In Chief Counsel Advice 201742022 the IRS considered whether certain arrangements related to a church’s §403(b)(9) retirement plan amount to loans to the employer prohibited under Reg. §1.403(b)-9(a)(2)(i)(C).
Reg. §1.403(b)-9(a)(2)(i)(C)’s exclusive benefit rule provides the following requirement for a program to be considered a valid IRC §403(b)(9) retirement account:
(C) The assets held in the account cannot be used for, or diverted to, purposes other than for the exclusive benefit of plan participants or their beneficiaries (and for this purpose, assets are treated as diverted to the employer if there is a loan or other extension of credit from assets in the account to the employer).
The CCA considers two fact patterns to determine if they would create such a direct or indirect loan to the employer.
The first situation is described as follows:
Situation 1. One of the investment options offered by the Plan is an investment in shares in a limited liability company (LLC 1). LLC 1 is structured so that its primary function is to offer loans to Church, and the investment return to the Plan participants from LLC 1 is the interest paid by the Church on the loans. LLC 1 is not controlled directly or indirectly by Church.
The CCA concludes that this results in an indirect loan to the employer, noting:
In Situation 1, a participant’s investment in shares in LLC 1 would be an indirect loan to Church because LLC 1’s primary function is to make loans to Church, and LLC 1 is funded, in part, by Plan assets in the form of investments made at the direction of participants of amounts in their Plan accounts. While not a direct loan, the arrangement has been structured so that Church receives a substantially similar loan using the assets of the retirement income account as it would have under a direct loan. Such an indirect loan would violate the exclusive benefit requirement of § 1.403(b)-9(a)(2)(i)(C), and cause the Plan to no longer be treated as a retirement income account plan under § 403(b)(9).
The loan is indirect first because the employer does not control the LLC. Since the LLC’s primary function is to loan money to the employer the result is effectively the same as if the plan had directly loaned the money to the employer. That is, putting an “independent” entity between the plan and the employer did not change the result.
The second case involves an entity whose function is not primarily to loan money to the employer, but which is controlled by the employer and does make such a loan:
Situation 2. One of the investment options offered by the Plan is an investment in shares in a limited liability company (LLC 2). LLC 2 is structured so that it is controlled, either directly or indirectly, by Church. Offering loans to Church is not LLC 2’s primary function. LLC 2 makes a loan to Church.
The fact that the entity’s primary purpose is not to loan money to the employer does not protect it from the problem that the employer controls the entity. As the CCA reasons:
In Situation 2, a participant’s investment in shares in LLC 2 followed by a loan by LLC 2 to Church would also be an indirect loan to Church because LLC 2 is controlled by Church. This is true regardless of whether LLC 2 provides loans to other entities not related to Church. While not a direct loan, the arrangement has been structured so that Church may cause itself to receive a substantially similar loan using the assets of the retirement income account as it would have under a direct loan. Such an indirect loan would violate the exclusive benefit requirement of § 1.403(b)-9(a)(2)(i)(C), and cause the Plan to no longer be treated as a retirement income account plan under § 403(b)(9).
As a practical matter the CCA makes it clear that an entity offered as an investment vehicle for a participant must have a primary purpose other than loaning money to the employer and cannot be controlled by the employer for it to be possible for a loan to be made to the employer without automatically disqualifying the plan. But note that this does not mean that other facts could not still be imagined that would still create an indirect loan. For instance, as agreement by the entity to make a loan to the employer if the employer will agree to allow plan participants to invest in the entity just to name one potentially “bad fact” situation.
In a footnote, the CCA does note a situation that would not be a problem:
In contrast, if the assets of a retirement income account are invested in the publicly traded stock of a financial institution and the employer receives a loan from that financial institution, there is not an indirect loan from the retirement income account to the employer. In that case, the arrangement has not been structured to provide the employer a loan using the assets of the retirement income account substantially similar to a direct loan.