On September 12, 2011 at 2:00 p.m. Eastern time, the IRS will sponsor a free phone forum on participant loans from qualified retirement plans. The presentation will include the treatment of loans under Internal Revenue Code Section 72(p), their taxability, the most common reasons for loan failures and how to correct them under the Employee Plans Compliance Resolution System (“EPCRS”). To register for the free phone forum, go to www.irs.gov, click on the “Retirement Plans Community” page and then click on “Retirement Plans Phone Forums” in the middle of the page.
To prevent a plan loan from being considered a taxable distribution to the plan participant, plan sponsors must ensure that their loan administration conforms to procedures contained in the plan document and the requirements of IRC Section 72(p). Generally, IRC Section 72(p) requires that qualified plans: (1) offer loans based on an enforceable loan agreement that states the terms of the loan, (2) limit the amount of the loan to the lesser of 50% of the participant’s vested account balance or $50,000 (reduced by any outstanding balance on other loans), and (3) ensure that the participant makes level amortized repayments that fully repay the loan within 5 years, unless the loan proceeds are used to purchase the participant’s principal residence.
To avoid participant loan mistakes, plan sponsors should periodically review their plan documents and loan administration procedures. Are participant loans available under the terms of the plan? Are participant being required to repay their loans within 5 years? Are the repayments being made in accordance with the loan’s terms? Has payroll been notified to begin withholding the loan repayments? Not surprisingly, many loan failures occur simply because the plan sponsor failed to initiate the repayment payroll deduction from the participant’s wages and/or the deduction was inadvertently stopped due to an administrative error or a change in payroll providers.
Subject to some limited exceptions, once a plan loan’s terms and/or its actual repayments violate Section 72(p), the loan is no longer considered exempt and is treated as a taxable distribution to the participant. Should you have any questions about your company’s loan procedures and/or any potential loan failures, please consult your relationship attorney.