QRP, Solo 401k, SDIRA & HSA Prohibited Transactions

“Prohibited Transaction Rules” apply to all self-directed retirement accounts, including SDIRAs, Solo 401K, DB PlansQRPs, & HSA accounts. Your awareness of them is crucial to Checkbook Control investing success and compliance, when investing in real estate, cryptocurrency, syndications, hard money loans, merchant cash advance, litigation finance, pre-settlement funding, structured settlements, private equity and other and alternative investment opportunities.

The Prohibited Transaction Rules are outlined in Section 4975 of the Tax Code, titled “Tax on Prohibited Transactions,” and the IRS provides compliance information about them on its website. Read on for key info about the Prohibited Transaction Rules.

What Are the Prohibited Transaction Rules About?

  • The Prohibited Transaction Rules do not address what asset classes or investments are permitted to retirement plans, as nearly every type of investment is allowed. For detailed info about permitted investment types, click here.
  • The Prohibited Transaction Rules do address with whom retirement plans may transact.
  • The Prohibited Transaction Rules do determine the tax implications for self-directed retirement plans transacting with certain disqualified persons, described below.

The application of the Prohibited Transaction Rules is straightforward in the majority of scenarios. More complex transactions may require analysis by a qualified tax practitioner that is knowledgeable about this highly specialized area of tax law.

Prohibited Transaction Basics

A prohibited transaction is comprised of 3 elements, (1) a plan, (2) a disqualified person, and (3) a transaction between those two. Each of the 3 elements are defined in Section 4975 of the Tax Code, as summarized below.

“Prohibited transactions” may result from dealings between a retirement plan and any of the below disqualified persons.

  • The account-holder
  • A plan service provider
  • an employer whose employees are covered by the plan
  • family members of any of the foregoing, which includes
    – spouses
    – parents and grandparents (but not their spouses)
    – lineal descendants and their spouses
  • any entity in which combined ownership by any of the foregoing persons is 50% or more – a disqualified entity
  • an officer, director, or highly compensated employee of a disqualified entity
  • a 10% or more partner or shareholder in a disqualified entity

Transactions listed below, if engaged in by a retirement plan and a disqualified person, may result in a “prohibited transaction.”

  • any direct or indirect sale, exchange, or leasing of any property
  • any direct or indirect lending of money or other extension of credit
  • any direct or indirect transfer to or use of plan assets
  • any direct or indirect furnishing of goods, services, or facilities
  • any direct or indirect account-holder dealing with plan assets in his own interest (self-dealing)
  • any direct or indirect receipt of payment by the account-holder in connection with the plan

The prohibited transaction rules apply to the plans listed below and their disqualified persons.

  • 401k plans
  • Defined benefit plans
  • Profit-sharing plans
  • Keogh Plans
  • IRAs
  • Individual Retirement Annuities
  • Archer MSA
  • Health Savings Accounts (HSAs)
  • Coverdell education savings accounts (Coverdell IRA)

Consequences of a Prohibited Transaction

Checkbook Control 401k and Defined Benefit Plans

For Solo 401(k)s and Self-directed Defined Benefit Plans, the tax treatment is the same regardless of which disqualified person engaged in the transaction, as follows:

  • An initial tax of 15% of the amount involved in the prohibited transaction
  • If the prohibited transaction is not corrected within the taxable period, an additional tax of 100% of the amount involved in the transaction may be applied

Checkbook Control IRAs

The effect of a prohibited transaction on a Checkbook Control IRA-LLC depends on which disqualified person engaged in the transaction, as summarized below:

If the account-holder or account-beneficiary engage in a prohibited transaction, the IRA loses its status as a tax favored account as of the beginning of the taxable year in which the transaction took place and results in the following:

  • The fair market value of the entire IRA is considered to have been distributed to the account-holder as of the first day of the taxable year
  • The amount deemed distributed will be included in gross taxable income of the account-holder in accordance with rules governing traditional and Roth IRAs
  • A 10% penalty may be applied to amounts deemed distributed, in accordance with the early withdrawal penalties applicable to traditional and Roth IRAs
  • All such taxes will be reportable on the income tax return of the account-holder for the tax year in which the IRA was deemed to have been distributed

If disqualified persons other than account-holders and beneficiaries engage in a prohibited transaction with the IRA – the IRA is not disqualified – and that disqualified person will have to pay taxes, as follows:

  • An initial tax of 15% of the amount involved in the prohibited transaction
  • If the prohibited transaction is not corrected within the taxable period, an additional tax of 100% of the amount involved in the transaction may be applied

Prohibited Transaction FAQs

[hrf_faqs category=’prohibited-transactions’]