IRAs can Trigger Plan Asset Problems under the Internal Revenue Code’s Prohibited Transactions Rule

In my last post on this topic, I discussed that hedge funds need to make sure that ownership of the fund by benefit plan investors is not significant, which is set at 25% or more of the fund’s ownership by the Department of Labor in 29 CFR 2510.3-101(f). That regulation defines benefit plan investors to include any employee benefit plan as defined by ERISA in Section 3 (29 USC § 1003) as well as any plan described in Section 4975(e)(1) of the Internal Revenue Code.

The post then concludes that without an ERISA trigger, the fund does not need to worry about the various ERISA regulations that affect plan assets, even if IRA’s make up 25% or more of the fund’s ownership.

IRC Section 4975 prohibits transactions (by taxing them) that directly or indirectly benefit a disqualified person, and not the plan. Disqualified persons include service providers of the fund, such as custodians, auditors and brokers.

Because the DOL regulations drag in the IRC and the IRC treats IRAs as plans, if IRA’s make up 25% or more of a fund’s ownership, that fund is going to want to find an exemption from the provisions of Section 4975. The fund needs an exemption, because otherwise service providers won’t do business with it.

Subsection 4975(d)(20) provides such an exemption. It states that transactions between the fund and the service provider are exempt so long as the fund receives no less, nor pays no more, than adequate consideration for the service.

Please consult a CPA, ERISA attorney or tax attorney if service providers push back at you when you disclose (in response to their questionnaire) that the fund is a plan asset for purposes of the IRC. In most instances, if you are running a small hedge fund that trades equities or options on an exchange, the service provider exemption should be sufficient.

John A. Myer is a corporate and securities lawyer with Myer Law PLLC in Seattle, Washington.   This posting does not constitute legal advice.