IRS Invites Comments on Excise Tax Returns (Form 5330) and Conversion Transaction Netting Rules

IRS Opens Comments on Benefit Plan Excise Taxes and Conversion Netting

The IRS is soliciting public feedback on the extension of two existing information collections under the Paperwork Reduction Act. Comments must be received by March 13, 2026, to be assured of consideration. These collections pertain to excise taxes on employee benefit plans and the netting rules for certain conversion transactions. While no changes are proposed to the forms themselves, this renewal ensures these compliance requirements remain in effect.

Form 5330: The Heavy Burden of Employee Benefit Plan Compliance

The IRS is seeking comments on the information collection associated with Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, and Form 8868, used to request an extension of time to file the 5330. This form is crucial for employers sponsoring employee benefit plans, who must navigate a complex web of rules to avoid excise tax penalties.

Form 5330 serves as the vehicle for reporting and paying excise taxes imposed by several sections of the Internal Revenue Code. These sections target various failures and violations related to employee benefit plans:

• Section 4971: This section addresses failures to meet minimum funding standards for qualified pension plans. Employers who do not contribute enough to their pension plans as required face an excise tax.
• Section 4972: This section concerns excess contributions to qualified retirement plans. Contributions exceeding the deductible limits are subject to an excise tax.
• Section 4973(a)(3): Pertains to excess contributions to Coverdell education savings accounts.
• Section 4975: This section tackles prohibited transactions between a retirement plan and a "disqualified person," such as the employer or a fiduciary. Examples of prohibited transactions include the sale of property, lending of money, or furnishing of services between the plan and a disqualified person.
• Sections 4976, 4977, 4978, 4978A, 4978B, 4979, 4979A, and 4980: These sections cover a range of other excise taxes, including those related to certain fringe benefits, sales of employer securities, and reversions of qualified plan assets to the employer.

The IRS estimates that this information collection impacts 26,460 respondents, primarily businesses and for-profit organizations sponsoring employee benefit plans. The estimated time per respondent is substantial, at 47 hours and 26 minutes, resulting in a total annual burden of 1,255,149 hours. This significant time commitment underscores the complexity of employee benefit plan compliance and the potential penalties for non-compliance.

TD 8649: Recharacterizing Gains in Conversion Transactions

The IRS is also seeking comments on information collection related to Treasury Decision 8649, which concerns the netting rule for certain conversion transactions. This rule addresses situations governed by Section 1258 of the Internal Revenue Code (IRC).

• Context: IRC Section 1258: Section 1258, often called the "anti-conversion" rule, targets financial transactions designed to convert ordinary income into capital gains. It specifically applies to "conversion transactions," defined as those where substantially all of the taxpayer's expected return is attributable to the time value of money, effectively mimicking a loan but seeking capital gains treatment. Examples include certain straddles or the acquisition of property coupled with an agreement to resell it.

Treasury Regulations Section 1.1258-1 provides a "netting rule" that allows taxpayers to offset gains and losses from different positions within the same conversion transaction. This calculation determines the amount of gain that must be recharacterized as ordinary income.

For taxpayers to take advantage of this netting relief, specific requirements must be met:

• Identification Requirement: Taxpayers must identify all positions that are part of the conversion transaction on their books and records. This identification must occur before the close of the day on which the positions become part of the conversion transaction. Failing to properly identify these positions can result in the disallowance of netting, increasing the amount of gain recharacterized as ordinary income.
• All positions must be disposed of or terminated within a 14-day period in a single taxable year.
• Built-in losses (losses that existed before the position was part of the conversion transaction) generally cannot be netted for this purpose.

Deadlines and Industry Impact

As the IRS considers these ongoing regulations and their associated burdens, several key details are relevant for practitioners:

• Submitting Comments: Interested parties are encouraged to submit comments regarding the information collections to either Andres Garcia or LaNita Van Dyke, whose contact information can be found on the relevant IRS.gov notices.
• Specific Feedback Sought: The IRS is specifically requesting feedback on:
  • The necessity of the information collection, including its practical utility.
  • The accuracy of the IRS’s burden estimates for completing Form 5330 and related requirements.
  • Methods to enhance the quality, utility, and clarity of the information collected.
  • Strategies to minimize the burden on respondents, potentially through automation or other technological solutions.
  • Estimates of capital or start-up costs and ongoing operational costs associated with providing the required information.

The continuation of these requirements surrounding Form 5330 and the recharacterization of gains under Section 1258, known as the "anti-conversion" rule (which recharacterizes capital gains from "conversion transactions" as ordinary income) represents a status quo extension, impacting two distinct groups:

• Employee Benefit Plan Sponsors ("Losers"): The compliance burden related to excise taxes on benefit plans, arising from violations of Internal Revenue Code sections such as Section 4971 (taxes on failure to meet minimum funding standards) and Section 4975 (prohibited transactions), remains significant. Form 5330 (Return of Excise Taxes Related to Employee Benefit Plans) is used to report and pay the excise taxes generated by these violations. This means continued administrative costs and potential penalties for non-compliance.
• Financial Traders Using Conversion Strategies ("Losers"): The stringent requirements for netting gains and losses in conversion transactions under Treas. Reg. § 1.1258-1 continue to necessitate careful tracking and documentation. The regulation provides a method for taxpayers to net gains and losses from positions within the same conversion transaction before determining the amount of gain to be recharacterized as ordinary income under § 1258(a). This means a higher risk of ordinary income recharacterization and increased tax liability if positions are not properly identified and managed.

The IRS's continued focus on these areas underscores the importance of meticulous compliance for both benefit plan sponsors and financial traders utilizing conversion strategies.