Dear Ms. Buchanan,
This is in response to your request for an advisory
opinion as to whether the following proposed transaction would be
prohibited under section 4975 of the Internal Revenue Code (the “Code”),
26 U.S.C. § 4975.(1)
You represent that Salon Services and Supplies, Inc. is
a Washington state “S” Corporation (“S Company”) which is 68%
owned by Miles and Sydney Berry, a marital community (M). The other 32% is
owned by a third-party, George Learned (“G”). Miles Berry (Berry)
proposes to create a limited liability corporation (“LLC”) that will
purchase land, build a warehouse and lease the property to S Company. The
investors in the LLC would be Berry’s individual retirement account (“IRA”)
(49%), Robert Payne’s (“R”) IRA (31%) and G (20%). R is the
comptroller of S Company. R and G will manage the LLC. You represent that
S Company is a disqualified person with respect to Berry’s IRA under
section 4975(e)(2) of the Code. You represent that R and G are independent
of Berry. You also represent that the LLC does not contain plan assets
because it is a “real estate operating company” (REOC) as defined by
29 C.F.R. § 2510.3-101(e).
You state that an independent qualified commercial real
estate appraiser has appraised the rental value of the lease and has found
that the terms of the lease are not less favorable to the LLC and its IRA
investors than those obtainable in an arm’s length transaction between
unrelated parties. Finally, the custodian for Berry’s and R’s IRAs has
reviewed the LLC operating agreement and has approved the investment for
those two self-directed IRAs.
Section 4975(c)(1)(A) of the Code prohibits any direct
or indirect sale, exchange or leasing of any property between a plan and a
“disqualified person.” Section 4975(c)(1)(D) of the Code prohibits any
direct or indirect transfer to, or use by or for the benefit of, a
disqualified person of the income or assets of a plan. A “disqualified
person” is defined under section 4975(e)(2)(A) of the Code to include a
person who is a fiduciary. Code section 4975(e)(3) defines the term “fiduciary”
to include, in pertinent part, any person who exercises any discretionary
authority or discretionary control respecting management of such plan or
exercises any authority or control respecting management or disposition of
its assets. Section 4975(c)(1)(E) prohibits a fiduciary from dealing with
the income or assets of a plan in the fiduciary’s own interest or for
his or her own account. Section 4975(e)(1)(B) of the Code defines the term
“plan” to include an individual retirement account described in Code
section 408(a).
We first address the proposed lease as it relates to
Berry’s IRA. Berry is a fiduciary to his own IRA because he exercises
authority or control over its assets and management. 26 U.S.C. §
4975(e)(3). As a fiduciary, Berry is a disqualified person under section
4975(e)(2)(A) of the Code. You represent that S Company is a disqualified
person under section 4975(e)(2) of the Code. R, the comptroller of S
Company, is a disqualified person with respect to Berry’s IRA under
section 4975(e)(2)(H) as an officer of S Company. R, as an employee of S
Company, a company 68% owned by M, cannot be considered independent of
Berry.
Based upon your representations, it is the opinion of
the Department that a lease of property between the LLC and S Company
would be a prohibited transaction under Code section 4975, at least as to
Berry’s IRA. The lease constitutes a prohibited transaction regardless
of whether the LLC qualifies as a REOC under the Department’s plan
assets regulation. 29 C.F.R. § 2510.3-101.
The Department’s regulation at 29 C.F.R. §
2509.75-2(a) (Interpretative Bulletin 75-2), explains that a transaction
between a party in interest under ERISA(2)
(or disqualified person under the Code, in this case S Company) and a
corporation in which a plan has invested (i.e., the LLC) does not
generally give rise to a prohibited transaction. However, in some cases it
can give rise to a prohibited transaction. Regulation section 2509.75-2(c)
and Department opinions interpreting it have made clear that a prohibited
transaction occurs when a plan invests in a corporation as part of an
arrangement or understanding under which it is expected that the
corporation will engage in a transaction with a party in interest (or
disqualified person).(3)
According to your representations, it appears that
Berry’s IRA will invest in the LLC under an arrangement or understanding
that anticipates that the LLC will engage in a lease with S Company, a
disqualified person. Therefore, the lease would amount to a transaction
between Berry’s IRA and S Company that Code section 4975(c)(1)(A) and
(D) prohibits. Additionally, the proposed lease, if consummated, may also
constitute a violation by Berry, a fiduciary, of Code section
4975(c)(1)(D) and (E).
Finally, we note the express emphasis in 29 C.F.R. §
2509.75-2(c) that the Department considers “a fiduciary who makes or
retains an investment in a corporation or partnership for the purpose of
avoiding the application of the fiduciary responsibility provisions of the
Act to be in contravention of the provisions of section 404(a) of the Act.”
Thus, the proposed lease, which would violate section
4975(c)(1) of the Code, would also have to be referred to the Internal
Revenue Service for a determination as to whether it would consider the
transaction a violation of the exclusive benefit rule of section 401(a)(2)
of the Code, which is the Code’s analogue to the fiduciary
responsibility provisions of section 404(a) of ERISA.
Because we have concluded that the proposed lease would
constitute a prohibited transaction with respect to Berry’s IRA, the
issue of whether the Code prohibits the lease as it relates to R’s IRA
is moot, and does not need to be addressed.
This letter constitutes an advisory opinion under ERISA
Procedure 76-1, 41 Fed. Reg. 36281 (1976). Accordingly, this letter is
issued subject to the provisions of that procedure, including section 10
thereof, relating to the effect of advisory opinions.
Sincerely,
Louis J. Campagna
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations
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Under Reorganization Plan No. 4 of
1978, effective December 31, 1978 [5 U.S.C. App. at 214 (2000 ed.)],
the authority of the Secretary of the Treasury to issue
interpretations regarding section 4975 of the Code was transferred,
with certain exceptions not here relevant, to the Secretary of Labor.
As a result, citations to section 406 of the Employee Retirement
Income Security Act (ERISA), 29 U.S.C. § 1001 et seq. and applicable
regulations also refer to the parallel citations of section 4975 of
the Code.
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Section 3(14) of ERISA defines the
term “party in interest” for purposes of Title I of ERISA,
including the prohibited transaction provisions of ERISA section 406.
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See 29 C.F.R. §
2509.75-2(c); Opinion No. 75-103 (Oct. 22, 1975); 1978 WL 170764 (June
13, 1978). Further, prior to the promulgation of the Department’s
plan assets regulation, 29 C.F.R. § 2510.3-101, the Department had
issued Interpretive Bulletin 75-2 which discusses certain prohibited
transactions under section 406 of ERISA or section 4975 or the Code.
As indicated in the preamble to the plan assets regulation, part of
Interpretive Bulletin 75-2 was revised to coordinate it with the final
regulation (51 Fed. Reg. 41278). The remainder of the Interpretive
Bulletin 75-2, published at 29 C.F.R. § 2509.75-2(c), remains in
force and was not affected by the plan assets regulation. Regulation
section 2509.75-2(c) sets forth that a transaction between a party in
interest and a corporation in which a plan has invested may constitute
a prohibited transaction under certain circumstances. Such
transactions are prohibited regardless of whether or not they meet the
plan assets regulation.
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