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Property transfers to qualified plans.

In Keystone Consolidated Industries, Inc., 5/25/93, the Supreme Court ruled in an 8-to-1 decision that a transfer of unencumbered property by a qualified plan sponsor to the plan in order to satisfy its funding obligation gave rise to a prohibited transaction under Sec. 4975. In doing so, the court resolved a conflict between the Fourth Circuit in Wood, 955 F2d 908 (4th Cir. 1992), rev'g 95 TC 364, and the Fifth Circuit in Keystone, 951 F2d 76 (5th Cir. 1992). In its decision, the Supreme Court laid out the following rules: * A transfer of encumbered property to a plan by a disqualified person including the sponsoring entity is always a prohibited transaction. * A transfer of unencumbered property by a plan sponsor to the plan to satisfy an obligation to the plan is also a prohibited transaction. * A transfer of unencumbered property by a plan sponsor that does not satisfy an obligation to the plan is not a prohibited transaction.

The Court reasoned that the wording of Sec. 4975(f)(3) (which provides that a "transfer of real or personal property by a disqualified person to a plan shall be treated as a sale or exchange if the property is subject to a mortgage or similar lien which the plan assumes . . .") was meant to expand the universe of transactions subject to the prohibited transaction rules, and not to limit their reach. Thus, the Court reasoned that a direct or indirect sale or exchange of property between the plan sponsor and the plan, which is prohibited under Sec. 4975(c)(1)(A), included a transfer of any property, whether encumbered or not, by the plan sponsor to the plan if it was done in satisfaction of an obligation of the plan sponsor to the plan. The Tax Court and the Fifth Circuit in the Keystone case had reached a contrary conclusion. Those courts reasoned that Sec. 4975(f)(3) was meant to limit the reach of the prohibited transaction provisions on the contribution of property in kind by the sponsor to the plan to only those properties that were encumbered by a mortgage or lien.

For plan sponsors, contributions to qualified plans to satisfy a minimum funding obligation should therefore be made in cash. In Keystone, where truck terminals and other real property were contributed to the plan to satisfy its funding obligation, the sponsor would have had to refinance the properties or sell the assets and contribute the cash to the plan. In the case of a sale, this would have created no worse an income tax result than when property is contributed in kind, since the parties in Keystone and Wood did not dispute that the contribution of property gave rise to an income taxable event to the plan sponsor. Presumably, if the assets transferred to the plan were to continue to be used by Keystone in its business, the leasing of those assets by the plan to Keystone would have given rise to another prohibited transaction under Sec. 4975(c)(1)(A). Assuming this to be true, the only apparent advantages to transferring the property in kind to the plan would appear to be that there would be no need to pay a sales commission to a realtor and no need to find a buyer on what might have been short notice.

On the flip side, the contribution of property to the plan gave rise to an immediate taxable gain to Keystone. Assuming Keystone was in a tax-paying position, a sale to a third party might have generated a better tax result while still providing Keystone with enough cash to contribute to the plan to satisfy its minimum funding requirement. This might include structuring the deal partially as an installment sale or deferring a portion of the gain by using the like-kind exchange provisions under Sec. 1031 for a portion of the sale proceeds.

As a final note, plan sponsors who relied on the Fifth Circuit decision in the Keystone case and contributed property to qualified plans may be faced with a two-tiered excise tax. The second tier (100% of the amount involved) may be avoided by correcting the transaction. If the sponsor wants to keep the property in the hands of related parties, an additional prohibited transaction may result in trying to unwind the transaction. The retransfer of the property to the plan sponsor from the plan appears to be a prohibited transaction in and of itself. The sale of the property to a related party would also presumably fall within the prohibited transaction rules because this would be an indirect sale or exchange to a disqualified person. Thus, while the Keystone case has serious implications for transactions that have already occurred, extreme care must also be taken in correcting the transaction.
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Author:Zwick, Gary A.
Publication:The Tax Adviser
Date:Aug 1, 1993
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