IRC 4975: Disqualified Persons, Excise Taxes, and Exemptions

A prohibited transaction under IRC Section 4975 is any direct or indirect dealing between a tax-advantaged retirement or health account and a “disqualified person” that falls into one of the categories the statute bans. If it happens in an employer-sponsored plan, the disqualified person owes a 15 percent excise tax on the amount involved for every year the violation stays open, jumping to 100 percent if it isn’t corrected in time. If it happens in an IRA or HSA, the consequences are worse: the whole account can lose its tax-favored status and become taxable in a single year.

Which Accounts the Rule Covers

Section 4975 reaches further than most account holders expect. It applies to employer-sponsored qualified plans like 401(k)s, profit-sharing plans, and defined benefit pensions, and it applies with equal force to Traditional and Roth IRAs, SEP-IRAs, SIMPLE IRAs, Archer MSAs, health savings accounts, and Coverdell education savings accounts.¹

That last group is where problems tend to appear. A self-directed IRA holding real estate or an HSA used as an investment account is governed by the same rules that govern a large corporate pension. The dollar amounts differ; the rules don’t.

Who Counts as a Disqualified Person

A disqualified person is anyone whose relationship with the plan creates a potential conflict of interest, and the definition is drawn deliberately wide.

Fiduciaries, meaning anyone with decision-making authority over the plan or its assets, are disqualified. So is any service provider to the plan, such as an accountant, administrator, or attorney. The employer sponsoring the plan is disqualified, and so is any individual who owns 50 percent or more of that employer directly or indirectly.¹

The list keeps going. Officers, directors, 10 percent shareholders, and highly compensated employees earning at least 10 percent of the employer’s yearly wages all qualify. Partners or joint venturers holding a 10 percent or greater interest in a related entity qualify too.² With respect to their own IRA, the IRA holder is effectively a disqualified person.

Family gets swept in as well. A disqualified person’s spouse, parents, grandparents, children, grandchildren, and the spouses of children and grandchildren are all disqualified persons in their own right.¹ So is any corporation, partnership, trust, or estate that those individuals collectively own at least 50 percent of. Siblings and cousins are not on the list, but almost every other close relationship is.

What the Statute Bans

A prohibited transaction is any direct or indirect dealing between the plan and a disqualified person that falls into one of the categories below. “Indirect” carries real weight. If the economic benefit flows between the plan and someone it shouldn’t, it doesn’t matter how many entities sit in the middle.

Selling, exchanging, or leasing property between the plan and a disqualified person, even at fair market value.¹
Lending money or extending credit in either direction. A personal guarantee of a loan made to the plan counts.
Furnishing goods, services, or facilities between the plan and a disqualified person, unless a specific exemption applies.
Transferring plan income or assets to a disqualified person, or letting a disqualified person use them. This catch-all covers arrangements the other categories miss.
Fiduciary self-dealing. A fiduciary cannot make plan decisions that benefit themselves or accept compensation from a party whose interests conflict with the plan’s.¹

The Self-Directed IRA Trap

Real estate held in a self-directed IRA is where these rules most often go wrong. The IRS treats each of the following as a prohibited transaction: buying property for personal use now or in the future with IRA funds, selling your own property to the IRA, borrowing from the IRA, and using IRA assets to secure a personal loan.³

Sweat equity is the surprise. If your IRA owns a rental and you personally fix the roof, paint the walls, or manage the tenants, you have furnished services to the plan. Saving the IRA money by doing the work yourself doesn’t help. The personal labor is a benefit flowing between you and the account. The same problem shows up when a child rents the IRA-owned property, or when IRA expenses come out of a personal checking account with the plan to reimburse later. All expenses must be paid directly from the IRA, and all dealings must run through unrelated third parties.

Exemptions That Keep a Transaction Legal

Not every interaction between a plan and a disqualified person is banned. The statute recognizes several transactions that serve the plan’s interests without creating meaningful conflicts.

Participant Loans

An employer-sponsored plan such as a 401(k) can lend to a participant who is also a disqualified person, provided the loan is available to all participants on a reasonably equivalent basis, is not offered to highly compensated employees on better terms, charges a reasonable interest rate, is adequately secured, and follows the loan provisions in the plan document.² The maximum is the lesser of $50,000 or 50 percent of the vested balance, and repayment generally must occur within five years with at least quarterly payments.⁴

IRAs, SEP-IRAs, and SIMPLE IRAs cannot make participant loans at all. Any loan from these accounts is a prohibited transaction.⁴

Reasonable Services and Ordinary Benefits

A disqualified person can be paid reasonable compensation for legal, accounting, administrative, or other services the plan actually needs. If the pay exceeds fair market rates, only the excess is treated as a prohibited transaction.² A disqualified person can also receive any benefit owed to them as a plan participant, such as a normal distribution, if the benefit is calculated and paid on the same terms as for every other participant.

The Two-Tier Excise Tax for Employer Plans

When a prohibited transaction occurs in an employer-sponsored plan, the disqualified person who participated pays the tax. The plan itself does not.

The 15 Percent Annual Tax

The initial tax is 15 percent of the “amount involved” for each year or partial year within the taxable period. The amount involved is the greater of the money or fair market value of property given or received in the transaction, measured on the date it occurred.²

The 15 percent hits every year the violation stays open. An improper loan made on July 1 and left uncorrected for three full calendar years generates three separate 15 percent charges, each reported on its own Form 5330. For ongoing transactions like loans, the IRS treats the amount outstanding during each year as that year’s amount involved.⁵ The longer the violation runs, the more layers stack up.

The 100 Percent Tax

If the transaction is still uncorrected when the taxable period closes, the IRS adds a tax equal to 100 percent of the amount involved. For this second tier, the amount involved is measured at the highest fair market value during the taxable period, not just the value on the original date.² If the property appreciated while the violation was outstanding, the penalty tracks the appreciation.

What Happens to an IRA or HSA Instead

IRA and HSA owners don’t get the two-tier excise tax. They get something harsher. When an IRA owner or beneficiary engages in a prohibited transaction, the account loses its tax-advantaged status as of the first day of the tax year in which the violation occurred.⁶ The entire fair market value of the account on that date is treated as a distribution and included in the owner’s gross income. HSAs follow similar disqualification rules.⁷

The tradeoff is that once the IRA is disqualified, the Section 4975 excise tax no longer applies to that transaction.² It rarely feels like relief. If the owner is under 59½, the deemed distribution is also generally subject to the 10 percent early distribution penalty, because no exception in the tax code covers prohibited-transaction disqualifications.

Timing makes it worse. Because the account is deemed distributed on the first day of the tax year, a violation that occurs in December retroactively disqualifies the account for the whole year, and any growth during those months is included in the deemed distribution.

Correcting a Violation

For an employer-sponsored plan, correcting the transaction before the taxable period ends is the only way to avoid the 100 percent tax. Correction means undoing the transaction to the extent possible and putting the plan in a position no worse than if the disqualified person had followed the highest fiduciary standards.² In practice, that means returning property, repaying improper loans with interest, refunding excessive fees, and making the plan whole for investment gains it missed while its assets were diverted.

Even after correction, the 15 percent tax is still owed for each year the violation was outstanding. It is reported and paid on IRS Form 5330, due by the last day of the seventh month after the end of the filer’s tax year.⁵ For a calendar-year taxpayer, that means July 31.⁸

For IRA owners, correction offers far less. Once the prohibited transaction occurs, the account is disqualified retroactively, and there is no statutory mechanism to undo the disqualification and restore the IRA’s tax-exempt status.

The DOL Voluntary Fiduciary Correction Program

Fiduciaries who discover a prohibited transaction in an ERISA-covered plan may be able to use the Department of Labor’s Voluntary Fiduciary Correction Program to resolve the violation and obtain relief from certain penalties. Eligibility requires that neither the plan nor the applicant is under investigation by the DOL, IRS, or another agency in connection with the plan.⁹ The most common filing involves employers who failed to forward employee contributions or loan repayments to the plan on time.¹⁰ Approval through the VFCP can qualify the transaction for a class exemption from the excise tax.

How Long the IRS Has to Assess

The statute of limitations on the Section 4975 excise tax is three years if the prohibited transaction was disclosed on the annual Form 5500 filed for the plan, and six years if it was not.¹¹ The clock starts when the Form 5500 is filed, not when Form 5330 is filed. Failing to disclose the transaction doubles the window the IRS has to come after you, so disclosure works in your favor even when the underlying facts don’t.

1
Office of the Law Revision Counsel. 26 USC 4975 Tax on Prohibited Transactions
2
Office of the Law Revision Counsel. 26 U.S. Code 4975 – Tax on Prohibited Transactions
3
Internal Revenue Service. Retirement Topics – Prohibited Transactions
4
Internal Revenue Service. Retirement Topics – Plan Loans
5
Internal Revenue Service. Instructions for Form 5330 (Rev. December 2025)
6
Office of the Law Revision Counsel. 26 U.S. Code 408 – Individual Retirement Accounts
7
Office of the Law Revision Counsel. 26 U.S. Code 223 – Health Savings Accounts
8
Internal Revenue Service. Retirement Topics – Tax on Prohibited Transactions
9
U.S. Department of Labor Employee Benefits Security Administration. Voluntary Fiduciary Correction Program
10
Federal Register. Prohibited Transaction Exemption (PTE) 2002-51 Amendment
11
Internal Revenue Service. Statute of Limitations Processes and Procedures