Internal Revenue Code Section 4975
February 10th, 2012
When it comes to understanding the rules governing making investments through a 401(k) qualified retirement plan or Solo 401K Plan, one must first understand the intent of the IRS when it first developed the prohibited transaction rules. The IRS and the Internal Revenue Code do not describe what a 401(k) qualified plan or Solo 401K Plan can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions. The purpose of these rules is to encourage the use of 401(k) or Solo 401K Plans for accumulation of retirement savings and to prohibit those in control of their retirement funds from taking advantage of the tax benefits for their personal account.
To begin with, a transaction involving retirement funds such as an IRA or a 401(k) should not involve a “disqualified person”. The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the Solo 401K Plan participant, any ancestors or lineal descendants of the Solo 401K Plan participant, and entities in which the 401K Plan participant holds a controlling equity or management interest. The prohibited transaction rules outlined in Internal Revenue Code Section 4975 are centered around one using retirement funds in a transaction that directly involves or benefits, directly or indirectly a disqualified person. In other words, if the 401(k) or Solo 401(k) transaction does not involve a disqualified person you will very likely not run afoul to any of the IRS prohibited transaction rules under IRC 4975.
In addition to the prohibited transaction rules under Internal Revenue Code Section 4975, Internal Revenue Code Section 408 outlines a number of transactions that a 401(k) Plan may not engage in. Note – even though Section 408 specifically deals with IRAs, most 401(k) Plan documents specifically restrict 401(k) plan assets to be invested in any transaction that violates Internal Revenue Code Section 408. Firstly, a Solo 401K Plan may not purchase life insurance contracts. Seconds, a Solo 401K Plan may not purchase any collectibles, such as artwork, a metal or gem, baseball cards, stamps, etc. However, the IRS does permit a Solo 401K Plan to own certain gold coins (American Gold Eagle coins or coins at least .995 fine (99.5% pure)), one ounce silver coins minted by the Treasury Department, any coin issued under the laws of any state, a platinum coin described in 31 USCS 5112(k) ; and gold, silver, platinum or palladium bullion of a certain fineness that is in the physical possession of a financial institution.
In addition, as a result of certain restrictive shareholder restrictions imposed on “S” Corporations, an 401(k) qualified retirement cannot own stock in an S Corporation. Note – a 401(k) Plan can own stock in a “C” Corporation.