rr-06-38.pdf

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Part I

Section 4975.--Tax On Prohibited Transactions

26 CFR 141.4975-13: Definition of “amount involved” and “correction”.

Rev. Rul. 2006-38

ISSUE
What is the amount involved, for purposes of calculating the prohibited
transaction excise tax under § 4975 of the Internal Revenue Code, if an employer
does not timely pay elective deferrals to a qualified plan?
FACTS
Employer X
sponsors a calendar year profit-sharing plan that is qualified
under § 401(a) of the Internal Revenue Code and contains a qualified cash or
deferred arrangement described in § 401(k). Employees of Employer X are paid
on a payment date following the close of each payroll period. Pursuant to the
terms of the plan, during a specific payroll period, a portion of the pay of each
employee was withheld from his or her pay in accordance with a cash or deferred
election made by the employee. The aggregate amount withheld for all
employees for that payroll period totaled $100,000. Although Employer X could

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reasonably segregate this amount from its general assets and transmit it to the
plan on December 8, 2004, Employer X failed to do so, and did not correct the
failure until December 30, 2005.
The interest rate for underpayments under § 6621(a)(2) was 5 percent on
December 8, 2004, and on January 1, 2005.
LAW AND ANALYSIS
Section 4975(a) imposes a 15% excise tax (the first tier excise tax) on a
prohibited transaction. In addition, § 4975(b) imposes a 100% excise tax (the
second tier excise tax) on a prohibited transaction if that prohibited transaction is
not corrected during the taxable period. The tax applies to any disqualified
person who participates in the prohibited transaction (other than a fiduciary
acting only as such). Under § 4975, the applicable excise tax is applied to the
amount involved in the prohibited transaction.
1

Section 4975(c)(1)(D)
2
defines a prohibited transaction to include 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. In addition, § 4975(c)(1)(E) defines a
prohibited transaction to include any act by a disqualified person who is a
fiduciary whereby the fiduciary deals with the income or assets of a plan for his or
her own interest or for his or her own account. Section 4975(e)(2) includes in its
definition of a disqualified person an employer any of whose employees are
covered by the plan.

1
Section 102(a) of Reorganization Plan No. 4 of 1978 (43 F.R. 47713, October 17, 1978,
1979-1 C.B. 480) generally provides that the Secretary of Labor has the authority to issue
regulations interpreting § 4975(c)(1). However, the Secretary of the Treasury retains the
authority to issue rulings, etc., to the extent necessary for the continued enforcement of § 4975(a)
and (b) and § 4975(f)(4).

2
The Department of Labor has advised the Service that the failure to remit employee
contributions to an employee benefit plan may constitute a crime under 18 U.S.C. 664 which
provides, in relevant part, that anyone who unlawfully and willfully converts to his or her own use
or to the use of another, any of the moneys or funds, or other assets of any employee benefit plan
shall be subject to the fines and/or imprisonment as provided for under the provisions of title 18.
This revenue ruling does not express any opinion concerning the application of title 18 to the facts
set forth in it.

3
Section 4975(f)(4) defines the term “amount involved,” generally, as the
greater of (1) the amount of money and the fair market value of the other
property given or (2) the amount of money and the fair market value of the other
property received in such transaction. For purposes of the first tier excise tax,
the fair market value is determined as of the date on which the prohibited
transaction occurs, whereas, for purposes of the second tier excise tax, the fair
market value is the highest fair market value during the taxable period described
in § 4975(f)(2).
Section 4975(f)(2) defines the term “taxable period” as the period
beginning with the date on which the prohibited transaction occurs and ending on
the earliest of (1) the date of the mailing of a statutory notice of deficiency, (2) the
date on which the first tier excise tax is assessed, or (3) the date on which
correction of the prohibited transaction is completed.
Section 4975(f)(5) defines Acorrection@ as undoing the transaction to the
extent possible, but in any case placing the plan in a financial position not worse
than that in which it would be if the disqualified person were acting under the
highest fiduciary standards.
Section 141.4975-13 of the Temporary Pension Excise Tax Regulations
provides that, under paragraphs (4) and (5) of § 4975(f), § 53.4941(e)-1 of the
Foundation Excise Tax Regulations is controlling to the extent those regulations
describe terms appearing both in § 4941(e) and § 4975(f). The term “amount
involved” appears in both § 4941(e) and § 4975(f).
Section 53.4941(e)-1(b)(2)(ii) provides that, where the transaction involves
the use of money or other property, the amount involved is the greater of the
amount paid for such use or the fair market value of such use for the period for
which the money or other property is used and the amount involved is
determined for the entire period that the money or other property is used. In

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addition, § 53.4941(e)-1(e)(1) provides that, in the instance of a prohibited
transaction that is a loan, an additional prohibited transaction is deemed to occur
on the first day of each taxable year in the taxable period after the taxable year in
which the use occurred. Example (2) of § 53.4941(e)-1(b)(4) illustrates this
where principal and interest already have been repaid by stating that, in that
context, the amount involved is the principal times the percentage that
constitutes the fair market value of the use of money on the date of the
transaction for each year or partial year in the taxable period.
Rev. Rul. 2002-43, 2002-2 C.B. 85, addresses a prohibited transaction
that spans multiple taxable years in a taxable period where the first tier excise tax
rate changes and illustrates that where interest is not repaid in a given year, that
interest is added to the principal amount in the subsequent year.
Section 2510.3-102 of the Department of Labor regulations provides that,
for purposes of § 4975, amounts withheld from a participant’s wages for
contributions to a plan become plan assets as of the earliest date on which such
contributions can reasonably be segregated from the employer’s general assets.
However, in the case of a plan, such as a section 401(k) plan, in no event does
the date on which such contributions become plan assets occur later than the
15
th
business day of the month immediately following the month in which the
participant contributions are received by the employer (in the case of amounts
that a participant or beneficiary pays to an employer) or the 15
th
business day of
the month following the month in which such amounts would otherwise have
been payable to the participant in cash (in the case of amounts withheld by an
employer from a participant’s wages).
In the facts above, the failure to transmit the contribution until December
30, 2005, constitutes a prohibited transaction for 2004 and a prohibited
transaction for 2005 under § 4975(c)(1). Accordingly, (1) the amount involved for
the 2004 prohibited transaction is interest on $100,000 from December 8, 2004,

5
to December 31, 2004, and (2) the amount involved for the 2005 prohibited
transaction is interest on the new balance owed to the plan after increasing the
principal as a result of there not being a correction of the 2004 prohibited
transaction and is calculated from January 1, 2005, to December 30, 2005. The
taxable period for the 2004 prohibited transaction begins on December 8, 2004
and ends on December 30, 2005 (the date of the correction), and the taxable
period for the 2005 prohibited transaction begins on January 1, 2005 and ends
on December 30, 2005 (the date of the correction).
For purposes of calculating the § 4975 excise tax on a timely filed Form
5330 for a failure to transmit participant contributions or amounts that would have
otherwise been payable to the participant in cash, under the authority of § 7805,
the interest rate for underpayments described in § 6621(a)(2) on the date of the
prohibited transaction is an appropriate rate used to calculate the amount
involved. The following illustrates the application of this rate to the facts above
(and taking into account only the first tier excise tax):
Calculation of the amount involved

Date
Principal Interest Rate Time Amount involved
1. 12/8/2004 $100,000 .05 .0628415 $314
2. 1/1/2005 $100,314 .05 .9972602 $5,002

Calculation of the first tier excise tax under § 4975

Act Date of
#
Prohibited Transaction Taxable Period 2004 Taxable Year 2005 Taxable Year
1 12/8/2004 12/8/04 to 12/30/05 $314 $314
2 1/1/2005 1/1/05 to 12/30/05 ---------
$5,002
$314 $5,316
x .15
x .15
$47 $797

Accordingly, the § 4975(a) first tier excise tax totals $844 ($47 plus $797).
This revenue ruling only applies for purposes of determining the amount
involved under § 4975 where there is a failure to transmit participant

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contributions or amounts that would have otherwise been payable to the
participant in cash, and does not apply for self-dealing violations under § 4941.
HOLDING
Solely for purposes of calculating the prohibited transaction excise tax
under § 4975, the amount involved if an employer does not timely pay the
participant deferrals or contributions to a qualified plan is based on interest on
those elective deferrals.
Drafting Information
The principal author of this revenue ruling is Michael Rubin of the
Employee Plans, Tax Exempt and Government Entities Division. For further
information regarding this revenue ruling, please contact the Employee Plans’
taxpayer assistance telephone service at 877-829-5500 (a toll-free number),
between the hours of 8:30 a.m. and 4:30 p.m. Eastern Time, Monday through
Friday. Mr. Rubin can be reached at 202-283-9888 (not a toll-free number).