Question:  What are the consequences of participating in a prohibited transaction?

A disqualified person who takes part in a prohibited transaction must correct the transaction and must pay an excise tax based on the amount involved in the transaction. The initial tax on a prohibited transaction is 15% of the amount involved for each year (or part of a year) in the taxable period. If the transaction is not corrected within the taxable period, an additional tax of 100% of the amount involved is imposed. Both taxes are payable by any disqualified person who participated in the transaction (other than a fiduciary acting only as such). If more than one person takes part in the transaction, each person can be jointly and severally liable for the entire tax.

The amount involved in a prohibited transaction is the greater of the following amounts:

  • the money and fair market value of any property given; and
  • the money and fair market value of any property received.

If services are performed, the amount involved is any excess compensation given or received.

The taxable period starts on the transaction date and ends on the earliest of the following days:

  • the day the IRS mails a notice of deficiency for the tax;
  • the day the IRS assesses the tax; and
  • the day the correction of the transaction is completed.

The tax is paid with Form 5330.

For additional information, see Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans).