

The "amount involved," which is the Sec. 4975 excise tax base, was the greater of interest paid (zero) or fair market value of the use of the loan proceeds, as reflected by the 10.5% interest rate. The Tax Court decided that, in determining the amount involved as to the taxpayer's loan, the fair market interest rate was 10.5%. The Tax Court also upheld penalties for failure to file excise tax returns under Sec. 6651(a)(1).

The excise taxes and penalties (without interest) on the $340,000 loan are a staggering $1,021,670 (see Table 1, above). Of course, these excise taxes and penalties are in addition to the 1986 income tax on this loan resulting from its treatment as a taxable distribution.
Table 1: Medina excise taxes and penalties

 Excise Taxes
Year Sec. 4975(a) Sec. 4975(b)

Gideon L. Medina:
 1991 $ 2,685 $ 0
 1992 5,652 0
 1993 8,930 0
 1994 12,553 0
 1995 16,556 0
 1996 20,979 0
 1997(*) 0 468,469
Corazon P. Medina:
 1992 2,967 0
 1993 6,245 0
 1994 9,868 0
 1995 13,871 0
 1996 18,294 0
 1997(**) 0 414,769
 $118,600 $883,238

Year Penalty Total

Gideon L. Medina:
 1991 $ 671 $ 3,356
 1992 1,413 7,065
 1993 2,233 11,163
 1994 3,138 15,691
 1995 4,139 20,695
 1996 0 20,979
 1997(*) 0 468,469
Corazon P. Medina:
 1992 742 3,709
 1993 1,561 7,806
 1994 2,467 12,335
 1995 3,468 17,339
 1996 0 18,294
 1997(**) 0 414,769
 $19,832 $1,021,670

(*) For the tax period ending June 10, 1997.

(**) For the tax period ending June 30, 1997.

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Article Details
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Title Annotation:taxation
Author:Josephs, Stuart R.
Publication:The Tax Adviser
Geographic Code:1USA
Date:May 1, 1999
Previous Article:No "insider" inurement finding reinstates charitable exemption.
Next Article:Reasonable compensation rules.

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