Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 70-82

1970-1 C.B. 134

Sec. 503

IRS Headnote

A loan to an employer-grantor by an exempt employees' trust is not a prohibited transaction where the loan is secured by a savings account passbook placed in escrow.

Full Text

Rev. Rul. 70-82

Advice has been requested whether a loan made by an exempt employees' trust to the employer-grantor under the circumstances described below is a prohibited transaction within the meaning of section 503(c)(1) of the Internal Revenue Code of 1954 (redesignated as section 503(b)(1) by the Tax Reform Act of 1969, Public Law 91-172 C.B. 1969-3, 10).

An exempt employees' trust made a loan of 15x dollars to the employer-grantor. The loan is evidenced by a promissory note in the amount of 15x dollars, bearing interest at a reasonable rate, and is payable at the end of one year. Under an arrangement with a savings bank and an escrow agent, an officer of the employer-corporation placed his savings account passbook in escrow as security for repayment of the loan. The balance in the savings account is more than 20x dollars. The escrow agreement provides that if the note is not paid within the one year period, the escrow agent shall present the passbook to the bank with evidence of default on the note and effectuate payment, out of the savings account funds, of all sums due under the note, plus the costs of collection. The agreement further provides that, if the note is paid, the escrow agent shall present the passbook to the bank with evidence of payment of the note and effectuate the release of the funds in the savings account.

Under the banking laws of the jurisdiction, a third party has the right to withdraw funds from a savings account if he has the passbook in his possession and an enforceable assignment permitting him to withdraw such funds.

Section 503(c)(1) of the Code defines the term "prohibited transaction" to mean, among other things, any transaction in which a qualified employees' trust lends any part of its income or corpus, without the receipt of adequate security and a reasonable rate of interest to the employer-grantor of the trust.

Section 1.503(c)-1(b)(1) of the Income Tax Regulations defines the term "adequate security" as something in addition to and supporting a promise to pay, which is so pledged to the organization that it may be sold, foreclosed upon, or otherwise disposed of in default of repayment of the loan, the value and liquidity of which security is such that it may reasonably be anticipated that loss of principal or interest will not result from the loan.

In this case, the pledge of the savings account funds, as evidenced by the delivery of the savings account passbook to the escrow agent and the execution of the escrow agreement, is something in addition to and supporting the promise to pay, within the meaning of section 1.503(c)-1(b)(1) of the regulations. Furthermore, possession of the passbook and the escrow agreement between the corporation officer, the savings bank, and the escrow agent invests the escrow agent with the necessary powers under the banking laws of the jurisdiction to withdraw funds from the savings account in the event of default on the note. In addition, the funds in the savings account are sufficient to cover the loan principal and interest, plus any reasonable costs of collection, in the event of default on the loan.

Accordingly, it is held that the transaction in this case was not a prohibited transaction under section 503(c)(1) of the Code.