IRS Section 4975: Disqualified Persons, Excise Tax, and Corrections

IRC Section 4975 prohibits certain dealings between a retirement plan and the people who control or benefit from it, and it enforces the ban with an excise tax of 15% of the transaction’s value for each year it stands, rising to 100% if the violation is not corrected in time.¹ The rules cover 401(k)s, defined benefit plans, and IRAs, but an IRA violation carries a harsher outcome: the account loses its tax-favored status entirely, treated as fully distributed on January 1 of the year the violation occurred.²

The Five Categories of Prohibited Transactions

A prohibited transaction is any direct or indirect dealing between a retirement plan and a disqualified person that falls into one of five categories. Good faith, arm’s-length pricing, and even below-market terms favorable to the plan are all irrelevant. The statute treats the conflict itself as the harm.

Sales, exchanges, and leasing of property. A plan cannot buy, sell, exchange, or lease property with a disqualified person. A business owner cannot sell a building to their own 401(k) at an appraised price. The employer cannot lease office space to its own plan. The ban extends to transferring property that carries a mortgage or lien the disqualified person placed on it.¹

Lending money or extending credit. A plan cannot lend to a disqualified person, and a disqualified person cannot lend to the plan. An IRA cannot loan money to its own owner. A 401(k) cannot loan to the sponsoring employer. Guarantees of third-party loans count as indirect credit extensions. Interest rate and collateral are beside the point. Participant loans are permitted only when they meet a specific set of conditions covered below.

Providing goods, services, or facilities. Disqualified persons generally cannot furnish goods, services, or facilities to a plan, and the plan cannot furnish them to a disqualified person. The classic violation is a disqualified person using plan-owned real estate or vehicles for personal or business purposes. A narrow exemption permits services the plan actually needs, at reasonable compensation.

Using plan assets for personal benefit. Any transfer or use of plan income or assets that benefits a disqualified person is prohibited. This is the catch-all. Paying inflated fees to a service provider who is a disqualified person, or letting a family member live rent-free in property held by a self-directed IRA, both fall here.

Fiduciary self-dealing. A fiduciary cannot use plan assets in their own interest or receive consideration from someone doing business with the plan. If an investment advisor directs plan assets to a fund that pays the advisor a referral fee, that is self-dealing even if the fund itself is a sensible investment.

Who Counts as a Disqualified Person

Section 4975 only reaches transactions with disqualified persons, and the excise tax falls on that person, not on the plan. The definition sweeps in a wide circle:

Plan fiduciaries, meaning anyone who exercises discretionary control over plan management or assets, including trustees, paid investment advisors, and plan administrators.
The sponsoring employer, along with its officers, directors, and any 10%-or-greater shareholder.
Anyone owning, directly or indirectly, 50% or more of the employer’s voting stock or total value. For partnerships, the threshold applies to 50% of capital or profits interest.¹
Service providers to the plan: attorneys, accountants, third-party administrators.
Highly compensated employees who are also officers, directors, or 10%-or-more owners and earn above the IRS threshold ($160,000 for 2026).³
Family members of a disqualified person: spouse, ancestors, lineal descendants, and spouses of lineal descendants.
Corporations, partnerships, trusts, or estates in which disqualified persons hold a 50% or greater interest.

The family and controlled-entity rules trip people up most often. A self-directed IRA that owns rental real estate cannot rent to the owner’s adult child, because lineal descendants are disqualified persons. An IRA-owned LLC cannot lend startup capital to a company controlled by the IRA owner’s parent, because both the parent and the parent’s controlled entity are disqualified.

Note who bears the tax: the disqualified person who participated, jointly and severally with any others involved. A fiduciary who is disqualified solely because of the fiduciary role is not personally liable for the 4975 excise tax, though ERISA penalties can still apply separately.

How the Excise Tax Is Calculated

The penalty is built to escalate. Whether the plan gained or lost on the transaction changes nothing about the tax.

The 15% Tier 1 Tax

The initial excise tax is 15% of the “amount involved” for each year, or partial year, in the “taxable period.” That period starts on the date of the prohibited transaction and ends on the earliest of three events: the IRS mails a notice of deficiency, the IRS assesses the tax, or the disqualified person completes the correction.¹

A transaction that stays open for three years generates three separate 15% charges. Total exposure at that point: 45% of the amount involved, and the second tier has not yet applied.

The 100% Tier 2 Tax

If the violation is not corrected within the taxable period, an additional tax of 100% of the amount involved is imposed on top of the accumulated Tier 1 charges. Before issuing the notice of deficiency that closes the taxable period, the IRS must notify the Department of Labor and give it a reasonable opportunity to pursue correction. That DOL window is often the last practical chance to unwind the transaction before the 100% penalty becomes unavoidable.

What “Amount Involved” Means

The amount involved is the base figure for both tiers. The statute defines it as the greater of the money and fair market value given, or the money and fair market value received. For a property sale, that is the higher of the property’s fair market value or the price the plan paid. Tier 1 uses the fair market value on the transaction date; Tier 2 uses the highest fair market value at any point during the taxable period.

One exception matters. When the violation involves a service provider taking excessive compensation, only the excess over reasonable compensation counts as the amount involved, not the full fee.

Why IRAs Face a Harsher Penalty

An IRA that engages in a prohibited transaction stops being an IRA as of January 1 of the year the violation occurred. The entire balance is treated as distributed on that date at fair market value.²

The consequences pile up quickly. The full balance becomes taxable income that year. If the owner is under 59½, the 10% early distribution penalty under IRC 72(t) applies on top. And since the IRA ceases to exist retroactively, any contributions made during that year lose their tax-advantaged treatment too.

The statute builds in a tradeoff. An IRA owner who triggers disqualification is generally exempt from the Section 4975 excise tax on the same transaction. The deemed distribution is the penalty; you don’t pay both. For a 45-year-old with a $500,000 IRA, though, disqualification is almost always worse than the excise tax would have been, because the whole balance hits the return with the 10% surcharge attached.

Self-directed IRAs holding real estate or private company interests are where these violations show up most. An IRA owner who personally manages a rental held by the IRA, or lets a family member use it, has disqualified the entire account.

Exemptions

Not every dealing between a plan and a disqualified person is off-limits. The statute carves out several categories, and the Department of Labor grants further relief through Prohibited Transaction Exemptions (PTEs).

Reasonable Compensation for Services

Plans need professional help. The statute lets a plan pay reasonable compensation to a disqualified person for services the plan actually needs — investment management, legal advice, recordkeeping, and the like. The compensation must reflect fair market rates. Anything above market becomes a prohibited transfer for the disqualified person’s benefit. Service providers to covered plans must make detailed written disclosures about their direct and indirect compensation, including third-party payments and revenue-sharing.

Participant Loans

Participant loans are permitted despite the general lending ban if the plan document allows them and five conditions are met:¹

Loans must be available to all participants on a reasonably equivalent basis.
Highly compensated employees cannot receive larger loans than other employees.
The loan must follow specific provisions in the plan document.
The interest rate must be reasonable.
The loan must be adequately secured.

Separate rules under IRC 72(p) cap loan amounts and repayment periods, but these five conditions are what keep the loan from being a Section 4975 violation.

Administrative Exemptions

The DOL issues PTEs when it determines a category of transactions is feasible, beneficial to participants, and protective enough. Individual exemptions apply only to the specific transaction and parties who applied; class exemptions apply broadly and require no separate application. Widely used examples include PTE 84-24 (independent insurance producer commissions on non-securities annuities)⁴ and PTE 2020-02 (investment advice fiduciaries receiving 12b-1 fees and revenue sharing, provided they meet best-interest standards).⁵ PTE 84-14, the Qualified Professional Asset Manager exemption, allows otherwise prohibited transactions when an independent qualified manager makes the decision.⁶

PTE compliance is all-or-nothing. Miss a single condition and the exemption disappears, leaving a full prohibited transaction with the excise tax attached.

The 14-Day Securities Correction

A specific exemption exists for accidental prohibited transactions involving securities and commodities. If a disqualified person discovers, or reasonably should have discovered, that a transaction would be prohibited and corrects it within 14 days, it is not treated as a prohibited transaction at all, and any excise tax already assessed is abated or refunded.

Two limits apply. This exemption does not cover transactions involving employer securities or employer real property, and it does not cover transactions the disqualified person knew or should have known were prohibited at the time. The relief is for genuinely inadvertent trades, not for deals someone entered deliberately and later reconsidered. Correction here means undoing the transaction to the extent possible, restoring any losses the plan suffered, and returning any profits made using plan assets.

Reporting and Correcting a Violation

Once a violation is identified, the Tier 1 clock is already running. Two things need to happen: report the transaction to the IRS, and fix the underlying harm to the plan.

Form 5330

The disqualified person reports the violation and pays the Tier 1 tax on IRS Form 5330. The form requires the transaction date, the parties, and the calculated amount involved.⁷ The deadline is the last day of the seventh month after the end of the disqualified person’s tax year. A six-month extension is available by filing Form 8868 before that deadline, but the extension only delays the paperwork, not the tax itself.

If the transaction remains uncorrected across multiple years, a separate Form 5330 is due for each year, with the 15% tax recalculated for that period.

What Correction Actually Requires

Correction means undoing the transaction to the extent possible and putting the plan in at least the financial position it would have occupied absent the violation. In practice:

Prohibited sale: the disqualified person repurchases the asset at the greater of the original sale price or current fair market value, plus any income the plan would have earned in the interim.
Prohibited loan: the disqualified person repays the principal plus fair-market interest for the entire time the loan was outstanding.
Prohibited use of plan assets: the disqualified person pays fair market rental value for the period of use and restores any appreciation the plan missed.

If the plan lost money, the disqualified person must make up the loss including reasonable growth the assets would have earned. Completing correction before the taxable period closes is the only way to avoid the 100% Tier 2 tax.

The DOL Voluntary Fiduciary Correction Program

The Department of Labor’s Voluntary Fiduciary Correction Program covers 19 categories of correctable transactions, including late participant contributions, below-market-rate loans to parties in interest, improper asset sales, excessive compensation, and duplicate fiduciary fees.⁸ Completing the VFCP and receiving a “no action” letter from EBSA provides conditional relief from the Section 4975 excise tax through a companion class exemption, PTE 2002-51.

Two categories, delinquent participant contributions and certain inadvertent participant loan failures, are eligible for the Self-Correction Component and can be resolved without a full application. The DOL provides an online calculator that computes lost earnings using the IRC 6621(a)(2) underpayment rate with daily compounding.⁹

When the Statute of Limitations Starts

For most excise taxes on employee benefit plans, Form 5330 starts the clock. Section 4975 works differently. The statute of limitations begins running when the plan administrator files a Form 5500 series return that adequately discloses the prohibited transaction, not when Form 5330 is filed.¹⁰

If the Form 5500 sufficiently describes the transaction so the IRS can identify its existence and nature, the IRS has three years from that filing to assess the tax. If disclosure is inadequate, the window extends to six years.¹¹ Failing to disclose a known prohibited transaction on Form 5500 not only extends the enforcement window but may itself amount to a separate reporting violation.

1
Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions
2
Internal Revenue Service. Retirement Topics – Prohibited Transactions
3
IRS. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs
4
Federal Register. Amendment to Prohibited Transaction Exemption 84-24
5
U.S. Department of Labor. New Fiduciary Advice Exemption – PTE 2020-02
6
Federal Register. Prohibited Transaction Class Exemption 84-14
7
Internal Revenue Service. Instructions for Form 5330 (Rev. December 2025)
8
U.S. Department of Labor. Fact Sheet – Voluntary Fiduciary Correction Program
9
U.S. Department of Labor. Voluntary Fiduciary Correction Program Online Calculator
10
Internal Revenue Service. Chapter 11 – Statute of Limitations
11
Internal Revenue Service. 25.6.1 Statute of Limitations Processes and Procedures