lets say a construction company has a profit sharing plan. lets also say that this plan loans money to the clients of the construction company. the company insists that its clients COULD borrow from banks, but lending from the plan saves the client money by cutting out the middle man. i don't think the clients are parties in interest, but i am concerned that these transactions are prohibited anyway. any thoughts or suggestions?

There was an IRS ruling involving almost identical facts a number of years ago, except it involved a law firm. My recollection was that the IRS concluded it was a prohibited transaction.

Does the plan have a provision that permits loans to participants?

... and if it does, were the loan provisions followed, for example, loaning no more than $50,000 or 50% of vested balance?

the loans are not being made to participants.

A plan maintained by an employer is subject to the "exclusive benefit rule," for their employees or beneficiaries.

For the employer loaning money from the plan is violating this rule, thus compromising its qualified status.

ERISA has a similar rule for fiduciary duty to a plan in Section 404(a)(1)(A). It's known as the "exclusive purpose" rule.

I hope this is only a "what if" scenerio, and not really happening...

It is a prohibited transaction for a party in interest to deal with income or assets of a plan in his/her own interest (IRC 4975 ©(1)). Loaning money to clients would seem to be a prohibited transaction.

I agree with the last post. If this actaully occurring, it is a very serious problem.

If the customers are good credit risks and the terms are reasonable based on market conditions, these loans may be prudent investments.

But if any of these loans default, the owners could be in deep trouble and need to prove these loans were "arms length" transactions. They have the appearance of benefiting the company in a customer relations sort of way.