[4830-01-u]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 52
[EE-106-82]
RIN 1545-AE45
Loans to plan participants
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
SUMMARY: This document contains proposed Income Tax Regulations under section
72(p) of the Internal Revenue Code relating to loans made from a qualified
employer plan to plan participants or beneficiaries. Section 72(p) was added
by section 236 of the Tax Equity and Fiscal Responsibility Act of 1982, and
amended by the Technical Corrections Act of 1982, the Deficit Reduction Act of
1984, the Tax Reform Act of 1986 and the Technical and Miscellaneous Revenue
Act of 1988. These regulations provide guidance to the public with respect to
this provision, and affect any plan participant or beneficiary who receives a
loan from a qualified employer plan.
DATES: Written comments and requests for a public hearing must be received by
[INSERT DATE 90 DAYS AFTER DATE OF PUBLICATION IN THE FEDERAL REGISTER].
ADDRESSES: Send submissions to: CC:DOM:CORP:R (EE-106-82), Attention: Plan
Loans Guidance, room 5228, Internal Revenue Service, POB 7604, Ben Franklin
Station, Washington, DC 20044. In the alternative, submissions may be hand
delivered between the
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (EE-106-82), Courier's Desk,
Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC.
FOR FURTHER INFORMATION CONTACT: Vernon S. Carter, of the Office of the
Associate Chief Counsel (Employee Benefits and Exempt Organizations), IRS, at
(202) 622-6070 (not a toll free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to the Income Tax Regulations
(26 CFR Part 1) under section 72 of the Internal Revenue Code of 1986 (Code).
These amendments are proposed to conform the regulations to section 236 of the
Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), which added section
72(p) to the Code, and to the amendments to section 72(p) made by the
Technical Corrections Act of 1982, the Deficit Reduction Act of 1984, the Tax
Reform Act of 1986 and the Technical and Miscellaneous Revenue Act of 1988.
Explanation of provisions
Section 72(p) of the Code generally provides that an amount received as
a loan from a qualified employer plan by a participant or beneficiary is
treated as received as a distribution from the plan for purposes of section 72
(a deemed distribution), except to the extent certain conditions are
satisfied. For purposes of section 72, a qualified employer plan includes a
plan that qualifies under section 401 (relating to qualified trusts), 403(a)
(relating to qualified annuities) or 403(b) (relating to tax sheltered
annuities), as well as a plan (whether or not qualified) maintained by the
United States, a State or a political subdivision thereof, or an agency or
instrumentality thereof. A qualified employer plan also includes a plan which
was (or was determined to be) a qualified plan or a government plan. A loan
from a contract purchased under a qualified employer plan is also treated as a
loan from the plan. Section 72(p) also provides that an assignment or pledge
of (or an agreement to assign or pledge) any portion of a participant's or
beneficiary's interest in a qualified employer plan is to be treated as a loan
from the plan.
Under section 72(p), a loan from a qualified employer plan to a
participant or beneficiary is not treated as a distribution from the plan if
the loan satisfies certain requirements relating to the terms of the loan and
the repayment schedule, and to the extent the loan satisfies certain
limitations on the amount loaned. The proposed regulations require that the
loan be evidenced by an enforceable agreement, set forth in writing or in
another form that is approved by the Commissioner of Internal Revenue, that
includes terms that satisfy the statutory requirements. Thus, the agreement
must specify the amount of the loan, the term of the loan, and the repayment
schedule. The agreement may be set forth in more than one document.
If a loan fails to satisfy the repayment requirements or the enforceable
agreement requirement, the proposed regulations provide for the balance then
due under the loan to be treated as a distribution from the plan. This may
occur at the time the loan is made or at a later date if the loan is not
repaid in accordance with the repayment schedule. If the loan satisfies the
repayment requirements and the enforceable agreement requirement, but at the
time the loan is made the amount of the loan exceeds the statutory limitation
on the amount that is permitted to be loaned, the proposed regulations provide
that only the excess amount is a deemed distribution.
One of the repayment requirements is that the loan be repaid within five
years, unless the loan is used to acquire a dwelling unit which within a
reasonable time is used as the principal residence of the participant. The
proposed regulations provide that a principal residence has the same meaning
as under section 1034 (relating to the taxation of a sale of a residence) and
that tracing rules established under section 163(h)(3)(B) (relating to
interest deductions for indebtedness incurred with respect to the acquisition
of a principal residence) will be used to determine whether the section
72(p)(2)(B)(ii) exception to the five-year repayment requirement applies.
(Notice 88-74 (1988-2 C.B. 385), sets forth certain standards applicable under
section 163(h)(3).)
The Tax Reform Act of 1986 amended section 72(p) to require that, in
order for a loan to not be treated as a distribution, the loan must be repaid
in substantially level installments (not less frequently than quarterly) over
the term of the loan.
Section 72(p) authorizes regulations to allow exceptions from this
requirement. Pursuant to this authorization, the proposed regulations permit
loan repayments to be suspended during a leave of absence of up to one year,
if the participant's pay from the employer is insufficient to service the
debt, but only if the loan is repaid by the latest date permitted under
section 72(p)(2)(B).
If the repayment terms of a loan are not satisfied after the loan has
been made due to a failure to make a scheduled loan repayment, the proposed
regulations provide for the balance then due under the loan to be deemed to be
distributed. The proposed regulations permit a grace period, to the extent
the grace period does not extend beyond the end of the calendar quarter next
following the calendar quarter in which the repayment was scheduled to be
made.
If a loan is treated as a distribution under section 72(p), the proposed
regulations state that the amount so distributed is to be treated as a taxable
distribution, subject to the normal rules of section 72 if the participant's
interest in the plan includes after-tax contributions (or other tax basis). A
deemed distribution would also be a distribution for purposes of the 10
percent tax in section 72(t) and the excise tax on excess distributions under
section 4980A. However, a deemed distribution under section 72(p) is not
treated as an actual distribution for purposes of the qualification
requirements of section 401, the rollover and income averaging provisions of
section 402 and the distribution restrictions of section 403(b).
By contrast, if a participant's accrued benefit is reduced (offset) in
order to repay a loan, an actual distribution occurs for purposes of the
provisions in sections 401, 402 and 403(b) referred to above. Thus, for
example, a plan is prohibited from enforcing its security interest in a
participant's account balance attributable to amounts contributed pursuant to
an election under section 401(k) until a date on which distribution is
permitted under section 401(k).
The proposed regulations do not address all issues arising under section
72(p). Comments are requested on whether further guidance should be provided
on issues that are not addressed and how the issues should be resolved,
including the effect of a deemed distribution on the tax treatment of
subsequent distributions from the plan and the application of the $50,000
limitation and the five year repayment requirement to a refinancing and to
multiple loan arrangements.
Taxpayers may rely on these proposed regulations for guidance pending
the issuance of final regulations. If, and to the extent, future guidance is
more restrictive than the guidance in these proposed regulations, the future
guidance will be applied without retroactive effect.
Special Analysis
It has been determined that this notice of proposed rulemaking is not a
significant regulatory action as defined in EO 12866. Therefore, a regulatory
assessment is not required. It also has been determined that section 553(b)
of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and,
therefore, a Regulatory Flexibility Analysis is not required. Pursuant to
section 7805(f), this notice of proposed rulemaking will be submitted to the
Chief Counsel for Advocacy of the Small Business Administration for comment on
its impact on small business.
Comments and Request for Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original and
eight (8) copies) that are submitted timely to the following address:
CC:DOM:CORP:R (EE-106-82)
Attention: Plan Loans Guidance, room 5228
Internal Revenue Service
POB 7604, Ben Franklin Station
Washington, DC 20044
All comments will be available for public inspection and copying. A public
hearing may be scheduled if requested in writing by any person that timely
submits written comments. If a public hearing is scheduled, notice of the
date, time, and place for the hearing will be published in the Federal
Register.
Drafting Information
The principal author of these proposed regulations is Vernon S. Carter,
Office of the Associate Chief Counsel (Employee Benefits and Exempt
Organizations). However, other personnel from the IRS and Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805. * * *
Par. 2. Section 1.72-17A is amended as follows:
1. Paragraphs (d)(1), (d)(2) and (d)(3) are redesignated as
paragraphs (d)(2), (d)(3) and (d)(4), respectively.
2. New paragraph (d)(1) is added to read as follows:
1.72-17A Special rules applicable to employee annuities and distributions
under deferred compensation plans to self-employed individuals and owner-
employees.
* * * * *
(d) * * * (1) The references in this paragraph (d) to section
72(m)(4) are to that section as in effect on August 13, 1982. Section
236(b)(1) of the Tax Equity and Fiscal Responsibility Act of 1982 repealed
section 72(m)(4), generally effective for assignments, pledges and loans made
after August 13, 1982, and added section 72(p). See section 72(p) and
1.72(p)-1 for rules governing the income tax treatment of certain
assignments, pledges and loans from qualified employer plans made after August
13, 1982.
Par. 3. Section 1.72(p)-1 is added to read as follows:
1.72(p)-1 Loans treated as distributions.
The following questions and answers provide guidance under section 72(p)
pertaining to loans from qualified employer plans (including government plans
and tax-sheltered annuities and employer plans that were formerly qualified).
LIST OF QUESTIONS
Q-1: In general, what does section 72(p) provide with respect to loans
from a qualified employer plan?
Q-2: What is a qualified employer plan for purposes of section 72(p)?
Q-3: What requirements must be satisfied in order for a loan to a
participant or beneficiary from a qualified employer plan not to be a deemed
distribution?
Q-4: If a loan from a qualified employer plan to a participant or
beneficiary fails to satisfy the requirements of Q&A-3 of this section, when
does a deemed distribution of an amount received occur?
Q-5: What is a principal residence for purposes of the exception in
section 72(p)(2)(B)(ii) from the requirement that a loan be repaid in five
years?
Q-6: In order to satisfy the requirements for a principal residence
plan loan, is a loan required to be secured by the dwelling unit that will
within a reasonable time be used as the principal residence of the
participant?
Q-7: What tracing rules apply in determining whether a loan qualifies
as a principal residence plan loan?
Q-8: Can a refinancing qualify as a principal residence plan loan?
Q-9: Does the level amortization requirement of section 72(p)(2)(C)
apply when a participant is on a leave of absence without pay?
Q-10: If a participant fails to make the installment payments required
under the terms of a loan that satisfied the requirements of Q&A-3 of this
section when made, when does a deemed distribution occur and what is the
amount of the deemed distribution?
Q-11: Do sections 72 and 4980A apply to a deemed distribution as if it
were an actual distribution?
Q-12: Is a deemed distribution under section 72(p) treated as an actual
distribution for purposes of the qualification requirements of section 401,
the distribution provisions of section 402, or the distribution restrictions
of section 401(k)(2)(B) or 403(b)(11)?
Q-13: How does a reduction (offset) of an account balance in order to
repay a plan loan differ from a deemed distribution?
Q-14: How is the amount includible in income as a result of a deemed
distribution under section 72(p) required to be reported?
Q-15: What withholding rules apply to plan loans?
Q-16: If a loan fails to satisfy the requirements of Q&A-3 of this
section and is a prohibited transaction under section 4975, is the deemed
distribution of the loan under section 72(p) a correction of the prohibited
transaction?
Q-17: What are the income tax consequences if an amount is transferred
from a qualified employer plan to a participant or beneficiary as a loan, but
there is an express or tacit understanding that the loan will not be repaid?
Q-18: If a qualified employer plan maintains a program to invest in
residential mortgages, are loans made pursuant to the investment program
subject to section 72(p)?
Q-19: When is the effective date of these regulations?
ASSUMPTIONS FOR EXAMPLES
The examples included in the questions and answers below are based on
the assumption that a bona fide loan is made to a participant from a qualified
defined contribution plan pursuant to an enforceable agreement (in accordance
with Q&A-3(b) of this section), with adequate security and with an interest
rate and repayment terms that are commercially reasonable. (The particular
interest rate used for illustration below is 8.75 percent compounded
annually.) In addition, unless the contrary is specified, it is assumed in
the examples that the amount of the loan does not exceed 50 percent of the
participant's nonforfeitable account balance, the participant has no other
outstanding loan (and had no prior loan) from the plan or any other plan
maintained by the participant's employer or any other person required to be
aggregated with the employer under section 414(b), (c) or (m), and the loan is
not excluded from section 72(p) as a loan made in the ordinary course of an
investment program as described in Q&A-18 of this section. No inference
should be drawn from these regulations or the examples therein that a loan
would not result in a prohibited transaction under section 4975 or would be
consistent with the fiduciary standards of Title I of the Employee Retirement
Income Security Act of 1974, as amended. See, for example, 29 CFR 2550.408b-
1 (interpreting the statutory prohibited transaction exemption for loans to
participants and beneficiaries).
QUESTIONS AND ANSWERS
Q-1: In general, what does section 72(p) provide with respect to loans
from a qualified employer plan?
A-1: (a) Loans. Under section 72(p), an amount received by a
participant or beneficiary as a loan from a qualified employer plan is treated
as having been received as a distribution from the plan (a deemed
distribution), unless the loan satisfies the requirements of Q&A-3 of this
section. For purposes of section 72(p), a loan made from a contract that has
been purchased under a qualified employer plan (including a contract that has
been distributed to the participant or beneficiary) shall be considered a loan
made under a qualified employer plan.
(b) Pledges and assignments. Under section 72(p), if a participant or
beneficiary assigns or pledges (or agrees to assign or pledge) any portion of
his or her interest in a qualified employer plan as security for a loan, the
portion of the individual's interest assigned or pledged (or subject to an
agreement to assign or pledge) is treated as a loan from the plan to the
individual, with the result that such portion is subject to the deemed
distribution rule described in paragraph (a) of this Q&A-1. For purposes of
section 72(p), any assignment or pledge of (or agreement to assign or to
pledge) by a participant or beneficiary of any portion of his or her interest
in a contract that has been purchased under a qualified employer plan
(including a contract that has been distributed) shall be considered an
assignment or pledge of (or agreement to assign or pledge) an interest in a
qualified employer plan. However, if all or a portion of a participant's or
beneficiary's interest in a qualified employer plan is pledged or assigned as
security for a loan from the plan to the participant or the beneficiary, only
the amount of the loan received by the participant or the beneficiary, not the
amount pledged or assigned, is treated as a loan.
Q-2: What is a qualified employer plan for purposes of section 72(p)?
A-2: For purposes of section 72(p), a qualified employer plan means--
(i) A plan described in section 401(a) which includes a trust
exempt from tax under section 501(a);
(ii) An annuity plan described in section 403(a);
(iii) A plan under which amounts are contributed by an
individual's employer for an annuity contract described in section 403(b);
(iv) Any plan, whether or not qualified, established and
maintained for its employees by the United States, by a State or political
subdivision thereof, or by an agency or
instrumentality of the United States, a State or a political subdivision of a
State; or
(v) Any plan which was (or was determined to be) described in
paragraph (i), (ii), (iii), or (iv) of this Q&A-2.
Q-3: What requirements must be satisfied in order for a loan to a
participant or beneficiary from a qualified employer plan not to be a deemed
distribution?
A-3: (a) In general. A loan to a participant or beneficiary from a
qualified employer plan will not be a deemed distribution to the participant
or beneficiary if the loan satisfies the repayment term requirement of section
72(p)(2)(B), the level amortization requirement of section 72(p)(2)(C), and
the enforceable agreement requirement of paragraph (b) of this Q&A-3, but only
to the extent the loan satisfies the amount limitations of section
72(p)(2)(A).
(b) Enforceable agreement requirement. A loan does not satisfy the
requirements of this paragraph unless the loan is evidenced by a legally
enforceable agreement (which may include more than one document) set forth in
writing or in such other form as may be approved by the Commissioner, and the
terms of the agreement demonstrate compliance with the requirements of section
72(p)(2) and this section. Thus, the agreement must specify the amount of the
loan, the term of the loan, and the repayment schedule.
Q-4: If a loan from a qualified employer plan to a participant or
beneficiary fails to satisfy the requirements of Q&A-3 of this section, when
does a deemed distribution occur?
A-4: (a) Deemed distribution. For purposes of section 72, a
deemed distribution occurs at the first time that the requirements of Q&A-3 of
this section are not satisfied, in form or in operation, with respect to that
amount. This may occur at the time the loan is made or at a later date. If
the terms of the loan do not require repayments that satisfy the repayment
term requirement of section 72(p)(2)(B) or the level amortization requirement
of section 72(p)(2)(C), or the loan is not evidenced by an enforceable
agreement satisfying the requirements of Q&A-3(b) of this section, the entire
amount of the loan is a deemed distribution under section 72(p) at the time
the loan is made. If the loan satisfies the requirements of Q&A-3 of this
section except that the amount loaned exceeds the limitations of 72(p)(2)(A),
the amount of the loan in excess of the applicable limitation is a deemed
distribution under section 72(p) at the time the loan is made. If the loan
initially satisfies the requirements of section 72(p)(2)(A), (B) and (C) and
the enforceable agreement requirement of Q&A-3(b) of this section, but
payments are not made in accordance with the terms applicable to the loan, a
deemed distribution occurs as a result of the failure to make such payments.
See Q&A-10 of this section regarding when such a deemed distribution occurs
and the amount thereof and Q&A-11 of this section regarding the tax treatment
of a deemed distribution.
(b) Examples. The following examples illustrate the rules in
paragraph (a) of this Q&A-4 and are based upon the assumptions described in
ASSUMPTIONS FOR EXAMPLES:
Example 1. (a) A participant has a nonforfeitable account
balance of $200,000 and receives $70,000 as a loan repayable in level
quarterly installments over five years.
(b) Under section 72(p), the participant has a deemed
distribution of $20,000 (the excess of $70,000 over $50,000) at the time of
the loan, because the loan exceeds the $50,000 limit in
section 72(p)(2)(A)(i). The remaining $50,000 is not a deemed distribution.
Example 2. (a) A participant with a nonforfeitable account
balance of $30,000 borrows $20,000 as a loan repayable in level monthly
installments over five years.
(b) Because the amount of the loan is $5,000 more than 50% of the
participant's nonforfeitable account balance, the participant has a deemed
distribution of $5,000 at the time of the loan. The remaining $15,000 is not
a deemed distribution. (Note also that, if the loan is secured solely by the
participant's account balance, the loan may be a prohibited transaction under
section 4975 because the loan may not satisfy
29 CFR 2550.408b-1(f)(2)).
Example 3. (a) The nonforfeitable account balance of a
participant is $100,000 and a $50,000 loan is made to the participant
repayable in level quarterly installments over seven years. The loan is not
eligible for the section 72(p)(2)(B)(ii) exception for loans used to acquire
certain dwelling units.
(b) Because the repayment period exceeds the maximum five-year
period in section 72(p)(2)(B)(i), the participant has a deemed distribution of
$50,000 at the time the loan is made.
Example 4. (a) On August 1, 1998, a participant has a
nonforfeitable account balance of $45,000 and borrows $20,000 from a plan to
be repaid over five years in level monthly installments due at the end of each
month. After making monthly payments through July 1999, the participant fails
to make any of the payments due thereafter.
(b) As a result of the failure to satisfy the requirement that
the loan be repaid in level monthly installments, the participant has a deemed
distribution. See Q&A-10(c) Example
of this section regarding when such a deemed distribution occurs and the
amount thereof.
Q-5: What is a principal residence for purposes of the exception in
section 72(p)(2)(B)(ii) from the requirement that a loan be repaid in five
years?
A-5: Section 72(p)(2)(B)(ii) provides that the requirement in section
72(p)(2)(B)(i) that a plan loan be repaid within five years does not apply to
a loan used to acquire a dwelling unit which will within a reasonable time be
used as the principal residence of the participant (a principal residence plan
loan). For this purpose, a principal residence has the same meaning as a
principal residence under section 1034.
Q-6: In order to satisfy the requirements for a principal residence
plan loan, is a loan required to be secured by the dwelling unit that will
within a reasonable time be used as the principal residence of the
participant?
A-6: A loan is not required to be secured by the dwelling unit that
will within a reasonable time be used as the participant's principal residence
in order to satisfy the requirements for a principal residence plan loan.
Q-7: What tracing rules apply in determining whether a loan qualifies
as a principal residence plan loan?
A-7: The tracing rules established under section 163(h)(3)(B) apply in
determining whether a loan is treated as for the acquisition of a principal
residence in order to qualify as a principal residence plan loan.
Q-8: Can a refinancing qualify as a principal residence plan loan?
A-8: (a) Refinancings. In general, no. However, a loan from a
qualified employer plan used to repay a loan from a third party will qualify
as a principal residence plan loan if the plan loan qualifies as a principal
residence plan loan without regard to the loan from the third party.
(b) Example. The following example illustrates the rules in paragraph
(a) of this Q&A-8 and is based upon the assumptions described in ASSUMPTIONS
FOR EXAMPLES:
Example. (a) On July 1, 1999, a participant requests a $50,000 plan loan
to be repaid in level monthly installments over 15 years. On August 1, 1999,
the participant acquires a principal residence and pays a portion of the
purchase price with a $50,000 bank loan. On September 1, 1999, the plan loans
$50,000 to the participant, which the participant uses to pay the bank loan.
(b) Because the plan loan satisfies the requirements to qualify as a
principal residence plan loan (taking into account the tracing rules of
section 163(h)(3)(B)), such plan loan qualifies for the exception in section
72(p)(2)(B)(ii).
Q-9: Does the level amortization requirement of section 72(p)(2)(C)
apply when a participant is on a leave of absence without pay?
A-9: (a) Leave of absence. The level amortization requirement of
section 72(p)(2)(C) does not apply for a period, not longer than one year,
that a participant is on a leave of absence, either without pay from the
employer or at a rate of pay (after income and employment tax withholding)
that is less than the amount of the installment payments required under the
terms of the loan. However, the loan must be repaid by the latest date
permitted under section 72(p)(2)(B) and the installments due after the leave
ends (or, if earlier, after the first year of the leave) must not be less than
those required under the terms of the original loan.
(b) Example. The following example illustrates the rules of
paragraph (a) of this Q&A-9 and is based upon the assumptions described in
ASSUMPTIONS FOR EXAMPLES:
Example. (a) On July 1, 1997, a participant with a
nonforfeitable account balance of $80,000, borrows $40,000 to be repaid in
level monthly installments of $825 each over five years. The loan is not a
principal residence plan loan. The participant makes nine monthly payments
and commences an unpaid leave of absence that lasts for 12 months.
Thereafter, the participant resumes active employment and resumes making
repayments on the loan until the loan is repaid. The amount of each monthly
installment is increased to $1,130 in order to repay the loan by June 30,
2002.
(b) Because the loan satisfies the requirements of section
72(p)(2), the participant does not have a deemed distribution. Alternatively,
section 72(p)(2) would be satisfied if the participant continued the monthly
installments of $825 after resuming active employment and on June 30, 2002
repaid the full balance remaining due.
Q-10: If a participant fails to make the installment payments required
under the terms of a loan that satisfied the requirements of Q&A-3 of this
section when made, when does a deemed distribution occur and what is the
amount of the deemed distribution?
A-10: (a) Timing of deemed distribution. Failure to make any
installment payment when due in accordance with the terms of the loan violates
section 72(p)(2)(C) and, accordingly, results in a deemed distribution at the
time of such failure. However, the plan administrator may allow a grace
period, and section 72(p)(2)(C) will not be considered to have been violated
until the last day of the grace period. Any such grace period shall be given
effect for purposes of section 72(p)(2)(C) only to the extent it does not
continue beyond the last day of the calendar quarter following the calendar
quarter in which the required installment payment was due.
(b) Amount of deemed distribution. If a loan satisfies Q&A-3 of
this section when made, but there is a failure to pay the installment payments
required under the terms of the loan (taking into account any grace period
allowed under the preceding paragraph (a) of this Q&A-10), then the amount of
the deemed distribution equals the entire outstanding balance of the loan at
the time of such failure.
(c) Example. The following example illustrates the rules in
Q&A-10(a) and (b) of this section and is based upon the assumptions described
in ASSUMPTIONS FOR EXAMPLES:
Example. (a) On August 1, 1998, a participant has a
nonforfeitable account balance of $45,000 and borrows $20,000 from a plan to
be repaid over five years in level monthly installments due at the end of each
month. After making all monthly payments due through July 31, 1999, the
participant fails to make the payment due on August 31, 1999 or any other
monthly payments due thereafter. The plan administrator allows a three-month
grace period.
(b) As a result of the failure to satisfy the requirement that the loan
be repaid in level installments pursuant to section 72(p)(2)(C), the
participant has a deemed distribution on November 30, 1999, which is the last
day of the three-month grace period for the August 31, 1999 installment. The
amount of the deemed distribution is $17,157, which is the outstanding balance
on the loan at November 30, 1999. Alternatively, if the plan administrator
had allowed a grace period through the end of the next calendar quarter, there
would be a deemed distribution on December 31, 1999 equal to $17,282, which is
the outstanding balance of the loan at December 31, 1999.
Q-11: Do sections 72 and 4980A apply to a deemed distribution as if it
were an actual distribution?
A-11: (a) Tax Basis. If the employee's account includes after-tax
contributions or other investment in the contract under section 72(e), section
72 applies to a deemed distribution as if it were an actual distribution, with
the result that all or a portion of the deemed distribution may not be
taxable.
(b) Sections 72(t) and (m). Section 72(t) (which imposes a 10
percent tax on certain early distributions) and section 72(m)(5) (which
imposes a separate 10 percent tax on certain amounts received by a 5-percent
owner) apply to a deemed distribution under section 72(p) in the same manner
as if the deemed distribution were an actual distribution.
(c) Section 4980A. For purposes of section 4980A, a deemed
distribution under section 72(p) is taken into account in determining an
individual's excess distributions, as provided in 54.4981A-1T, Q&A a-8.
Q-12: Is a deemed distribution under section 72(p) treated as an actual
distribution for purposes of the qualification requirements of section 401,
the distribution provisions of section 402, or the distribution restrictions
of section 401(k)(2)(B) or 403(b)(11)?
A-12: No. Thus, for example, if a participant in a money purchase plan
who is an active employee has a deemed distribution under section 72(p), the
plan will not be considered to have made an in-service distribution to the
participant in violation of the qualification requirements applicable to money
purchase plans. Similarly, the deemed distribution is not eligible to be
rolled over to an eligible retirement plan and the participant is not eligible
to elect income averaging with respect to the deemed distribution. See also
1.402(c)-2, Q&A-4(d) and
1.401(k)-1(d)(6)(ii).
Q-13: How does a reduction (offset) of an account balance in order to
repay a plan loan differ from a deemed distribution?
A-13: (a) Difference between deemed distribution and plan loan offset
amount. (1) Loans to a participant from a qualified employer plan can give
rise to two types of taxable
distributions--
(i) A deemed distribution pursuant to section 72(p); and
(ii) A distribution of an offset amount.
(2) As described in Q&A-4 of this section, a deemed distribution
occurs when the requirements of Q&A-3 of this section are not satisfied,
either when the loan is made or at a later time. A deemed distribution is
treated as a distribution to the participant or beneficiary only for certain
tax purposes and is not a distribution of the accrued benefit. A distribution
of a plan loan offset amount (as defined in 1.402(c)-2, Q&A-9(b)) occurs
when, under the terms governing a plan loan, the accrued benefit of the
participant or beneficiary is reduced (offset) in order to repay the loan
(including the enforcement of the plan's security interest in the accrued
benefit). A distribution of a plan loan offset amount could occur in a
variety of circumstances, such as where the terms governing the plan loan
require that, in the event of the participant's request for a distribution, a
loan be repaid immediately or treated as in default.
(b) Plan loan offset. In the event of a plan loan offset, the
amount of the account balance that is offset against the loan is an actual
distribution for purposes of the Internal Revenue Code, not a deemed
distribution under section 72(p). Accordingly, a plan may be prohibited from
making such an offset under the provisions of section 401(a), 401(k)(2)(B) or
403(b)(11) prohibiting or limiting distributions to an active employee. See
1.402(c)-2, Q&A-9(c) Example 6.
Q-14: How is the amount includible in income as a result of a deemed
distribution under section 72(p) required to be reported?
A-14: The amount includible in income as a result of a deemed
distribution under section 72(p) is required to be reported on Form 1099-R (or
any other form prescribed by the Commissioner).
Q-15: What withholding rules apply to plan loans?
A-15: To the extent that a loan, when made, is a deemed distribution or
an account balance is reduced (offset) to repay a loan, the amount includible
in income is subject to withholding. If a deemed distribution of a loan or a
loan repayment by benefit offset results in income at a date after the date
the loan is made, withholding is required only if a transfer of cash or
property (excluding employer securities) is made to the participant or
beneficiary from the plan at the same time. See
35.3405-1(f)(4) and 31.3405(c)-1, Q&A-9 and Q&A-11 of this chapter for
further guidance on withholding rules.
Q-16: If a loan fails to satisfy the requirements of Q&A-3 of this
section and is a prohibited transaction under section 4975, is the deemed
distribution of the loan under section 72(p) a correction of the prohibited
transaction?
A-16: A deemed distribution is not a correction of a prohibited
transaction under section 4975. See 141.4975-13 and 53.4941(e)-1(c)(1) of
this chapter for guidance concerning correction of a prohibited transaction.
Q-17: What are the income tax consequences if an amount is transferred
from a qualified employer plan to a participant or beneficiary as a loan, but
there is an express or tacit understanding that the loan will not be repaid?
A-17: If there is an express or tacit understanding that the loan will
not be repaid, or, for any reason, the transaction does not create a debtor-
creditor relationship, then the amount transferred is treated as an actual
distribution from the plan for purposes of the Internal Revenue Code, and is
not treated as a loan or as a deemed distribution under section 72(p).
Q-18: If a qualified employer plan maintains a program to invest in
residential mortgages, are loans made pursuant to the investment program
subject to section 72(p)?
A-18: Residential mortgage loans made by a plan in the ordinary course
of an investment program are not subject to section 72(p) if the property
acquired with the loans is the primary security for such loans and the amount
loaned does not exceed the fair market value of the property. An investment
program exists only if the plan has established, in advance of a specific
investment under the program, that a certain percentage or amount of plan
assets will be invested in residential mortgages available to persons
purchasing the property who satisfy commercially customary financial criteria.
Loans will not be considered as made under an investment program if the loans
are only made available to, or any loan is earmarked for, any person or
persons who are participants or beneficiaries in the plan, or if such loans
mature upon a participant's termination from employment. In addition, no loan
that benefits an officer, director, or owner of the employer maintaining the
plan, or his or her beneficiaries, will be treated as made under an investment
program. No inference should be drawn that a transaction under such an
investment program is not a prohibited transaction under section 503 or 4975
or is not a violation of the applicable fiduciary standards for an employee
benefit plan, so that such a loan could be a prohibited transaction if it does
not satisfy the requirements of 29 CFR 2550.408b-1.
Q-19: When is the effective date of these regulations?
A-19: This section applies to assignments, pledges, and loans made on
or after the date that is three months after the date of publication of the
final regulations in the Federal Register.
Commissioner of Internal Revenue