Indirect church-employer loans violate retirement account rules

Plain-English summary

Chief Counsel considered whether the rule barring loans from a church section 403(b)(9) retirement income account to the employer applies to indirect as well as direct loans. In one situation, participants invested in an LLC whose primary function was lending to the church. In the other, participants invested in an LLC controlled by the church, which then lent money to the church. Both arrangements gave the church substantially similar access to retirement-account assets as a direct loan would. Chief Counsel concluded that both violated the exclusive-benefit requirement and caused the plan to fail the requirements for a section 403(b)(9) retirement income account.

Ruling snapshot

• Question: Does the prohibition on employer loans from a section 403(b)(9) retirement income account cover indirect loans through LLCs?
• Outcome: advice given
• Key authorities: IRC §§ 403(b)(9), 3121(w)(3), 414(e)(3)(A); Treas. Reg. §§ 1.403(b)-2, 1.403(b)-9(a)(2), 1.403(b)-11(c)(2)

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           memorandum
           Number: 201742022
           Release Date: 10/20/2017
           CC:TEGE:EB:QP4
           PRENO-128303-17

 UILC:     403.04-05

  date:    September 22, 2017

     to:   David Conrad, CC:TEGEDC

  from:    Stephen B. Tackney
           Deputy Associate Chief Counsel, (Employee Benefits)
           (Tax Exempt & Government Entities)

subject:   Application of rule prohibiting loans to the employer from a § 403(b)(9) retirement
           income account

           This Chief Counsel Advice responds to your request for assistance. This advice may
           not be used or cited as precedent.

           ISSUE

           You have asked whether the rule prohibiting loans from a § 403(b)(9) retirement income
           account of a participant to the participant’s employer under the exclusive benefit
           requirement of § 1.403(b)-9(a)(2)(i)(C) applies only to loans that are made directly from
           the retirement income account assets to the employer, or to all loans of retirement
           income account assets to the employer, including indirect loans.

           FACTS

           In order to address your question, we will analyze the following situations.

           For both situations, assume the employer (Church) is a church under § 3121(w)(3)(A).
           Church maintains a § 403(b)(9) retirement income account plan (the Plan) for its
           employees. The Plan satisfies the separate accounting requirement of
           § 1.403(b)-9(a)(2)(i)(A), the investment performance requirement of
           § 1.403(b)-9(a)(2)(i)(B), and the written plan requirement of § 1.403(b)-9(a)(2)(ii) (these
           requirements are described below in the Law section).

           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

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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.

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.

CONCLUSION

Situation 1. A Plan participant’s investment in shares in LLC 1 violates the rule under
§ 1.403(b)-9(a)(2)(i)(C) prohibiting any loan or other extension of credit from assets in
the Plan to Church because it is an indirect loan from the Plan to Church. Accordingly,
the Plan fails to meet the requirements for being a § 403(b)(9) retirement income
account plan.

Situation 2. A Plan participant’s investment in shares in LLC 2 violates the rule under
§ 1.403(b)-9(a)(2)(i)(C) prohibiting any loan or other extension of credit from assets in
the Plan to Church because it is an indirect loan from the Plan to Church. Accordingly,
the Plan fails to meet the requirements for being a § 403(b)(9) retirement income
account plan.

LAW

Section 403(b)(9)(B) defines a “retirement income account” as a defined contribution
program established or maintained by a church or a convention or association of
churches, including an organization described in § 414(e)(3)(A), to provide benefits
under § 403(b) for an employee or his beneficiaries.

Section 1.403(b)-2(b)(15) defines a “retirement income account” as a defined
contribution program established or maintained by a church-related organization to
provide benefits for its employees or their beneficiaries.

Section 1.403(b)-2(b)(6) defines a “church-related organization” as a church or a
convention or association of churches, including a church retirement board described in
§ 414(e)(3)(A). Section 1.403(b)-2(b)(5) defines a “church,” for purposes of the
regulations under § 403(b), as “a church as defined in § 3121(w)(3)(A) and a qualified
church-controlled organization as defined in § 3121(w)(3)(B).”

Section 1.403(b)-9(a)(2)(i) provides three requirements for a defined contribution
program established or maintained by a church-related organization to be a retirement
income account: (1) a separate accounting requirement described in
§ 1.403(b)-9(a)(2)(i)(A); (2) an investment performance requirement described in
§ 1.403(b)-9(a)(2)(i)(B); and (3) an exclusive benefit requirement described in

PRENO-128303-17                                        3

§ 1.403(b)-9(a)(2)(i)(C). Additionally, § 1.403(b)-9(a)(2)(ii) requires that a retirement
income account must be maintained pursuant to a written plan and the plan document
must state the intent to be a retirement income account.

The exclusive benefit requirement under § 1.403(b)-9(a)(2)(i)(C) provides that, in order
to be a § 403(b)(9) retirement income account,

    "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).”

Section 1.403(b)-11(c)(2) provided a now-expired transition rule that required
§ 403(b)(9) plans with such pre-existing loans to take "reasonable steps to eliminate the
loan or other extension of credit to the employer."

ANALYSIS

The exclusive benefit requirement of § 1.403(b)-9(a)(2)(i)(C) requires that assets cannot
be used for, or diverted to, purposes other than for the exclusive benefit of plan
participants or their beneficiaries. In addition, § 1.403(b)-9(a)(2)(i)(C) explicitly provides
that a loan or other extension of credit from assets in a participant’s retirement income
account to the employer is treated as a diversion of assets to the employer, violating the
exclusive benefit requirement of § 1.403(b)-9(a)(2)(i)(C). The expansive scope of this
rule prohibiting loans to the employer is consistent with the transition rule in
§ 1.403(b)-11(c)(2) for sponsors of § 403(b)(9) retirement income accounts that had
loans or other extensions of credit with the employer prior to issuance of the final
regulations, which required the “eliminat[ion]” of any prior loans.

A direct loan from the plan to the employer results in a loan or other extension of credit
from assets in a participant’s retirement income account to the employer. In the case of
an indirect loan, such as is described in Situation 1 and Situation 2, an arrangement has
been structured so that the employer receives a substantially similar loan or other
extension of credit using the assets of the retirement income account as it would have
under a direct loan.1 Accordingly, for purposes of § 1.403(b)-9(a)(2)(i)(C), both direct
and indirect loans are loans or other extensions of credit from assets in a participant’s
retirement income account to the employer, which cause assets in the retirement
income account to be treated as diverted to the employer, violating the exclusive benefit
requirement of § 1.403(b)-9(a)(2)(i)(C).


1
  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.

PRENO-128303-17                             4

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).

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).

This Chief Counsel Advice does not address the tax consequences of the scenarios
discussed in this writing, except as expressly provided, including the tax consequences
of a retirement income account ceasing to be a retirement income account.

Please call Cheryl Press, Jason Levine, or Patrick Gutierrez at (202) 317-4148 if you
have any further questions.