In Advisory Opinion 2011-09A, the Department of Labor (the “DOL”) provided its view on the applicability of Prohibited Transaction Exemption (“PTE”) 80-26 to certain transactions involving individual retirement accounts (“IRAs”).
The Advisory Opinion involves the following facts. The beneficial owner of an IRA (an “IRA Owner”) may direct a trust company to open a futures trading account (an “Account”) with a Broker, through which the IRA Owner may deposit and self-direct IRA assets. The Broker may require that, prior to the establishment of the Account, the IRA Owner effectuate an indemnification agreement (an “Indemnification Agreement”). This agreement secures a Broker against certain losses attributable to the Account, such as an investment-related loss and/or tax in connection with a futures contract. In some cases, the amount of this loss may exceed the amount of the IRA’s assets (an “excess loss”). In that instance, the Indemnification Agreement will require the IRA Owner to provide the Broker with cash equal to the excess loss. This Indemnification Agreement therefore constitutes an impermissible “extension of credit” from an IRA Owner to his or her IRA, in violation of section 4975(c)(1)(B) of the Internal Revenue Code (the “Code”). The issue addressed by the Advisory Opinion: Does PTE 80-26 provide relief from this prohibited transaction?
The Advisory Opinion says the following on this issue. PTE 80-26 permits parties in interest-such as an IRA Owner- with respect to employee benefit plans (including IRAs) to make certain loans and extensions of credit to such plans. Relief is available under the PTE for extensions of credit described in Code section 4975(c)(1)(B), to the extent the conditions of the PTE are met. In the latter regard, the PTE requires that, among other things, the proceeds of such a loan or extension of credit may be used only: (1) for the payment of ordinary operating expenses of the plan, or (2) for a purpose incidental to the ordinary operation of the plan.
PTE 80-26 and the preamble to the original notice of proposed exemption for PTE 80-26 provide the following examples of “ordinary operating expenses”: plan benefits, insurance premiums, and/or administrative expenses. In this case, the DOL takes the position that condition (1) is satisfied only to the extent that proceeds from an extension of credit by a party in interest to a plan are used to pay for an expense incurred by the plan in the course of an ordinary, operational plan activity. The investment performance of a futures contract entered into by an IRA is independent of, and unrelated to, any activity (ordinary or otherwise) attributable to the operation of the IRA. Therefore, an excess loss does not meet condition (1).
With respect to condition (2), PTE 80-26 and subsequent amendments thereto provide the following examples of a plan’s use of proceeds for a purpose “incidental to the ordinary operation of the plan”: bank overdrafts, the crediting of dividends or interest, plan liquidity problems and the transfer of a participant’s account balance from one account to another. The Advisory Opinion notes that these examples are consistent with the plain meaning of the term “incidental,” which is “occurring as a minor accompaniment” or “liable to occur in consequence of or in connection with something”. The DOL takes the position that the Indemnification Agreement, which is required by the Broker in order for the IRA to engage in futures trading, is not “incidental” and does not meet condition (2).
The Advisory Opinion concludes that, in light of the above, relief under PTE 80-26 is not available with respect to an Indemnification Agreement or any extension of credit made in connection with an excess loss.