Checkbook QRP, self-directed Solo 401k and checkbook-control IRA investors are aware (I hope that’s true) of the Prohibited Transaction Rules and Disqualified Persons discussed in IRC 4975. So, if you’re familiar with IRC 4975 are you covered? Or, do you need to know more than that to stay in compliance and protect your assets?
The Plan Asset Rule
There’s a lesser known extension of IRC 4975 in the Code of Federal Regulations that discusses something known as the Plan Asset Rule. In a nutshell, the Plan Asset Rule says that when retirement plans own a “significant” share of an entity, all of that entity’s assets are treated as assets of the retirement plans for purposes of the prohibited transaction rules. The implications of this can be staggering; if retirement plans collectively own a significant portion of an entity, all the disqualified persons of all the retirement plan investors are disqualified persons to that entity. Furthermore, the Plan Asset Rule can have a cascading affect, because if a company falling under the Plan Asset Rule invests in another entity, that can be cause for the secondary entity to likewise be subject to the rule.
Fortunately, the regulations carve out many exceptions to the Plan Asset Rule.
Exceptions to the Plan Asset Rule
Being that I’m confident that you enjoy reading tax regulations as much I do, following is an excerpt from the regs:
“Generally, when a plan invests in another entity, the plan’s assets include its investment, but do not, solely by reason of such investment, include any of the underlying assets of the entity. However, in the case of a plan’s investment in an equity interest of an entity that is neither a publicly-offered security nor a security issued by an investment company registered under the Investment Company Act of 1940 its assets include both the equity interest and an undivided interest in each of the underlying assets of the entity, unless it is established that –
(i) The entity is an operating company, or
(ii) Equity participation in the entity by benefit plan investors is not significant.”
The bolded words highlight some of the exceptions to the rule, which include:
- Investment in a publicly offered security
- Investment in fund registered under the Investment Company Act
- Investment in an operating company, meaning a company “in the production or sale of a product or service other than the investment of capital.” The operating company exception includes what the tax regulations refer to as “venture capital operating companies” and “real estate operating companies.”
- Investment by retirement plans is not significant, representing less than 25% of ownership
When Don’t The Exceptions to the Plan Asset Rule Apply?
In the words of the regulations, “when a plan or a related group of plans owns all of the outstanding equity interests” of an entity, the exceptions don’t apply. So, if an operating company is wholly owned by retirement plans, all of its assets may be treated as assets of the retirement plans.
In most instances the Plan Asset Rule will not apply to investments of IRA-LLCs and Solo 401(k)s. Nonetheless, as an extension of the Prohibited Transaction Rules, self-directed investors must be aware of it and know when it may apply.