Prohibited transactions are transactions that are disallowed in the Solo 401k plan. The Prohibited Transaction guidelines can be found in Section 4975 of the Internal Revenue Code. Prohibited Transactions often have the same rules for Solo 401k and Self-Directed IRA plans.
While most prohibited transaction rules deal with whom the Solo 401k or IRA is prohibited from transacting with – there is a class of assets that are prohibited to purchase with retirement funds – Collectibles. Collectibles might include rugs, artwork, wine and other spirits and collectible coins.
Aside from those handful of collectible items, there aren’t many assets or asset classes that are off-limits to a retirement plan.
Far more common is the prohibited transaction about who the retirement plan can engage with in a transaction. The parties whom are “off-limits” to doing deals with the retirement plan are called Disqualified Persons.
Disqualified persons include: yourself, your spouse, your immediate family (parents, grandparents, children and grandchildren) and any related businesses. For example, your wife’s accounting firm and your son-in-law’s construction company are both disqualified and thus prohibited to transact with your Solo 401k plan.
There are three general types of prohibited transactions, including: Self-dealing transactions, conflict of interest transactions and direct/indirect prohibited transactions.
Taxes and penalties on prohibited transactions are severe, and be up to 115% of the asset in the transaction. Further, the tax is often levied on both parties involved. As with the example above, if your Solo 401k engaged your son-in-law’s construction company to complete the rehab on a property owned by the Solo 401k trust, both you and your son would potentially be liable for any taxes and penalties incurred during the prohibited transaction.
It is possible to correct a prohibited transaction should one occur. Correcting the prohibited transaction essentially means undoing the transaction without harming the plan. The plan should be made whole as much as possible and everything should continue on as if you had adhered to the highest “fiduciary standards” in the first place.