In general, an amount received by a participant or beneficiary as a loan from a qualified retirement plan is treated as a deemed distribution from the plan, and is taxable to the participant or beneficiary, unless certain requirements are met. In order to not be taxable, the loan must: (1) have a repayment term of no more than 5 years (except for the purchase of a primary residence); (2) have a level amortization schedule (with payments not less frequently than quarterly); (3) be evidenced by an enforceable agreement; and (4) cannot not exceed certain dollar limitations. The final and proposed regulations clarify many of these requirements.
The final regulations, generally expand upon guidance that the IRS has previously provided in the following areas:
- Cure Period . A plan may provide a "cure period" (previously referred to as a "grace period") for situations in which payments are not made on a timely basis. The cure period can extend through the end of the calendar quarter following the calendar quarter in which the installment payment was due. If the participant or beneficiary does not make the late installment payment by the end of the cure period, the entire outstanding balance of the loan plus any accrued interest is considered a deemed distribution and the outstanding balance is immediately taxable.
- Deemed Distributions . If a loan is required to be treated as a deemed distributed, such as when a participant fails to make an installment payment by end of the cure period, the unpaid amount of the loan (including accrued interest) is considered outstanding for purposes of determining the maximum permissible loan amount for any subsequent loan to a participant or beneficiary. For example, if a participant receives a $20,000 loan on January 1, 2000, to be repaid in 20 quarterly installments of $1,245 each, and as of December 31, 2000, the participant has failed to make the quarterly installment payment that was due on September 30, 2000, the outstanding loan balance ($19,179) is deemed distributed as of December 31, 2000. Should the participant attempt to obtain an additional loan from the plan, the amount that was deemed distributed will be considered for the purposes of determining the maximum permissible loan amount on the new loan.
- Use of Electronic Media . To satisfy the requirement that a loan be evidenced by a legally enforceable agreement, a loan agreement may be set forth in the form of an electronic medium under certain conditions. Specifically, the electronic medium must: (1) be reasonably accessible to the participant or the beneficiary under a system that is designed to preclude anyone other than the participant or the beneficiary from requesting a loan; (2) provide the participant or beneficiary with a reasonable opportunity to review the terms of the loan and to confirm, modify or rescind the terms of the loan before the loan is made, and (3) provide confirmation of the loan terms to the participant or beneficiary, within a reasonable period after the loan is made, through a written paper document or an electronic medium. If the confirmation is provided electronically, it must be provided in a manner that is no less understandable to the participant or beneficiary than a written paper document and it must advise the participant or beneficiary of the right to receive a written paper document at no charge. Thus, for example, if a 401(k) plan sponsor provides internet account access that allows participants to review and make changes to their 401(k) accounts, the plan sponsor could include an additional option for participants to receive a loan from their account balances, provided sufficient safeguards have been established to prevent anyone other than the participant from receiving a loan from the participant.s account, the participants have the right to revoke the loan before it is made, and the plan sponsor provides confirmation of the transaction.
- Signature Requirement . If a signature is not required for the loan to be enforceable under applicable law, the agreement need not be signed by the participant or the beneficiary to satisfy the legally enforceable agreement requirement.
- Effective Date . The final regulations apply to employer plan loans that are made on or after January 1, 2002. Plan sponsors, who grant loans prior to the effective date, must apply a reasonable, good faith interpretation of the statutory rules established for employer plan loans. Compliance with the proposed or final regulations would satisfy this requirement.
The proposed regulations, issued simultaneously with the final regulations, address issues which have not been addressed by any of its previous guidance on plan loans. The proposed regulations provide new guidance on the following areas:
- Loan Refinancing . A participant with an outstanding loan may refinance that loan, provided certain requirements are met. If the term of the replacement loan ends later than the term of the original loan, then both loans are treated as outstanding on the date of the transaction. Consequently, each loan must satisfy the requirements for plan loans and collectively the loans must satisfy the dollar limitations for plan loans. If the term of the replacement loan does not end later than the term of the original loan, the original loan is not aggregated with the replacement loan for purposes of the dollar limitations for plan loans. For example, a participant with a vested account balance that exceeds $100,000 borrows $20,000 from the plan on January 1, 2002, to be repaid in quarterly installments for a 5-year term, ending on December 31, 2006. On January 1, 2003, when the outstanding balance is $16,750, the participant refinances the loan with a new $30,000 loan from the plan to be repaid in 20 quarterly installments for a 5-year term, ending on December 31, 2007. Since the replacement loan ends after the term of the original loan, the plan must treat both loans as outstanding on January 1, 2003 to determine whether the maximum permissible loan amount has been exceeded. The combined total of the original loan and the replacement loan is $46,750, which is less than the maximum permissible loan amount. Thus, no amount of the replacement loan will be deemed distributed as a result of the refinancing transaction.
- Multiple Loans . A participant may receive more than one loan from a plan, provided each loan satisfies the requirements for plan loans, including the dollar limitations for the collective amount of loans made to the participant. However, if two or more loans have previously been made from the plan during the year, any additional loan shall be treated as a deemed distribution. For example, if a participant with a vested account balance of $50,000 receives a loan on January 1, 2002, in the amount of $20,000 to be repaid in quarterly installments for 5 years, the Participant may receive additional loans, if the plan permits multiple loans, provided the new loans combined with the original loan does not exceed 50% of the participant.s vested account balance.
- Suspension of Loans during Military Service . If a plan suspends the obligation to repay a loan made to an employee while the employee is performing uniformed services (regardless of whether it is "qualified military service" under USERRA), the suspension will not cause the loan to be a deemed distribution if the suspension exceeds one year and if the suspension causes the term of the loan to be extended. However, upon the completion of military service, the loan repayments must resume at the same intervals and in the same amount as prior to the suspension of payments. Additionally, the loan must be repaid in full by the end of the original loan term, as extended for the period of military service, which means the employee will be required to either increase the amount of loan payments after the suspension or make a balloon payment at the end of the loan term to account for the interest that has accrued during the loan suspension.
- Deemed Distributions . If a loan is deemed distributed to a participant and such loan has not been repaid, any payment thereafter from the plan to a participant shall not be treated as a qualified employer plan loan unless the loan otherwise satisfies the requirements for employer plan loans and the following conditions are met: (1) there is an arrangement between the participant, the plan, and the employer, enforceable under applicable law, under which payments will be made by payroll withholding and (2) the plan receives adequate security from the participant in addition to the participant.s accrued benefit. If the loan has not been repaid and one of these conditions no longer applies, i.e., the participant revokes the payroll withholding, the outstanding balance of the loan is considered a deemed distribution.
- Effective Date . The proposed regulations will apply to loans made on or after the first January 1 which is six months after the date the proposed regulations are finalized. Thus, the earliest date the proposed regulations would be effective is January 1, 2002, assuming the regulations are finalized by June 30, 2001.
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