In addition to establishing fiduciary duties, the Employee Retirement Income Security Act of 1974 (ERISA) also lists a number of transactions between a plan and a "party in interest" or a fiduciary that are specifically prohibited. Engaging in a nonexempt prohibited transaction not only violates ERISA, but it can also create significant tax liability. These are transactions that lawmakers believed would be most easily subject to abuse if not specifically prohibited.
Party in interest
A party in interest is almost any individual or any entity having anything to do with the plan, including fiduciaries; employees of the employer maintaining the plan; owners of the employer maintaining the plan; service providers to the plan, including recordkeepers; and generally, anyone related to any of these people or entities.
Party in interest transactions
Under the prohibited transactions rules, a fiduciary is prohibited from causing a plan to engage in a transaction if the fiduciary knows or should know that the transaction constitutes a direct or indirect:
- Sale or exchange, or leasing, of any property between the plan and a party in interest
- Lending of money or other extension of credit between the plan and a party in interest
- Furnishing of goods, services, or facilities between the plan and a party in interest
- Transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan
- Acquisition, on behalf of the plan, of any employer security or employer real property in violation of ERISA
In addition, the prohibited transaction provisions prohibit a fiduciary from:
- Dealing with the assets of the plan in his/her own interest or for change to his/her own account
- Acting in his/her individual account, or in any other capacity, acting in any transaction involving the plan on behalf of a party (or representing a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries
- Receiving any consideration for his/her own personal account from any party dealing with the plan in connection with a transaction involving the assets of the plan
Prohibited transaction exemptions
ERISA's prohibited transaction rules are so broad that, in the absence of extensive exemptions, many necessary plan operations would likely be impossible. In acknowledgment of this, lawmakers created exemptions, referred to as "statutory exemptions."
In addition, the DOL has created and continues to create generally applicable exemptions, referred to as "class exemptions," which cover a broad type of transaction affecting more than a single plan or sponsor, as well as specific exemptions for individuals and entities available upon request, referred to as "individual exemptions."
- Statutory exemptions. ERISA itself lists many exemptions to the prohibited transaction rules. For example, the statutory exemptions include an exemption for participant loans to active employees, contracting for services with recordkeepers, and providing plan benefits to fiduciaries who are also participants. Generally, the statutory exemptions require that the transaction meet several conditions (e.g., in the case of investment advice, the requirements of ERISA Section 408(g) must be met) before it will fit within the exemption. A failure to meet any of these will cause the transaction to be a prohibited transaction. Participant loans to employees, for example, must meet all of the statutory exemption provisions or they will be prohibited transactions under ERISA.
- Class exemptions. There are several class exemptions, which are authorized by ERISA and granted by the DOL. The class exemptions include an exemption for failure to timely remit participant contributions to the plan, where the contributions are voluntarily restored and the other conditions of the exemption are satisfied. The class exemptions are available here
- Individual exemptions. Like the class exemptions, the individual exemptions are authorized by ERISA and granted by the DOL. Individual exemptions are numerous, driven by individual circumstances and concerns, and must be applied for by a plan sponsor (or its authorized representative).
- Penalties. Non-exempt retirement plan prohibited transactions can result not only in ERISA liability but also in the assessment of excise taxes under the Code. The Code's rules are not identical to ERISA's rules. Therefore, it is possible for a transaction to be a prohibited transaction under ERISA but not under the Code. Both sets of rules should be consulted if there is any concern that a transaction might be prohibited under either statute.
- Liability under ERISA. ERISA requires a full, prompt correction of prohibited transactions. Generally, this means that the plan must be made whole, and the party involved must disgorge any profits resulting from the transaction.
- Liability under the Code. The Code imposes a 15% excise tax on "disqualified persons" in connection with qualified plan prohibited transactions, but 403(b) plans are exempt from the tax. A disqualified person under the Code is similar to a party in interest under ERISA, although not identical. The amount subject to the tax is the amount involved in the transaction, and the tax can increase rapidly if the transaction is not promptly and appropriately addressed. An individual liable for this tax would use an IRS Form 5330 to report the liability and pay the tax.
Source: DOL Class Exemption