What is a prohibited transaction in a retirement plan?

The idea

A retirement plan is supposed to exist for the exclusive benefit of employees and their beneficiaries. A prohibited transaction is a deal that lets the plan’s money or property benefit an insider instead. Publication 560 describes them as transactions between the plan and a disqualified person that are prohibited by law. The usual victims are small business owners who treat the plan like a private account: lending themselves plan money, buying property from the plan, or paying a relative from it.

What counts

The publication lists the general categories. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person. Any act of a fiduciary by which they deal with plan income or assets in their own interest. A fiduciary receiving consideration for their own account from any party dealing with the plan in a transaction involving plan assets. And any of these acts between the plan and a disqualified person: selling, exchanging or leasing property; lending money or extending credit; furnishing goods, services or facilities. Your own promissory note made out to the plan is also a prohibited transaction and does not count as a deductible payment.

There is an exemption. A prohibited transaction does not take place if you are a disqualified person who receives a benefit to which you are entitled as a plan participant or beneficiary, as long as the benefit is figured and paid under the same terms as for all other participants. Section 4975 and its regulations list other exemptions.

Who is a disqualified person

The list is long. It includes a fiduciary of the plan; a person providing services to the plan; an employer any of whose employees are covered by the plan; an employee organization any of whose members are covered; a direct or indirect owner of 50% or more of an employer that is a corporation, partnership or trust; a family member of those persons (spouse, ancestor, lineal descendant, or the spouse of a lineal descendant); an entity in which those owners hold 50% or more; an officer, director, 10%-or-more shareholder or highly compensated employee (earning 10% or more of the employer’s yearly wages) of certain of those persons; and a 10%-or-more partner or joint venturer. For a small business owner the practical reading is that you, your spouse, your children and parents, and your wholly owned company are all likely to be disqualified persons.

The taxes, with an example

The initial tax is 15% of the amount involved for each year (or part of a year) in the tax period. If the transaction is not corrected within the tax period, an additional tax of 100% of the amount involved is imposed. Both are payable by any disqualified person who participated (other than a fiduciary acting only as such), and if more than one person took part each can be jointly and severally liable for the entire tax. The 15% tax is paid with Form 5330.

The amount involved is the greater of the money and fair market value of property given, and the money and fair market value of property received; if services are performed, it is any excess compensation given or received. Example: an owner borrows $10,000 from the plan and the loan stays outstanding for parts of 2 years. The 15% tax is $10,000 × 15% × 2 = $3,000; if the loan is never repaid within the tax period, the 100% tax adds another $10,000. The calculator above performs this arithmetic.

Correcting it

You can avoid the 100% tax by correcting the transaction as soon as possible. Correcting means undoing it as much as you can without putting the plan in a worse financial position than if you had acted under the highest fiduciary standards. The tax period begins on the transaction date and ends on the earliest of the day the IRS mails a notice of deficiency, the day it assesses the tax, or the day the correction is completed. If the transaction is not corrected in that period, you usually have an additional 90 days after the notice of deficiency to correct it, extended if the IRS grants reasonable time or you petition the Tax Court. If you correct it in the period, the IRS will abate, credit or refund the 100% tax.

Special consequences for IRAs

If an employee improperly uses a SEP IRA, such as by borrowing from it, that is a prohibited transaction and the SEP IRA no longer qualifies as an IRA. The assets are treated as distributed to the employee on the first day of the year in which the transaction occurred. The employee must include in income the fair market value of the assets at that date that exceeds any cost basis, and may owe the additional tax for early withdrawals. See our early withdrawal calculator for that tax, and the distribution timing page for the other withdrawal rules.

Sources

• IRS Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) (2025): Chapter 4, Prohibited Transactions (Exemption; Disqualified person); Tax on Prohibited Transactions (Amount involved; Tax period; Payment of the 15% tax; Correcting a prohibited transaction; Correction period); Chapter 2, Additional Taxes (Prohibited transaction; Effects on employee); Employer's promissory note. Read November 2, 2026.

Edition read: Publication 560 (2025), for use in preparing 2025 returns. Where the publication gives 2026 figures, this page labels them 2026. Dollar limits change every year; check the current publication and form instructions for your plan year. This page summarizes the publication and does not replace it.