4130 / What penalties typically apply if there has been a prohibited transaction?

The IRS imposes both a first tier excise tax (15 percent) and a second tier excise tax (100 percent) on a prohibited transaction. The tax is applied to the amount involved in the transaction. Here, the excise tax would be applied to the payment of the fees to the service provider. The DOL likely will be providing future guidance on how and when a penalty would be imposed on prohibited transactions arising from a failure to make the proper disclosures.

The regulations provide relief to covered service providers who, acting in good faith and applying reasonable diligence, made an error or omission in disclosing the required information. A service provider that meets these conditions can provide the correct disclosures within 30 days of its discovery without the arrangement being treated as failing to be reasonable due to failure to provide adequate disclosures.

A provider whose actions do not meet this criterion may be able to take advantage of the general 14 day correction period that applies to private foundations. Under this rule, certain prohibited transactions that are corrected within 14 days of discovery are exempt from the penalties associated with prohibited transactions. The 14 day correction period generally is only available if the transactions do not relate to self-dealing by plan fiduciaries. It should be available for violations arising from:

(1)  sale, exchange or leasing of plan assets;

(2)  lending of plan assets;

(3)  furnishing of goods, services and facilities; and

(4)  use of plan assets by a disqualified party.

A failure to adequately provide a required disclosure that is corrected within 14 days of discovery would appear to be eligible for this treatment and should not become a prohibited transaction.

The final 408(b)(2) regulations identify a process that a responsible plan fiduciary can follow when a disclosure failure has been discovered. That process, if followed, provides an exemption to a responsible plan fiduciary from the penalties of engaging in a prohibited transaction. This process does not exempt the arrangement from being a prohibited transaction.

The IRS tax qualification correction program, generally referred to as EPCRS, is not available to reduce any excise taxes such as those arising from a prohibited transaction. EPCRS is available only for correcting IRC Section 401(a) qualification failures. A prohibited transaction in and of itself is not a qualification issue.¹

The DOL provides a correction process under its VFC Program that is available to correct a breach of fiduciary duty. This correction generally provides relief to a plan fiduciary from investigation and penalties under ERISA Sections 502(l) and 502(i). This option would be available to any plan fiduciary that did not meet the exemptions from certain prohibited transactions penalties that are provided for in the final 408(b)(2) regulations.