SECURE Act Summary

SECURE Act Summary

On December 20, 2019 the "SECURE Act" (Setting Every Community Up for Retirement Enhancement Act of 2019) was enacted part of the Further Consolidated Appropriations Act, 2020, P.L. 116-94, H.R. 1865 (with basically the same provisions of H.R. 1994, originally passed by the House on May 23, 2019).  The SECURE Act makes significant changes to retirement savings law.  This legislation is the first significant retirement benefit legislation in more than a decade.

The following is a brief summary of the key provisions in the SECURE Act:

1.              Authorizing Multiple Employer Defined Contribution Plans

The SECURE Act expands the use of multiple employer plans ("MEPs") by allowing totally unrelated companies to use a single shared defined contribution MEP provided the third-party plan administrator is a pooled plan provider registered with the IRS and acknowledges that it is a named fiduciary of the plan.  (SECURE Act § 101 adding IRC § 413(e) and ERISA §§ 3(43) and 3(44))   The Committee Report 116-65 on an earlier version of the SECURE Act (which was substantially the same as the version passed) (May 16, 2019) (the "Committee Report") notes that this change will make MEPs more attractive by eliminating barriers to the use of MEPs and improving the quality of MEP service providers.  Under prior guidance, an open MEP used by unrelated employers even without commonality of interests or not in same industry or locality would run afoul of Department of Labor guidance.  Under the SECURE Act and IRC § 413(e)(4), the Treasury is directed to issue guidance as to how to spin of assets of a non-compliant employer into a separate plan (so as to avoid the one bad apple issue).  The new rules are effective for plan years beginning after December 31, 2020. 

2.              Increasing the Auto Enrollment Safe Harbor Cap after First Year of Enrollment

Existing rules provided that for automatic enrollment safe harbor 401(k) plans, there is a cap on the default contribution rate to 10% of an employee’s compensation.  The SECURE Act increases the automatic enrollment limit for salary deferrals under the automatic enrollment safe harbor from 10% to 15% of compensation for any year after the first year of participation. (SECURE Act § 102 amending IRC § 401(k)(13)(C)(iii))  This is effective for plan years beginning after December 31, 2019.

3.              Simplification of Safe Harbor 401(k) Rules.

The SECURE Act, with respect to non-elective safe harbor plans, i.e., 401(k) plans that provide employer contributions of 3% of each employee’s compensation regardless of whether the employees make deferrals, provides for               elimination of the annual safe harbor notice requirement, although participants must still receive an annual notice to make or change elections which is required for all 401(k) plans. However, employers that make safe harbor matching contributions will still need to give the advance notice. This change is effective for plan years beginning after December 31, 2019.  SECURE Act § 103 amending IRC § 401(k)(12).  

The SECURE Act also provides with respect to non-elective safe harbor plans an allowance of a retroactive amendment to a plan to become a non-elective safe harbor 401(k) plan at any time before the 30th day preceding the close of the plan year, and allowance of an amendment after that time if it provides for a nonelective contribution of at least 4% of compensation (rather than 3%) for all eligible employees for that plan year, if the amendment is made no later than the last day for distributing excess contributions for the plan year, that is, by the close of following plan year. SECURE Act § 103 amending IRC § 401(k)(13).  This relief does not apply to safe harbor matching contribution plans. These provisions are effective for plan years beginning after December 31, 2019. 

4.              Small Employer Credits   

Increased Credit for Small Employer Pension Plan Start-Up Costs - The SECURE Act increases the credit for small employer pension plan startups by changing the calculation of the flat dollar amount limit on the credit to the greater of (a) $500 or (b) the lesser of (i) $250 multiplied by the number of non-highly compensated employees of the employer who are eligible to participate in the plan or (ii) $5,000. The credit applies for up to three years.  (SECURE Act § 104 amending IRC § 45E)  

5.         Small Employer Automatic Enrollment Credit (up to 3 years) - The SECURE Act creates a new tax credit of up to $500 per year (up to 3 years) to employers of small businesses (100 or less employees) to defray startup costs for new section 401(k) plans and SIMPLE IRA plans that include automatic enrollment.  (SECURE Act § 105, adding IRC § 45T) 

6.              Repeal Prohibition on Contributions to Traditional IRAs After Age 70-1/2 Maximum Age for Traditional IRA Contributions

The SECURE Act repeals the prohibition on contributions to traditional IRAs by individuals who have attained age 70-1/2.  (SECURE Act § 107 striking IRC § 219(d)(1))  The Committee Report notes that as Americans live longer, an increasing number continue employment beyond traditional retirement age.  This is effective for contributions made on or after January 1, 2020.

7.              Plan Participant Loans through Credit Cards Not Allowed

The SECURE Act prohibits plans from making plan loans accessible to participants through credit cards or any other similar arrangement.  (SECURE Act § 108 adding IRC § 72(p)(2)(D))  The Committee Report notes that the change will ensure that plan loans are not used for routine or small purchases, which would deplete retirement savings.  This rule is effective for loans made after December 20, 2019.  

8.              Portability of Lifetime (Annuity) Income Options

In order to encourage the use of annuity options in retirement plans, the SECURE Act permits tax-qualified defined contribution plans, section 403(b) plans, and eligible 457(b) plans to be amended to provide for (i) direct rollovers to other employer-sponsored retirement plans or IRAs of a lifetime annuity income investment or (ii) distributions of an annuity income investment in the form of a qualified distribution, if the annuity income distribution option is no longer authorized to be held as an investment option under the existing plan.  (SECURE Act § 109, amending IRC §§ 401(a)(38), 401(k)(2)(B)(i)(VI), 401(k)(2)(B)(iii), 403(b)(11)(D), 403(b)(7)(A), 457(d)(1)(A)(iv) and 457(d)(1)(D))  The Committee Report notes that this change will permit participants to preserve annuity their income investments and avoid surrender charges and fees.  This is effective for plan years beginning after December 31, 2019.

9.              Fiduciary Safe Harbor for Selection of Lifetime Income Provider

The SECURE Act provides that fiduciaries (i) have an optional safe harbor to satisfy the prudence requirement with respect to the selection of insurers for guaranteed retirement income contract (annuity options) and (ii) are protected from liability for any losses that may result to the participant or beneficiary due to an insurer's inability in the future to satisfy its financial obligations under the terms of the contract. The safe harbor requires that fiduciary (i) engages in an objective and thorough search to identify the insurer, (ii) considers the financial capability of such insurer to satisfy its obligations under the guaranteed retirement income contract and (iii) considers the cost (including fees and commissions) of the guaranteed retirement income contract; and on the basis of such consideration, (i) the fiduciary concludes that at the time of selection the insurer is financially capable of satisfying its obligations under the guaranteed contract, and  (ii) the relative cost of the selected guaranteed contract is reasonable.  The fiduciary must obtains written representations from the insurer that (i) the insurer is licensed to offer guaranteed retirement income contracts, (ii) the insurer, at the time of selection and for each of the immediately preceding seven plan years operates under a certificate of authority from the insurance commissioner of its State, has filed audited financial statements in accordance with state law, maintains reserves which satisfies all the state statutory requirements and is not operating under an order of supervision, rehabilitation, or liquidation.  In addition, the insurer must undergo at least every five years a financial examination (under state law) domiciliary State (or representative, designee, or other party approved by such commissioner) by the insurance commissioner or its designee, and the insurer must notify the fiduciary of any change its representation.  The statute provides that nothing in this provision shall be construed to require a fiduciary to select the lowest cost contract. A fiduciary may consider the value of a contract, the insurer’s financial strength and the cost of the contract. (SECURE Act § 204 adding ERISA § 404(e)) These provisions are effective December 20, 2019.

10.              Treatment of Custodial Accounts on Termination of Section 403(b) Plans

The SECURE Act provides that, not later than six months after the date of enactment, the Treasury shall issue guidance under which if an employer terminates a 403(b) custodial account, the final distribution to participants needed to effectuate the plan termination may be the distribution of an individual custodial account in kind to the participant. The individual custodial account will be maintained on a tax-deferred basis as a 403(b) custodial account until paid out, subject to the 403(b) rules in effect at the time that the individual custodial account is distributed. The Treasury guidance is to be retroactively effective for taxable years beginning after December 31, 2008.  (SECURE Act § 110)

11.           Clarification of Retirement Income Account Rules Relating to Church-Controlled Organizations

The SECURE Act of 2019 amends IRC § 403(b)(9) to clarify that individuals who may be covered by retirement income accounts maintained by church-controlled organizations may include not only duly ordained or licensed ministers but also employees of tax-exempt church-controlled organizations that are controlled by or associated with a church or a convention or association of churches (e.g., church-affiliated hospitals and universities). (SECURE Act § 111 amending IRC § 403(b)(9).) This is effective for years beginning on or after December 20, 2019.

12.           Allowing Part-time Workers Who Have Been Working for 3 Years to Participate in 401(k) Plans

Long term part-time employees who work less than 1,000 hours per year can under current law be excluded from participating in a qualified retirement plan.  The SECURE Act will require employers to maintain a 401(k) plan to have a dual eligibility requirement of (i) completing 1,000 hours of service or (ii) having three consecutive years of service where the employee completes at least 500 hours of service in each.  (SECURE Act § 112 amending IRC § 401(k)(2)(D))  This rule will not apply to collectively bargained plans.  With respect to long-term part-time employees who are eligible under the above provisions matching or other employer contributions are not required, relief is provided from the nondiscrimination and top-heavy rules for such coverage.  New IRC § 401(k)(15).  The effective date is for plan years beginning after December 31, 2020.  

13.           Withdrawals from Retirement Plans for Birth or Adoption

The SECURE Act provides for withdrawals from retirement plans of up to $5,000, even before 59-1/2 and without the IRC § 72(t) 10% early distribution penalty in the year following the birth or adoption of a child.  (SECURE Act § 113 adding IRC § 72(t)(2)(H))  This is effective for distributions made after December 31, 2019. 

14.           Age for Required Minimum Distributions

Prior to 2020, minimum distributions would generally be taken from retirement plans or IRAs beginning with the year in which the employee or IRA owner attains age 70-1/2 (or April 1 following the first year in which this occurs).  The SECURE Act of 2019 changes the required beginning date on which the required minimum distributions must begin from the calendar year in which the participant attains age 70-1/2 to the calendar year in which the participant attains age 72.  (SECURE Act § 114 amending IRC §§ 401(a)(9)( C)(i)(I), 401(a)(9)(B)(iv)(I) and 401(a)(9)( C)(ii)(I), last sentence of § 408(b) and § 457(d)(1)(A)(i))  According to the Committee Report, although the policy behind the required minimum distribution rule is to ensure that individuals spend their retirement savings during their lifetime and not use their retirement plans for estate planning purposes, nevertheless, age 70-1/2 was first applied in the early 1960s and has never been adjusted to take into account increases in life expectancy. This applies for distributions made after December 31, 2019 for individuals who attain age 70½ after such date.  

15.           Community Newspapers Pension Funding Relief

Community newspapers are generally family-owned, non-publicly traded, independent newspapers. The SECURE Act provides pension funding relief for community newspaper plan sponsors by increasing the interest rate to calculate those funding obligations to 8%. Additionally, the SECURE Act provides for a longer amortization period of 30 years from 7 years. (SECURE Act § 115 adding IRC § 430(m))  These two changes would reduce the annual amount struggling community newspaper employers would be required to contribute to their pension plan.  This is effective for plan years ending after December 31, 2017.

16.           Treating Excluded Difficulty of Care Payments as Compensation for Determining Retirement Contribution Limitations

Many home healthcare workers do not have a taxable income because their only compensation comes from "difficulty of care" payments exempt from taxation under IRC § 131.  Because such workers do not have taxable income, they cannot save for retirement in a defined contribution plan or IRA. The SECURE Act allows home healthcare workers to contribute to a plan or IRA by amending IRC sections 415(c) and 408(o) to provide that tax exempt difficulty of care payments are treated as compensation for purposes of calculating the contribution limits to defined contribution plans and IRAs.  (SECURE Act § 116 adding §§ 408(o)(5) & 415(c)(8))  This is effective for plan years beginning after December 31, 2015 and for IRA contributions made after December 31, 2019.   

17.           Plans Adopted by Filing Due Date for Year

The SECURE Act amends IRC § 401(b) to provide that a qualified retirement plan is adopted before the due date (including extensions) of the tax return for the taxable year may be treated as having been adopted as of the last day of the taxable year.  (SECURE Act § 201 amending IRC § 401(b))  The Committee Report notes that this additional time to establish a plan provides flexibility for employers considering adopting a plan and the opportunity for employees to receive contributions for that earlier year and begin to accumulate retirement savings.  This is effective for plans adopted for tax years beginning after December 31, 2019.  See also below regarding SECURE Act § 601 relating to provisions relating to Plan amendments needed for implementing SECURE Act.   

18.           Combined Annual Reports for Group of Plan

The SECURE Act directs the IRS and DOL to provide for the filing of a consolidated Form 5500 for similar plans. Plans eligible for consolidated filing would be defined contribution plans with the same trustee, the same named fiduciary under ERISA, and the same administrator, using the same plan year, and providing the same investments or investment options to participants and beneficiaries.  (SECURE Act § 202)  The Committee Report notes that the change will reduce aggregate administrative costs, making it easier for small employers to sponsor a retirement plan.  This is effective for plan years beginning after December 31, 2021.

19.           Disclosure Regarding Lifetime Annuity Income

SECURE Act amends ERISA to require that benefit statements provided to defined contribution plan participants must include a "lifetime income disclosure" at least once every 12-months. The lifetime income disclosure would show the monthly payments the participant would receive if the total account balance were provided as lifetime income streams, including a qualified joint and survivor annuity for the participant and the participant's surviving spouse and a single life annuity. The DOL is directed to develop a model disclosure. Disclosure in terms of monthly payments will allow participants to correlate the funds in their defined contribution plan to lifetime income. Plan fiduciaries, plan sponsors, or other persons will have no liability under ERISA solely by providing annuity income stream equivalents that are derived in accordance with permitted assumptions and guidance and that include the explanations contained in the model disclosure.  (SECURE Act § 203 adding ERISA §§ 105(a)(2)(B)(iii) and 105(a)(2)(D))  This applies to benefit statements furnished more than 12 months after the latest to occur of the DOL issuing (i) interim final rules, (ii) the model disclosure or (iii) the assumptions that may be used in the disclosure.   

20.           Modification of Nondiscrimination Rules for Closed Defined Benefit Plans

The SECURE Act provides relief from nondiscrimination, minimum coverage and minimum participation rules for defined benefit plans that are closed to new participants but allow existing participants to continue to accrue benefits. This relief is subject to the plan satisfying certain requirements, including that the plan’s benefits were nondiscriminatory during the year in which the plan was closed and the two following years.  The modification will protect the benefits for older, longer-service employees as they near retirement.  This is generally effective on the date of enactment – December 20, 2019, although plan sponsors can elect an earlier effective date.  

21.           Modification of PBGC Premiums for CSEC Plans

In 2014, different funding rules were adopted for three types of pension plans: single-employer, multiemployer and cooperative and small employer charity (CSEC) plans. The SECURE Act provides flat-rate premiums of $19 per participant, and variable rate premiums of $9 for each $1,000 of unfunded vested benefits for CSEC plans.  (SECURE Act § 206 adding ERISA §§ 4006(a)(3)(A) & 4006(a)(3)(E)(v))  This is effective presumably on the date of enactment – December 20, 2019.  

22.           Expansion of Section 529 Plans

The SECURE Act expands 529 education savings accounts to cover costs associated with registered apprenticeships, homeschooling, up to $10,000 of qualified student loan repayments (including those for siblings) and private elementary, secondary, or religious schools.  (SECURE Act § 302 adding IRC §§ 529(c)(8) and 529(c)(9))  This is effective for distributions made after December 31, 2018.   

23.           Modifications to Required Minimum Distribution Rules

The SECURE Act modifies the required minimum distribution rules with respect to defined contribution plan and IRA balances upon the death of the employee or account owner. Under the SECURE Act, distributions to individuals are generally required to be distributed by the end of the tenth calendar year following the year of the employee or IRA owner's death; provided, however, that this 10-year requirement will not apply to the surviving spouse of the employee (or IRA owner), to disabled or chronically ill individuals, to individuals who are not more than 10 years younger than the employee (or IRA owner), or to children of the employee (or IRA owner) who have not reached the age of majority.  (SECURE Act § 401 amending IRC § 410(a)(9)(E) and adding § 401(a)(9)(H))  This is generally effective for distributions with respect to employees who die after December 31, 2019.  However, for collectively bargained plans, this applies with respect to employees who die in calendar years after the earlier of (i) the later of the date of termination of the collective bargaining agreement or December 31, 2019 or (ii) December 31, 2021.  

24.           Reduced Minimum Age for Pension Plan In-Service Distributions (from Division M)

The SECURE Act in a different section (to offset certain expenses arising in that section) allows in-service distributions under a defined benefit, money purchase plans or governmental section 457(b) plan at age 59 ½ (rather than age 62 that was permitted for pension plans or age 70 ½  that was permitted for 457(b) plans).  This is effective for plan years beginning after December 31, 2019.  (SECURE ACT Division M § 104).   

25.           Increase in Penalty for Failure to File Tax Return

In general tax provision, the SECURE Act increases the penalty for failure to file a tax return to the lesser of $435 or 100% of the amount of the tax due. (SECURE Act § 402 amending IRC § 6652)  According to the Committee Report, increasing the penalties will encourage the filing of timely and accurate returns which will improve overall tax administration.  This is effective for tax returns for which the due date with extension is after December 31, 2019.  

26.           Increased Penalties for Failure to File Retirement Plan Returns

The SECURE Act increases the failure to file penalties for retirement plan returns. The Form 5500 penalty would be increased from $25 to $250 per day, not to exceed $150,000 (up from $15,000).  Failure to file a registration statement would incur a penalty of $10 per participant per day (up from $1), not to exceed $10,000 (up from $1,000).  Failure to provide a required withholding notice would result in a penalty of $100 for each failure (up from $10), not to exceed $50,000 for all failures during any calendar year (up from $5,000). (SECURE Act § 403 amending IRC §6651))  This is effective for returns, statements and notifications required to be provided/filed after December 31, 2019.  

27.           Information Sharing

The SECURE Act allows the IRS to share returns with the U.S. Customs and Border Protection for purposes of administering the heavy vehicle use tax.  (SECURE Act § 404 adding IRC § 6103(o)(3))  This is effective presumably on the date of enactment – December 20, 2019.

28.           Plan Amendment Deadline

Tax-qualified retirement plans will need to be formally amended to reflect the requirements of the SECURE Act. The deadline for such amendments is the end of the first plan year beginning on or after January 1, 2022 (January 1, 2024 for collectively bargained and governmental plans). However, tax-qualified plans must be operated in accordance with the new law as of the respective effective dates.   

COST-OF-LIVING ADJUSTMENTS 2020

COST-OF-LIVING ADJUSTMENTS

2020

Pension Plan and Related Limits			2019	2020
Pre-tax elective deferral maximum under IRC § 401(k), 403(b), and 457(b) plans (IRC §§ 402(g)(3) & 457 (e)(15))			$19,000	$19,500
Age 50 and older “catch-up” adjustment for 401(k), 403(b), and governmental 457(b) plans and SEPs (IRC § 414(v)(2)(B)(i))			$6,000	$6,500
Annual compensation limit under IRC §§ 401(a)(17), 404(l) and 408(k)			$280,000	$285,000
Annual benefit limit for defined benefit plans under IRC § 415(b)			$225,000	$230,000
Annual contribution limit for defined contribution plans under IRC § 415(c)			$56,000	$57,000
Highly compensated employee threshold for purposes of nondiscrimination testing in the following year under IRC § 414(q)(1)(B)			$125,000	$130,000
Key employee threshold for officers for top heavy plan under IRC § 416(i)(1)(A)(i)			$180,000	$185,000
ESOP account balance for 5 and 1 year distributions under IRC § 409(o)(1)(C)(ii)			$1,130,000 and $225,000	$1,150,000 and $230,000
Limit on premiums paid for qualified longevity annuity contracts (QLACs) under Treas. Reg. § 1.401(a)(9)-6 (adopted 2014)			$130,000	$135,000
Minimum earnings level to qualify for SEP under IRC § 408(k)			$600	$600
SIMPLE plan elective deferral limit under IRC § 408(p)(2)(E)			$13,000	$13,500
SIMPLE 401(k) or IRA age 50 catch-up (IRC § 414(v)(2)(B)(ii))			$3,000	$3,000
Basic/Roth IRA contribution limit under IRC §§ 219(b)(5)(A) & 408A. (Age 50 $1,000 IRA catchups do not have cost-of-living adjustments)			$6,000	$6,000
Adjusted gross income (AGI) phase-out of deduction for IRA where the participant or spouse contributing to the IRA also participates in an employer-sponsored retirement plan (IRC § 219(g)(1) & (3))  For married joint filers – For single filers –			$103,000 to $123,000    $64,000 to $74,000	$104,000 to $124,000 $65,000 to $75,000
AGI phase-out of deduction for IRA for married persons filing jointly where the spouse who is contributing to the IRA also participates in the employer-sponsored retirement plan (IRC § 219(g)(7))			$193,000 to $203,000	$196,000 to $206,000
Health Savings Account contribution limits (single and family)			$3,500 and $7,000	$3,550 and $7,100
PBGC guaranteed benefit (annual single life annuity)			$67,295	$69,750
PBGC flat-rate premiums per participant for a single-employer plans			$80	$83
PBGC variable-rate premium for single-employer plans per $1,000 of Unfunded Vested Benefits			$43	$45
PBGC premiums for multiemployer plans per participant			$29	$30
Taxable wage base subject to FICA tax			$132,900	$137,700

PARTICIPANT LOANS: A ROAD MAP FOR PRACTITIONERS

August 8, 2018

PARTICIPANT LOANS:

A ROAD MAP FOR PRACTITIONERS

Summary: The availability of participant loans from tax-qualified retirement plans often results in increased Plan participation by non-highly compensated employees.  Employers often choose to make loans available from their plans as a matter of employee relations.  However, plan loans are subject to complicated rules under both ERISA and the Code, and they are a trap for the unwary if they are not administered properly in compliance with these rules.  Recent developments regarding participant loans include certain changes made by the Tax Cuts and Jobs Act of 2017 and other recent IRS guidance.  This article provides a roadmap for practitioners in advising clients on instituting and operating a participant loan program.

The ability of participants in qualified plans, especially § 401(k) plans, to obtain loans from such plans is responsible in no small way for the popularity of the plans and the increased participation of employees in such plans.  Plan loans, however, are subject to a very specific set of rules, which, if not followed, may subject such loans to income and penalty taxes.  Specifically, such loans must comply with the conditions set forth in § 408(b)(1) of the Employee Retirement Income Security Act of 1974, as amended (ERISA), and § 72(p) of the Internal Revenue Code of 1986, as amended (Code).  If these conditions are not met, loans to plan participants may be prohibited transactions under ERISA, may violate the "anti-alienation" rules of ERISA and the Code and may be deemed to be taxable distributions to the participants who received the loans.  This article attempts to chart the course that must be followed so that unintended consequences are avoided.

Part I examines the prohibited transaction rules of ERISA § 408.  Part II examines the taxable distribution rules of Code § 72(p), as well as issues relating to deemed distributions and foreclosures.  Other miscellaneous issues are examined in Part III.

PART I - PROHIBITED TRANSACTION STATUTORY EXEMPTION

Generally

Loans from a plan to a participant are prohibited extensions of credit from the plan to a party in interest unless the requirements of the statutory exemption of ERISA § 408(b)(1) and Code § 4975(d)(1) are met.[1]  The requirements of Code § 4975(d)(1) must also be met in order that the loan not violate the anti-assignment rule of Code § 401(a)(13) and ERISA § 206(d).

The conditions of this statutory prohibited transaction exemption of ERISA § 408(b)(1) and Code § 4975(d)(1) are that the loans must:

(1)    be available to all participants and beneficiaries on a reasonably equivalent basis;
(2)    not be available to highly compensated employees in an amount greater than to other employees;
(3)    be made in accordance with the loan provisions set forth in the plan;
(4)    bear a reasonable rate of interest; and
(5)    be adequately secured.[2]

In addition, Department of Labor (DOL) regulations require that the loan program be legitimate.[3]

Requirement of Plan-Wide Availability on a Reasonably Equivalent Basis

General.  The loans must be available to all participants and beneficiaries on a reasonably equivalent basis.[4]  To meet this requirement, (1) the loans must be available without regard to race, religion, gender, etc.; (2) consideration must be given only to factors that would be considered in normal commercial circumstances by an entity in the business of making similar types of loans, including, for example, the creditworthiness and financial need of the applicant; and (3) the loans in actual practice must not be unreasonably withheld from any applicant.[5]

Availability May Be Limited to Parties in Interest.  The DOL takes the position that the plan-wide availability requirement is required only with respect to parties in interest, and that a plan may limit loans to parties in interest.[6]  Active employees of the sponsoring employer are all parties in interest.  Former employees are typically not parties in interest, but certain former employees by reason of some other relationship to the company or plan may be parties in interest.[7]  A plan could therefore not exclude all former participants where some are parties in interest.

A plan provision permitting loans is a benefit, right or feature subject to the nondiscriminatory availability test of Treas. Reg. § 1.401(a)(4)-4.  Most loan programs easily meet this rule for active employees.  However, because plan loans are only required to be made available to those former employees who are also parties in interest, the potential for discrimination with respect to former employees in favor of highly compensated former employees is greater.  In recognition of this problem, the § 401(a)(4) regulations provide that former employees who are parties in interest may be treated as active employees.[8]

Minimum Loan Amounts.  Minimum loan amounts of up to $1,000 may be established without violating the reasonably equivalent basis requirement.[9]

Other Restrictions Allowed.   A plan is allowed to limit the availability of loans to specific purposes such as hardship, college tuition, home purchases, etc., provided that loans continue to be made available to participants and beneficiaries on a reasonably equivalent basis.[10]

Loans to Particular Bargaining Unit Employees.  A plan whose participants are members in several unions and makes a loan feature available only as their collective bargaining agreements are renegotiated would not violate the reasonably equivalent requirement, if within a reasonable time period all bargaining units approve the loan feature.[11]

Prohibited Loans to Executive Officers Under Sarbanes Oxley Act.   The Sarbanes Oxley Act of 2002 prohibits loans to directors or executive officers.  There is no clear authority as to whether the Sarbanes Oxley Act of 2002 prohibition on loans to executive officers would apply to 401(k) plan loans, as extensions or arrangements of credit by the issuer.  A joint memo by 25 law firms "Interpretive Issues Under § 402 - Prohibition on Certain Insider Loans," (Oct. 15, 2002) argued that 401(k) loans should be permitted, since the officer is effectively borrowing from himself and the loan is from the plan rather than the issuer, but there has been no SEC guidance on the matter.  The DOL in a field assistant bulletin has held that possible restrictions on loans to officers and directors under the Sarbanes Oxley Act would not cause a plan to violate the reasonably equivalent basis rule for participant loans under ERISA § 408(b)(1)(A).[12]

Loan Fees.  The preamble to the DOL regulations makes it clear that fees may be charged to cover the administrative cost of making loans.[13]

Requirement That Loans Not Be More Available to Highly Compensated Employees than to Other Employees

The loans may not be available to highly compensated employees[14] in an amount greater than to other employees.[15]  To meet this requirement, it must be determined upon consideration of the facts and circumstances that the program does not operate to exclude large numbers of participants from receiving loans.  A loan program will not fail because it limits loans to a maximum dollar amount or to a maximum percentage of a participant's vested accrued benefit, despite the fact that under a percentage limit the maximum loan amount will vary with the size of the participant's accrued benefit.[16]

Requirement That the Plan Document Specifically Permit Loans

General.  The loans must be made in accordance with loan provisions set forth in the plan.[17]  Regulations provide that plan provisions must contain explicit authorization for the establishment of a loan program.[18]  In addition, the plan document or a written document forming part of the plan must include:  (1) the identity of the person or position authorized to administer the loan program; (2) a procedure for applying for loans; (3) the basis on which loans will be approved or denied; (4) limitations (if any) on the type of loans offered; (5) the procedure for determining a reasonable rate of interest; (6) the types of collateral that may secure the loan; and (7) the events constituting default and the steps that will be taken to preserve plan assets in the event of such default.[19]

Summary Plan Description (SPD).  The enumerated items described in the preceding paragraph affect the rights and obligations of participants and therefore must be set forth in a plan's SPD.[20]   The preamble to the final regulations notes that the SPD alone can satisfy the plan provision requirement if it contains the required loan provisions and is a document forming part of the plan.[21]

Loan Documentation.  Typically, loan documents will include the plan loan provisions (contained in the plan or SPD), loan application guidelines, a loan application, a loan disclosure statement, and a promissory note and security agreement.

Requirement of a Reasonable Interest Rate

General.  The loans must bear a reasonable rate of interest.[22]  To meet this requirement, the loan must provide the plan with a return commensurate with the interest rates charged by persons in the business of lending money for loans that would be made under similar circumstances.[23]  A strict reading of the regulations may require different interest rates depending on each participant's creditworthiness.[24]  Thus, if local banks would lend the participant, taking into account his or her creditworthiness and the collateral offered, at a fixed rate of 12%, a plan that loaned at 8% would not be charging a reasonable rate of interest and would not be entitled to the relief provided by ERISA § 408(b)(1).[25]

State Usury Laws Not Relevant.  State usury laws may not be used to justify a low rate of interest.[26]

Rates of Interest Commonly Used.  Some courts have analyzed reasonable interest taking into account that the loan is a compensating balance loan with the loan secured by a sum of money deposited by the borrower with the lender, and therefore, according to expert testimony cited in one case, a rate of one or two percent above the certificate of deposit rate would be reasonable. [27]  Many plans have been charging the prime interest rate plus 1 or 2 percentage points.  However, because the prime rate in recent years has been low, IRS officials have indicated at a 2011 phone forum that prime plus 2 percent is currently what the IRS deems to be a reasonable rate of interest.[28]  Other plans charge the prevailing rate for home equity loans.

Rates for Loan Renewals.  When a loan is subject to renewal, the prevailing market rate at the time of renewal must be charged.[29]

Fixed Versus Adjustable Rates.  Most plans charge a fixed interest rate for the loan for administrative convenience, although adjustable rates are also permitted.

Requirement of Adequate Security

Security That Can Be Foreclosed With "No Loss."  The loans must be adequately secured.[30]  To meet this requirement, the security posted must be:  (1) something more than a mere promise to pay; (2) capable of being foreclosed on or otherwise disposed of in the event of default in an amount equal to the amount due; and (3) of such value and liquidity that it is reasonably anticipated that there will be no loss of principal or interest.[31]

Use of 50% of Participant's Vested Accrued Benefit as Security.  A participant's vested accrued benefit may be adequate security, but only up to 50% of such benefit may be so utilized.[32]

Spousal Consent.  Because foreclosure of a plan loan is treated as a distribution, spousal consent to waive the qualified joint and survivor annuity requirement, where applicable, must be obtained.  Spousal consent rules apply mainly to defined benefit plans (and money purchase pension plans).[33]  The spousal consent rules can be met by obtaining spousal consent to the loan and foreclosure not more than 90 days before the date the loan is made.[34]  The adequate security requirement of ERISA § 408(b)(1) may require that spousal consent be obtained at the time a loan is made from a plan subject to the spousal consent rules.[35]

Mortgage Loans. Code § 72(p)(3) provides that an interest deduction may not be taken with respect to a plan loan if it is:  (i) made to a key employee (as defined in Code § 416(i)), or (ii) secured by the participant's § 401(k) elective deferrals.  If a loan to a non-key employee is secured by the participant's principal residence (i.e., a mortgage) rather than by his or her § 401(k) account, the mortgage interest deduction would be allowed.[36]

In certain limited circumstances, plans that have investment programs making mortgages available to individuals including plan participants will not be subject to the limits of Code § 72(p) with respect to the participant loans.[37]

Source of Loan Proceeds.  Typically, participant loans from defined contribution plans are taken directly from the participant's account.  Often a special loan subaccount is created.[38]  The loan then becomes an investment of the individual account but not of the entire plan.  Under another method most commonly used by plans that do not have individual accounts, the participant borrows from the plan as a whole and, as the loan principal and interest are repaid, they accrue to the entire plan rather than to the participant's account.  The loan is then considered a general investment of the entire plan.

Impact of Source of Collateral on "No Loss" Rule.  Where a loan is treated as an investment attributable solely to the participant's account, the adequate security requirement will be met and the "no loss" rule satisfied even if the security interest cannot be immediately foreclosed on (e.g., because of "in-service distribution" restrictions).[39]  However, if the loan investment is allocated to the plan as a whole, the preamble to the 1989 DOL regulations states that the security of the accrued benefit may not be sufficient without some additional security, such as mandatory payroll deduction or discounting the value of the vested accrued benefit to take into account the time delay between any possible default and the first distributable event with respect to the borrowing participant's account.[40]

Legitimacy Requirement. 

DOL regulations provide that to meet the requirements of ERISA § 408(b), there must be a legitimate loan program that is administered by the fiduciary primarily in the interest of participants.[41]  The legitimacy of a loan program will be determined by consideration of all facts and circumstances.[42]  Where there is, for example, no intention that the loan be repaid by the participant, the loan is not exempt.  Likewise, a loan program designed to benefit a party in interest other than a participant is not exempt.[43]

PART II - CODE RULES TO PREVENT TAXABLE DISTRIBUTIONS; DISTRIBUTION VERSUS FORECLOSURE

Code § 72(p) Generally

Code § 72(p) provides that loans to participants or beneficiaries from a qualified plan (i.e., under Code §§ 401(a), 403(a), or 403(b)) will be treated as taxable distributions from the plan,[44] unless:

(1)    the loan does not exceed statutory dollar limit or percentage limit;

(2)    the loan requires repayment within 5 years (or a longer period if the loan is used to acquire a principal residence);

(3)    the loan requires substantially level amortization over its term; and

(4)    the loan is evidenced by a legally enforceable agreement in writing or acceptable electronic medium.[45]

Plans that May Offer Loans

Plans that may offer loans include: (i) qualified plans under Code § 401(a); (ii) Code § 403(a) and Code § 403(b) annuity plans; and (iii) governmental 457 plans.[46]  However, loans cannot be taken from Individual Retirement Accounts (IRAs) or Simple Employee Pensions (SEPs).

Requirement That the Loan Be Limited in Amount

General.  The statutory requirement is that the total of all outstanding loans of the participant from the plan[47] may not exceed the lesser of:

(i)  $50,000 reduced by the excess, if any, of (A) the highest outstanding balance of loans during the one-year period ending on the day before the date of the loan, over (B) the outstanding balance of loans from the plan on the date the loan is made;[48] or

(ii)  the greater of (A) one-half the present value of the participant's nonforfeitable accrued benefit, or (B) $10,000.[49]

$10,000 Minimum Not Typically Relevant.  Despite the statutory authority to do so, plans do not typically provide that a participant may borrow $10,000 regardless of the size of his or her nonforfeitable accrued benefit, because the ERISA adequate security requirement,[50] discussed in Part I above, precludes plans from considering more than 50% of the participant's vested accrued benefit as collateral, and would require additional collateral.  For example, a vested accrued benefit of $18,000 would not be adequate security for a $10,000 loan.

$50,000 Limit May Be Restated in Simpler Way.  The complex statutory formulation of the $50,000 prong of the loan limit may be more simply stated:  the maximum amount of any individual new loan is limited to $50,000 reduced by the highest outstanding balance of loan(s) during the one-year period before the new loan is made.[51]

For example, if the highest outstanding balance on prior plan loans of a participant during the preceding year is $25,000, and the outstanding balance of prior loans immediately before taking the new loan is $15,000, the maximum aggregate loan balance the participant may have (under the statutory formulation) cannot exceed $50,000 reduced by $10,000 (the excess of $25,000 over $15,000), or $40,000.  Since the $15,000 prior loan is still outstanding, the maximum new loan cannot exceed $25,000.  The same result is reached by simply limiting the new loan itself to $50,000 minus the highest outstanding loan balance during the preceding year ($50,000 minus $25,000).

The 50% of vested accrued benefit limit of Code § 72(p)(2)(A) must still be met on an aggregate basis for all loans from controlled group plans, and cannot be simplified in the above manner.

Loan Considered Outstanding for Maximum Permitted Amount After Deemed Distribution and Additional Security for Subsequent Loans.  For purposes of calculating the maximum permitted amount of a subsequent loan under Code § 72(p)(2)(A), a loan that has been deemed distributed under § 72(p) and has not been repaid (such as by plan loan offset) is still considered outstanding until the loan obligation has been satisfied for purposes of determining the maximum amount of any subsequent loan to the participant.[52]

As amended in December 2002, regulations provide that if a loan is deemed distributed to a participant and has not been repaid (such as by plan loan offset), then no payment made thereafter to the participant will be treated as a loan for purposes of § 72(p)(2), unless there is  an enforceable arrangement among the plan, participant, and employer, under which repayments will be made by payroll withholding or the plan receives adequate security in addition to the participant's accrued benefit for the additional loan. [53]

Frequency of Loans.  Some plans provide that no more than one loan may be outstanding at any time.  Others provide for waiting periods between loans.[54] 

Requirement That the Loan Be Repaid within Five Years

General.  A loan by its terms must require repayment within five years.[55]  If the loan is not required to be repaid within five years, it is an immediate taxable distribution.  In addition, if a loan providing for repayment over five years is not repaid during such period, the amount remaining payable at the end of the five years is a taxable distribution.[56]  If there are required periodic payments, the first of which is due to be made within two months of the date the loan was made, legislative history indicates that the five-year repayment period will be measured from the due date of that first payment, but some practitioners recommend amortization over 59 months in such cases.[57]

Principal Residence Loans.  Loans used to acquire a principal residence are an exception to the five-year repayment requirement.[58]  Nonetheless, plans typically do impose some limit on principal residence loans, such as 10, 15 or 20 years.  A principal residence loan that is for a significantly longer period than the period under commercially available loans (e.g., longer than 30 years) may not be permissible.[59]

A principal residence has the same meaning as under Code § 121 (relating to exclusion of gain from sale of principal residence).[60]  There is no requirement that it be a principal residence for any specific period of time.[61]  Tracing rules similar to those applicable under Code § 163(h)(3)(B) (relating to the deduction for home acquisition indebtedness) apply.[62]  Refinancings do not qualify as principal residence loans, although a plan loan that would otherwise qualify may be used to repay a bank loan.[63]

Requirement of Level Amortization

General.  Substantially level amortization over the term of the loan is required, and participants must make payments no less frequently than quarterly.[64]

Payroll Deductions and Written or Electronic Authorizations.  Most plans provide for loan repayment by payroll deduction. 

Some state wage-and-hour laws require that payroll deductions be in writing.  These laws, however, may be preempted by ERISA.  For example, a 1994 DOL Advisory Opinion held that a New York Law requiring written authorization for payroll deductions, is preempted by ERISA to the extent it prevents a plan from implementing a salary reduction arrangement by a telephone voice response system.[65]  Similarly, a 1996 DOL Advisory Opinion held that ERISA preempts a Puerto Rico law that allows authorized payroll deductions only for contributions to pension plans and not for loans.[66]

Cessation of Payments during Leave of Absence.  The level amortization requirement will not be violated if repayments cease while an employee is on a leave of absence for a period of up to one year.[67]  However, the loan (plus interest accruing during the leave of absence) must still be paid within the original five-year period, and therefore when the employee returns to work an accelerated payment schedule or a lump sum repayment at the end of the five year period would be necessary.[68]  If repayments cease while an employee is on a military leave of absence even for a period beyond one year as permitted under Code § 414(u)(4), the suspension will not cause the loan to be deemed distributed, as long as loan repayments resume upon the completion of the military service, the amount then remaining due on the loan is repaid in substantially level installments thereafter, and the loan is fully repaid by the latest permissible term of a loan (five years for a non-principal residence loan) plus the period of the military service.[69] 

Level Amortization in Loan Refinancings.  Regulations as added in 2002 provide that while a loan can be refinanced and additional amounts may be borrowed, the prior loan and additional loan must each satisfy the requirements in § 72(p)(2)(B) and (C) that each loan be repaid in level installments, not less often than quarterly, over five years.[70]  The loans collectively must satisfy the amount limitations of § 72(p)(2)(A).  A refinancing is, in effect, treated as a new loan that is then applied to repay a prior loan if the new loan both replaces a prior loan and has a later repayment date. This rule does not apply to a refinancing loan under which the amount of the prior loan is to be repaid by the original repayment date of the prior loan.[71]

Regulatory Requirement of an Enforceable Agreement in Writing or Electronically

The Treasury regulations impose an additional requirement in order to avoid a deemed distribution under Code § 72(p):  the loan must be evidenced by a legally enforceable agreement (which may include more than one document), and the terms of the agreement must demonstrate compliance with the requirements of Code § 72(p) (specifying the amount of the loan, the date of the loan and the repayment schedule in accordance with the rules of § 72(p)).[72]

Regulations issued in 2000 provide that the loan agreement must be in a written enforceable agreement or in an electronic medium reasonably accessible to the participant under a system (i) reasonably designed to preclude anyone other than the participant from requesting a loan, (ii) that provides a reasonable opportunity to review the terms of the loan and to confirm, modify or rescind the terms of the loan, and (iii) that provides a confirmation of the loan terms through a written document or an electronic medium.[73]  If an electronic medium is used to provide confirmation of the loan terms, it must be reasonably accessible and must be provided in a manner no less understandable than a written paper document.  Also, the participant must be advised of the right to receive a copy of the confirmation on a written document without charge.[74]  The regulations provide that the loan agreement does not have to be signed if the agreement is enforceable under applicable law without signature.[75]

The IRS has indicated that a Plan sponsor should maintain the loan application, executed promissory note, proof that loan proceeds were used to purchase or construct a primary residence (if applicable), proof of loan repayments, in the event of default, proof of collection activities, and if there is a deemed distribution on Form 1099-R.[76]

Consequences of Violating Code § 72(p)

Violation in Form or in Operation.  A deemed distribution will occur when the requirements of Code § 72(p) are not satisfied in form or in operation.[77]

Deemed Distribution at Time Loan Is Made.[78]  If the terms of the loan do not require repayment within five years and level amortization or are not evidenced by an enforceable agreement in accordance with § 72(p) and the regulations, the entire amount of the loan is deemed distributed at the time the loan is made.  If the terms of the loan merely fail to satisfy the amount requirement of § 72(p)(2)(A), only the amount in excess of the permissible loan amount is a deemed distribution at the time the loan is made.

Later Deemed Distribution for Not Making Level Installment Payments.  If the loan initially satisfies the requirements of Code § 72(p), but repayments are not being made in accordance with the level amortization requirement of Code § 72(p)(2)(C), a deemed distribution occurs at the time of such failure.[79]  However, the plan administrator may allow a cure period extending up to the end of the calendar quarter following the calendar quarter in which the required installment payment was due and not made.  Such cure period given by the plan administrator will avoid a deemed taxable distribution until the end of the grace period.[80]  If the installment payment is not made before the expiration of the cure period, the entire outstanding balance of the loan (including accrued interest) will be a deemed distribution.[81] Chief Counsel Advice 201736022 provides two examples of failures to make loan payments under a qualified plan that were timely corrected, so that a loan default was avoided, and the loan was deemed to be satisfactorily reinstated.[82]  

Case-Law Regarding Deemed Distributions for Not Making Timely Payments.  There are various cases regarding deemed distribution under Code § 72(p) with income tax and Code § 72(t) early distribution tax for failure to make timely payments on participant loans. [83]  Several cases have held that failure to provide documentary evidence of the loan would result in a deemed distribution with ordinary income (and a 10% early distribution tax). [84]

Interest on Loan Not Included in Income.  Interest that accrues after a deemed distribution under Code § 72(p) is not included for purposes of Code § 72, and therefore the additional interest is not treated as an additional loan and does not result in an additional deemed distribution under Code § 72(p).[85]

Section 72(t) Tax.  When there is a deemed distribution of a plan loan, in addition to the income tax under § 72(p) there will also be a 10% Code § 72(t) early distribution tax if the deemed distribution occurs prior to age 59-1/2.[86]

Tax Reporting.  Any deemed distribution under Code § 72(p) must be reported on IRS Form 1099-R.[87]

Distinction between Taxable Deemed Distribution and Foreclosure

A Taxable Deemed Distribution Is Not Necessarily an Actual Distribution.  Even if Code § 72(p) is violated and there is a deemed taxable distribution under Code § 72(p), such distribution is not treated as an actual distribution for purposes of the in-service distribution restrictions under  § 401 regulations for money purchase plans, the eligible rollover distribution rules of Code § 402, the in-service distribution restrictions of Code § 401(k)(2)(B), or the vesting requirements of Treas. Reg. § 1.411(a)-7(d)(5) (regarding graded vesting schedule where prior distribution occurred).[88]  Thus, it is possible to be taxed on the deemed distribution at an earlier time than the actual distribution. A deemed distribution will therefore not be considered an in-service distribution or an eligible rollover distribution.  After a taxable deemed distribution occurs, the participant may still want to repay the loan, in order, for example, to be able to take a new plan loan.

A Plan Loan Offset (But Not a Default Alone) Is Treated as an Actual Distribution.  The regulations provide that an actual distribution occurs when, under the terms governing the plan loan, the accrued benefit of the participant is reduced (offset) in order to repay the loan.[89]  This might occur, for example, where the terms governing the plan loan require that if a participant requests a distribution, a loan must be repaid immediately or treated as in default.  A distributable event under the plan, e.g., age 59-1/2 or severance from employment, may be required to offset the loan.  The amount of the account balance that is used to offset the loan is treated as an actual distribution.  On the other hand, an event of default under the loan documents without an actual offset does not automatically cause there to be a Code § 72(p) taxable event.

Plan loan procedures may provide for offset for failure to make payments when due if a distribution is permitted.  Other common offset triggers are termination of employment or termination of the plan.[90]

Foreclosure Should Be Avoided if Restrictions on In-Service Distributions Apply.  Restrictions on in-service distributions (e.g., under Code § 401(k)(2)(B)) are violated if foreclosure occurs and the participant's accrued benefit is offset by the loan amount.[91]  (The same should apply with respect to the Code § 72(t) 10% penalty tax on early distributions.)  A taxable distribution under § 72(p) by itself, however, is not considered an in-service distribution, as stated above.

Coordination of Foreclosure with Requirement of Participant Consent to Actual Distributions.  Plan distributions in excess of $5,000 require a participant's consent under Code § 411(a)(11).  Thus, plan loan documents should provide that the participant consents both to the taking of the loan and to a foreclosure in the event of a default.

Coordination with Spousal Consent Requirements.  To foreclose on a plan loan, spousal consent, if applicable, is required.  Code § 417(a)(4) requires that no part of a participant's accrued benefit may be used as security for a loan from a plan subject to the qualified joint and survivor annuity rules and the qualified pre-retirement survivor annuity rules of Code § 401(a)(11) unless there is spousal consent.  Accordingly, spousal consent should be obtained at the time the loan is made.  See above, Pt. I, discussion of adequate security and spousal consent.

Foreclosure as Eligible Rollover Distribution; 20% Withholding Obligation.  A distribution from a qualified plan is subject to 20% mandatory withholding if the distribution is an "eligible rollover distribution" and the participant fails to elect a direct rollover.  As stated above, if a loan becomes a deemed taxable distribution because it does not comply with Code § 72(p), it is not an eligible rollover distribution and cannot be rolled over.[92]  The pre-1993 10% voluntary withholding rules apply in such case.[93]

If a loan is foreclosed by offsetting the accrued benefit, however, there is an actual distribution, and if this offset occurs prior to a deemed distribution this offset is considered an eligible rollover distribution which may be rolled over and is subject to 20% withholding.[94]  Although the foreclosed amount constitutes an eligible rollover distribution and is included in the amount subject to withholding, withholding need only be made from cash or other property distributed, and if there is no other cash or property distributed, there is nothing to withhold from.[95] 

If a deemed distribution of a loan or a loan offset results in income at a date after the loan is made, withholding is required only if a transfer of cash or property is made to the participant or beneficiary from the plan at the same time.[96]

Direct Rollovers and Trust-to-Trust Transfers of Notes.  A trust-to-trust transfer of assets (under Code § 414(l)) from one plan to another can include the transfer of a participant note.[97]  Ordinary rollovers, where amounts are first distributed to participants and then rolled over, should intuitively not be able to be made with a note because the interest of the lender and the borrower will merge once the note is distributed to the participant.  Nevertheless, recent regulations and rulings provide that a direct rollover under Code § 401(a)(31) may be made with a note even though a direct rollover is considered a distribution.[98]

Extension of Rollover Period for Offset Loans under Tax Cuts and Jobs Act of 2017.  If an offset of a loan occurs before the amount has been taxed as a deemed distribution (e.g., on account of termination of employment or termination of the plan), the offset loan is eligible for a tax-free rollover to an eligible retirement plan (including a qualified plan or an IRA) under Code § 402(c)(3)(A).[99]  Prior to the Tax Cuts and Jobs Act of 2017, the offset loan rollover would have to be made within 60 days from the date of offset.  The Tax Cuts and Jobs Act added Code § 402(c)(3)(C) to provide that, for plan loan offsets in tax years beginning after Dec. 31, 2017, the period during which a "qualified plan loan offset amount" (i.e., an offset due to termination of employment that results in failure to meet repayment terms of loan, or an offset due to termination of the plan) may be rolled over to an eligible retirement plan is extended from the 60 day period after the offset to the due date (including extensions) for filing an income tax return for the tax year in which the plan loan offset occurs.[100] Note that a rollover of an offset loan cannot be made where there was already a deemed distribution, since the tax was already paid.

PART III - MISCELLANEOUS ISSUES

Exemption from Truth-in-Lending Requirements

Plan loans used to be subject to federal truth-in-lending disclosure statement requirements under Regulation Z of the Truth-in-Lending Act.  However, effective July 1, 2010 Regulation Z was amended to specifically exempt 401(a), 403(b) and 457(b) participant loans from the truth-in-lending disclosure requirement, provided that the loan is comprised of fully vested funds from the participant's account and the loan is in compliance with the requirements of the Internal Revenue Code.[101]

Applicability of Loan Provisions to Individual Retirement Accounts (IRAs)

Loans from IRAs are not permitted.  Although IRAs are not subject to ERISA, they are subject to the Code § 4975 excise tax on prohibited transactions.[102]  Furthermore, pursuant to Code § 408(e)(2), if in any year an individual for whose benefit an IRA is established engages in any transaction prohibited by Code § 4975 with respect to the IRA, the IRA ceases to be an IRA as of the first day of such year (and all of the assets of the IRA on the first day of such year are treated as having been distributed on such day).[103]

Loans in Bankruptcy

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") provides that all retirement funds exempt from taxation under Internal Revenue Code §§ 401, 403, 408, 408A, 457 or 501(a) are protected from bankruptcy creditors.  Bankruptcy Code §§ 522(b)(3)(C) & 522(d)(12).  (IRAs are limited to $1 million as adjusted.  Bankruptcy Code § 522(n).)  With regard to participant loans, BAPCPA provides in Bankruptcy Code § 362(b)(19) that the bankruptcy petition does not operate as a stay for the withholding of wages to pay for participant loans under ERISA § 408(b)(1) or Code § 72(p).  Thus, withholding from wages for participant loans could remain in effect even though the participant is in bankruptcy.

With regard to Chapter 7 liquidations, BAPCPA introduced a means test (measuring monthly disposable income), and there are some cases regarding whether amounts withheld to repay participant loans are counted as part of the means test.[104]  This issue would not be applicable to a Chapter 13 individual bankruptcy filing, as the means test does not apply to Chapter 13 filings (and in fact was instituted to limit Chapter 7 filings to encourage Chapter 13 filings instead).

Impact of Loan Repayments on Code § 415 Annual Additions

Loan repayments are not treated as annual additions for purposes of Code § 415.[105]

Code § 411(d)(6)-Anti-Cutback Protection Not Applicable

Plan loans are not Code § 411(d)(6) protected optional forms of benefit and may be cut back or taken away without violating the anti-cutback rules.[106]

EPCRS Correction for Plan Loan Defaults

The Employee Plans Compliance Resolution System ("EPCRS") program in Revenue Procedure 2016-51 provides that where there is a failure to repay a plan loan by the end of the calendar quarter following the quarter in which the payments are due, which generally would be a taxable deemed distribution under § 72(p), the voluntary correction program ("VCP") of EPCRS can be used by reamortizing the loan balance over the remainder of the loan period or by repaying the arrears in lump sum, or a combination of the two.[107]  This may cure not just the operational failure but can also avoid the deemed distribution under § 72(p) (and a Form 1099-R reporting the deemed distribution will not be required), provided relief is specifically requested from the IRS that the loan failure will not result in § 72(p) deemed distribution tax.[108]  Alternatively, the VCP relief can be limited to reporting the deemed distribution in the year of correction instead of the year of failure.[109]  Examples when the IRS may limit the VCP relief to reporting the deemed distribution in the year of correction instead of the year of failure (and not avoiding the deemed distribution tax entirely) could be, for example, where the affected employee is a key employee or an owner-employee[110] or where the loan cannot be reamortized within the five year term and will need to be defaulted in the correction year. [111]

Prior to 2018, there were reduced VCP correction fees for loan failures based on the number of participants: (i) $300 for 13 or fewer affected participants; (ii) $600 for 50 or fewer affected participants; (iii) $1,000 for 100 or fewer affected participants; (iv) $2,000 for 150 or fewer affected participants; and (v) $3,000 for greater than 150 affected participants.[112] However, Rev. Proc. 2018-4 eliminates the reduced VCP fees for loan errors and provides for uniform VCP user fees (for all failures) based on the entire plan's assets as follows: (i) $1,500 if the plan's assets are of $500,000 or less; (ii) $3,000 if the plan's assets are $500,001 to $10,000,000; and (iii) $3,500 if the plan's assets are of over $10,000,000.[113]

Charles C. Shulman

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[1]      In general, ERISA § 408(b)(1) and Code § 4975(d)(1) mirror each other.  There are some differences, however.  For example, ERISA applies even to nonqualified plans.  In addition, any employee of a plan sponsor is a party in interest under ERISA § 3(14); only a highly compensated employee is a disqualified person under Code § 4975(e)(2).  Therefore, prohibited transaction excise taxes under § 4975 would only apply to prohibited loans to employees who are highly compensated or are otherwise disqualified persons.

        The Department of Labor (DOL) regulations cited below apply equally to the ERISA requirements and the Code requirements pursuant to § 102 of Reorgani­zation Plan No. 4 of 1978, which  transferred the authority relating to these provisions from the Treasury Department to the Labor Department.  See, DOL Reg. § 2550.408b‑1(a)(1).

[2]      ERISA § 408(b)(1) and Code § 4975(d)(1); DOL Reg. § 2550.408b-1.

        DOL regula­tions provide that loans that meet the conditions of ERISA § 408(b)(1) are exempt not only from the prohibited transaction rules of ERISA § 406(a) (for extensions of credit to a party in interest) but also from the self-dealing prohibitions of ERISA § 406(b)(1) and (2).  DOL Reg. § 2550.408b-1(a)(1).  Such loans, however, are not exempt from the anti-kickback rule of ERISA § 406(b)(3) or the fiduciary duties of ERISA § 404.  DOL Reg. § 2550.408b-1(a)(2).   As stated above, the conditions of the above exemption must also be met so that the loan does not violate the anti-alienation rules of ERISA § 206(d)(2) and Code § 401(a)(13)(A).

[3]      DOL Reg. § 2550.408b-1(a)(3).

[4]      ERISA § 408(b)(1)(A).

[5]      DOL Reg. § 2550.408b-1(b)(1).

[6]      ERISA Advisory Opinion 89-30A; Preamble to DOL Regulations, 54 Fed. Reg. 30522 (July 20, 1989).

[7]      Note that a loan cannot be made available to certain owner-employees or certain shareholder-employees because the exemptions of ERISA § 408(b) do not apply to these individuals.  ERISA § 408(d).  (See, DOL Info. Ltr. to Thomas M. Curtin (Oct. 7, 1999) regarding a loan to a participant who later becomes an owner employee, quoted in 26 BNA Pen. & Ben. Rptr. 2437 (October 18, 1999).)

[8]      Treas. Reg. § 1.401(a)(4)‑10(c).

[9]      DOL Reg. § 2550.408b-1(b)(2).

[10]    DOL Reg. § 2550.408b-1(a)(4), Ex. 8.

[11]    DOL Adv. Op. 95-19A.

[12]    DOL Field Assistance Bulletin 2003-1 (April 15, 2003).

[13]    54 Fed. Reg. 30520, 30522 (July 20, 1989).  See DOL Field Assistance Bulletin 2003-3 that based on DOL Reg. § 2550-404c-1(b)(2)(ii)(A), reasonable expenses associated with taking a plan loan may be charged to the participant's account.

[14]    For 2018, highly compensated employees are:  those earning over $120,000 in 2017 (who, if the top-paid group election is made, are also in the top 20% group), or 5% owners.  Code § 414(q).

[15]    ERISA § 408(b)(1)(B).

[16]    DOL Reg. § 2550.408b-1(c).

[17]    ERISA § 408(b)(1)(C).

[18]    DOL Reg. § 2550.408b-1(d)(1).

[19]    DOL Reg. § 2550.408b-1(d)(2).

[20]    DOL Reg. § 2550.408b-1(d), Ex. (1).

[21]    54 Fed. Reg. 30520, 30523 (July 20, 1989).

[22]    ERISA § 408(b)(1)(D).

[23]    DOL Reg. § 2550.408b-1(e).

[24]    In practice, plan-wide rates are typically used, possibly in recognition of the fact that the 50% account balance collateral makes participants' other creditworthiness less meaningful.

[25]    DOL Reg. § 2550.408b-1(e), Ex. (1).

[26]    DOL Reg. § 2550.408b-1(e), Ex. (3).  See, preamble to final DOL regulations.  54 Fed. Reg. 30520, 30525 (July 20, 1989).  See, also, McLaughlin v. Rowley, 698 F. Supp. 1333 (N.D. Tex. 1988), which held that state usury laws with respect to plan loans are preempted by ERISA.

[27]    See McLaughlin v. Rowley, 698 F. Supp. 1333 (N.D. Tex. 1988) (where trustees of a defined contribution plan were held liable, among other things, for charging less than a prudent interest rate on plan loans to participants; the plan was an individual account defined contribution plan, although assets were pooled for investment purposes; the plan charged only 7% during the period 1977 to 1982; the DOL's expert witness testified that loans in such case are comparable to "compensating balance loans," which are loans that are secured by a sum of money deposited with the lender; the expert further testified that prudent lenders would charge fair market rates of interest at one or two percentage points above the rate paid on the a borrower's certificate of deposit; the rate would also vary in accordance with the size and the term of the deposit; the fact that the security for the loan is substantially the same as the amount of the loan does not matter; the court rejected the claim that the participants were merely borrowing their own money).

[28]    Participant Loans IRS Phone Forum, Sept. 12, 2011, https://www.irs.gov/pub/irs-tege/loans_phoneforum_transcript.pdf; 38 BNA Pension & Benefits Reporter 1694 (Sept. 20, 2011).

[29]    DOL Reg. § 2550.408b-1(e), Ex. (2).

[30]    ERISA § 408(b)(1)(E).

[31]    DOL Reg. § 2550.408b-1(f)(1).

[32]    DOL Reg. § 2550.408b-1(f)(2).  See Part II below regarding 50% loan limit under Code § 72(p)(2)(A). 

        Note that while the 50% § 72(p) limit is a requirement at the time the loan is taken, it is not clear if the 50% adequate security requirement of DOL Reg. § 2550.408b-1(f)(2) must be met over the term of the loan.

[33]    Code § 401(a)(11).  Profit-sharing plans are not subject to spousal consent rules if the participant's entire accrued benefit is payable on death to his or her surviving spouse (or another designated beneficiary with the spouse's consent) and a life annuity payment form is not elected.  Code § 401(a)(11)(B)(iii).

[34]    Treas. Reg. § 1.401(a)-20, Q&A 24. 

[35]    The preamble to Treas. Reg. § 1.401(a)-20, 53 Fed. Reg. 31837, 31840 (August 22, 1988), states that the DOL has indicated that a loan may not be adequately secured if consent to a reduction in the accrued benefit is not obtained before the loan is secured.  Mardy, Loesel & Hamburger, Guide to Assigning & Loaning Plan Money ¶ 416 (Thompson Publishing Group), provides that the DOL concern is lessened by the "no loss" rule of the 1989 DOL regulations under which a delayed foreclosure is permissible as long as there are precautions taken to avoid loss of principal or interest on the loan.  It would seem, however, that since the inability to foreclose without spousal consent could result in loss of principal or interest on the loan, plans subject to the spousal consent requirement should require such consent at the time of the loan.

[36]    See, PLR 8933018 (interest on loans made to non-key employees that are secured by recorded deed on residence and not by amount attributable to § 401(k) deferrals is deductible).

[37]    See, Conference Report to TEFRA, H.R. Conf. Rep. No. 97-760 (1982), which states that residential mortgage investments made in the ordinary course of an investment program are not considered plan loans under § 72(p) if the loans do not exceed the fair market value of the property, are not self-directed investments of an individual account and are not made to officers, directors or owners.  The fiduciary duty and prohibited transaction rules must still be complied with.  Id.  See, also, Treas. Reg. § 1.72(p)-1, Q&A 18 which states that a mortgage investment program exists only if the plan has established, in advance of a specific investment, that a certain percentage or amount of the assets will be invested in residential mortgages.  The above regulations also impose certain additional requirements.  See, also, PLR 8824045 (mortgage loans made available only to plan participants are subject to § 72(p)); PLR 9110039 (mortgage loan program primarily for plan participants is subject to § 72(p)); DOL Adv. Op. 81-12A (mortgage loan program as a plan investment must be prudent).

[38]    When plans take the loan proceeds directly from a participant's accounts, this is often done in a certain order; for example, the following order: 401(k) contributions, catch-up contributions, rollover contributions, matching contributions, employer contributions, Roth contributions, Roth catch-up contributions, Roth rollovers, after-tax contributions.

[39]    See, DOL Reg. § 2550.408b‑1(f)(1) and Preamble to final DOL regulations, 54 Fed. Reg. 30520, 30526 (July 20, 1989).

[40]    Id.

[41]    DOL Reg. § 2550.408b-1(a)(3).

[42]    Id.

        See also, Treas. Reg. § 1.72(p)-1, Q&A 17 that if the loan is not bona fide (e.g., an understanding that the loan will not be repaid) the amount transferred is treated as an actual distribution and not as a loan or deemed distribution under Code § 72(p).

        In determining whether there is a bona fide loan, courts will focus on:  existence of a debt instrument, security, interest and fixed repayment date, record of loan, ability to repay, relationship of parties, and other factors.  See, e.g., Patrick v. C.I.R., T.C. Memo 1998-30 (transfers from profit sharing plan to two participants who were shareholders of the employer were taxable income to the participants and not plan loans). See also, Fuller v. C.I.R., T.C. Memo. 1980-370, 1980 WL 4206 (1980) (as long as the proper formalities are observed, the burden is on the IRS to prove that the transaction was not a loan; the court held that even though the employer, sole shareholder and loan recipient was also one of the plan's trustees, and even though loan repayments had been sporadic, a loan transaction in which the proper formalities had been observed was a loan, rather than a taxable distribution, from the plan).​

[43]    Id. 

[44]    A taxable distribution, in turn, may also trigger a 10% early distribution penalty tax under Code § 72(t), if applicable.  Treas. Reg. § 1.72(p)-1, Q&A 11, 65 Fed. Reg. 46591 (July 31, 2000).

[45]    Code § 72(p)(2); Treas. Reg. § 1.72(p)-1, Q&A 3.

[46]   Code § 72(p)(4); Treas. Reg. § 1.72(p)-1, Q&A 2.

[47]    All plans of an employer (determined under the rules of subsections (b), (c) and (m) of Code § 414) are treated as a single plan for purposes of the loan rules.  Code § 72(p)(2)(D)(i) and (ii).

[48]   The reason for adjusting the maximum by the repayment amount is to prevent an employee from effectively maintaining a permanent outstanding $50,000 loan balance. 21 H.R. Rep. 99-426 at 735 (1985).

       With respect to the maximum participant loan amount when the participant has prior loans, the IRS in Memorandum for Employee Plans (EP) Examinations Employees, revised at TE/GE-04-0417-0020 (July 26, 2017) (to be incorporated into IRM 4.71.1.14), provides that the IRS will permit two alternative methods for computing the highest outstanding balance within one year of the request for a new loan. As stated in the Memorandum for EP Employees, if a participant borrowed $30,000 in February which was fully repaid in April, and $20,000 in May which was fully repaid in July, before applying for a third loan in December, the plan may determine that no further loan would be available, since $30,000 + $20,000 = $50,000.  Alternatively, the plan may identify "the highest outstanding balance" as $30,000, and permit the third loan in the amount of $20,000.   Both methods will be acceptable on audit.

[49]    Code § 72(p)(2)(A).  Note that the 50% limit appears to be a requirement at the time the loan is made but not an ongoing obligation.  See Treas. Reg. § 1.72(p)-1, Q&A 4.

[50]    DOL Reg. § 2550.408b-1(f)(2).

[51]   This could be the sum of the highest outstanding balances for each loan during the one year period or alternatively the highest outstanding balance of all loans combined at any point during the one year period.  See discussion above regarding Memorandum for EP Employees (July 26, 2017).

[52]    Treas. Reg. § 1.72(p)-1, Q&A 19(b)(1).

See, Raymond H. v. C.I.R., T.C. Memo. 2011-139, aff'd, 2012-1 U.S. Tax Cas. (CCH) P 50391, 2012 WL 2036776 (5th Cir. 2012) (an individual who was a long time U.S. Air Force employee had borrowed money from his thrift savings plan; repayments were to be made by payroll withholding; the individual lost his job and the plan notified the individual that the remaining portion of the loan was due; he did not timely repay the loan and received a Form 1099R for a deemed distribution; the individual filed with the Tax Court, which held that he received a constructive distribution and was subject to the additional 10% tax under IRC § 72(t) for a premature distribution); Marquez v. C.I.R., T.C. Summ. Op. 2009-80, 2009 WL 1405883 (T.C. 2009) (the refinancing of a plan loan under which both the original and new loan were treated as being outstanding for purposes of IRC § 72(p)(2), resulted in a constructive distribution and the imposition of a 10% premature distribution tax; when the refinancing was authorized, the participant was advised that an additional loan could be made on the same terms as the original loan, or a new loan for a smaller amount could be made, either of which alternatives would have avoided exceeding the permissible loan limitation); Billups v. I.R.S., T.C. Summ. Op. 2009-86, 2009 WL 1519901 (T.C. 2009) (a participant refinanced a loan from a qualified plan, which resulted in exceeding the permissible loan limitation under IRC § 72(p); the individual had an outstanding loan balance of $27,013, and the participant refinanced it to borrow an additional $12,630, thus increasing his loan balance to $39,748; Tax Court determined that his loan would violate IRC § 72(p) limitations if it exceeded one-half of his $52,863 loan balance; court concluded that the sum of the new loan and the loan it replaced was $66,655 ($39,642 + $27,017), and that amount exceeded the applicable 50% of his account balance (the highest amount of permissible loan value without exceeding IRC § 72(p) limitation) by $39,748).​

[53]    Treas. Reg. § 1.72(p)-1, Q&A 19(b)(2).  67 Fed. Reg. 71821 (December 3, 2002).

[54]    See discussion below in section entitled "Proposed Amendments Regarding Refinancing and Multiple Loans" regarding a controversial proposed regulatory limit of two loans per year. 

[55]    Code § 72(p)(2)(B).

[56]    Conference Report to TEFRA 1982; Treas. Reg. § 1.72(p)-1, Q&A 4.

[57]    Joint Committee of Taxation General Explanation to TEFRA 1982 (Blue Book) § IV.D.2.

[58]    Code § 72(p)(2)(B)(ii).

[59]    See, Mardy, Loesel & Hamburger, "Guide to Assigning & Loaning Plan Money," ¶ 465.  See also, Treas. Reg. § 1.72(p)-1 (“The examples included . . . are based on the assumption that a bona fide loan is made to a participant . . . with adequate security and with an interest rate and repayment terms that are commercially reasonable”).

[60]    Treas. Reg. § 1.72(p)-1, Q&A 5.

[61]    Treas. Reg. § 1.72(p)-1, Q&A 6.

[62]    Treas. Reg. § 1.72(p)-1, Q&A 7.

[63]    Treas. Reg. § 1.72(p)-1, Q&A 8.  See Part I above regarding mortgage loans and mortgage investment programs.

[64]    Code § 72(p)(2)(C). 

[65]    DOL Adv. Op. 94-27A.  It held that Dreyfus Service Corporation's telephone voice response system could be used to make salary deferrals into pension plans because New York Labor Law § 193, which requires written authorization for payroll deductions (implying that telephone requests are not sufficient), is preempted by ERISA with respect to employee benefit plans.

        The New York State Department of Labor has issued at least one opinion that written authorization for payroll deductions may be satisfied when a blanket authorization has been made in writing for any future loan requests by electronic communications.  Butterworth, "Paperless Plan Administration:  Electronic Communications from Employees," 22 Tax Mgmt. Comp. Plan. J. 8 (August 5, 1994).

[66]    DOL Adv. Op. 96-01A.  It involved § 5(g) of Puerto Rico Act No. 17, which allows payroll deductions in writing for purposes of mandatory contributions to pension and savings plan, implying their payroll deductions for purposes of repaying plan loans would not be permitted.  The DOL held that § 5(g) is preempted by ERISA and ERISA § 514, since particularly, § 5(g) attempts to specifically regulate ERISA-covered plans.

[67]    Treas. Reg. § 1.72(p)-1, Q&A 9(a).

[68]    Treas. Reg. § 1.72(p)-1, Q&A 9(a) & Q&A 9(d) Ex. (1).

See, however, Frias v. C.I.R., T.C. Memo 2017-139 (a plan loan taken before a leave of absence was considered a plan distribution since the participant failed to begin making payments even though she was received paychecks from her employer while on leave).

[69]   Treas. Reg. § 1.72(p)-1, Q&A 9(b) & (c); Conf. Rep. to TRA 1986.

The participant loan interest rate may be restricted during the military service to 6% under the Soldiers & Sailors Civil Relief Act Amendments of 1942.  See, Treas. Reg. § 1.72(p)-1, Q&A 9(d), Ex (2).

[70]    Treas. Reg. § 1.72(p)-1, Q&A 20(a)(1).  67 Fed. Reg. 71821 (Dec. 3, 2002).

[71]    Treas. Reg. § 1.72(p)-1, Q&A 20(a)(2).

[72]    Treas. Reg. § 1.72(p)-1, Q&A 3(b).

[73]    Treas. Reg. § 1.72(p)-1, Q&A 3(b)(2).

[74]    Id.

[75]    Treas. Reg. § 1.72(p)-1, Q&A 3(b).  In 65 Fed. Reg. 46677 (July 31, 2000) the Treasury asked for comments on the impact of the Electronic Signatures in Global and National Commerce Act, P.L. 106-229, June 30, 2000, 15 U.S.C. §§ 7001-7031, on plan loan transactions.

[76]   Employee Plans News (April 1, 2015).  See also Fidelity Points of View (April 2015) criticizing the requirement to have documentation verifying that the loan proceeds were used to purchase or construct the home.

[77]    Treas. Reg. § 1.72(p)-1, Q&A 4(a).

[78]    Id.

[79]    Treas. Reg. § 1.72(p)-1, Q&A 4(a) & 10(a).  The same is true for the other requirements of § 72(p) such as the five-year repayment requirement.  Treas. Reg. § 1.72(p)-1, Q&A 4(a).

[80]    Treas. Reg. § 1.72(p)-1, Q&A 10(a). 

[81]    Treas. Reg. § 1.72(p)-1, Q&A 10(b).

[82]   In the first situation, loan payments were missed in two consecutive months, March 31 and April 30, which fell in different calendar quarters.  Loan payments were resumed in the following two months and applied to the previously missed payments.  In the third calendar quarter, the individual caught up all payments so that the loan was current.  In the second situation, the taxpayer missed payments for three consecutive months during the fourth quarter of the year.  In the following quarter, the taxpayer refinanced the loan with a new replacement loan equal to the outstanding balance of the original loan including the missed payments.  In both cases Chief Counsel Advice 201736022 held that the missed loan payments were timely corrected, so that a loan default was avoided.

[83]    See, e.g., Leon v. C.I.R., T.C. Summ. Op. 2008-86, 2008 WL 2796058 (T.C. 2008) (distribution following termination of employment includible in income under § 72(p) and subject to § 72(t) 10% penalty on early distribution on the expiration of the 90-day grace period to repay the loan); Plotkin v. C.I.R., T.C. Memo. 2001-71, T.C.M. (RIA) P 2001-071 (2001) (money purchase plan loan to sole shareholder violated the five year payment requirement and in addition to being a taxable distribution under § 72(p) would also be subject to the additional 10% early distribution tax under § 72(t)); Raymond H. v. C.I.R., T.C. Memo. 2011-139, T.C.M. (RIA) P 2011-139 (2011), aff'd, 2012-1 U.S. Tax Cas. (CCH) P 50391, 109 A.F.T.R.2d 2012-2433, 2012 WL 2036776 (5th Cir. 2012) (an individual who was a U.S. Air Force employee had borrowed money from his thrift savings plan; repayments were to be made by payroll withholding; the individual lost his job and the plan notified the individual that the remaining portion of the loan was due; he did not timely repay the loan and received a Form 1099-R for a deemed distribution; the individual filed with the Tax Court, which held that he received a constructive distribution and was subject to the additional 10% tax under IRC § 72(t) for a premature distribution); Matthews v. C.I.R., T.C. Summ. Op. 2014–84, 2014 WL 4251116 (T.C. 2014) (a participant who had a plan loan outstanding requested a distribution of funds from his 401(k) plan; he asked that the funds be used first to pay off the loan, a portion of the funds were withheld for income tax and the remaining were distributed to him and used for a rollover IRA; the Tax Court held that the 10% premature distribution penalty under IRC § 72(t) applied to the amount of the distribution used for the loan payoff); El v. C.I.R., Tax Ct. Rep. (CCH) 60251, Tax Ct. Rep. Dec. (RIA) 144.9, 2015 WL 1063061 (T.C. 2015) (Tax Court held that the 10% tax imposed under IRC § 72(p) for exceeding the permissible requirements for a loan under IRC § 72(p)(2) is not a penalty for purposes of IRC § 7491(c); therefore, the IRS does not bear the burden of proving that an assessment under § 72(p) is proper); Gowen v. C.I.R., TC Summary Opinion 2017-57 (Tax Court held that a CPA who defaulted on a plan loan during one tax year must include the deemed distribution once the cure period for repayment expires in the next tax year; the CPA who had a master's degree in taxation allowed a loan payment to a qualified plan to go into default in the third quarter of the year and failed to cure the default by the end of the fourth quarter; the CPA argued that the failure should be reported in the following tax year because he did not receive final notice from the plan custodian until after the end of the year; however, the Tax Court held that the failure was reportable for the year in which the failure occurred rather than the following year).

[84]    Olagunju v. C.I.R., T.C. Memo. 2012-119,  2012 WL 1392677 (holding that a distribution had to be included in gross income when the record contained no loan documents or other evidence showing that the distribution was evidenced by a legally enforceable agreement); Bormet v. C.I.R., T.C. Memo 2017-201 (an individual who obtained an initial loan, suffered an injury and received short-term and then long-term disability benefits, was reported by the retirement plan's TPA as being in default for nonpayment of a loan for $26,954; the individual claimed that the loan had been renegotiated but was unable or unwilling to offer any evidence that the loan was renegotiated or evidence of his disability; the Tax Court concluded that there was insufficient evidence of a renegotiated loan and determined that the entire unpaid balance of $26,954 should be includable in the individual's income)..

[85]    Treas. Reg. § 1.72(p)-1, Q&A 19(a).

[86]    Treas. Reg. § 1.72(p)-1, Q&A 11. See, e.g., Leon and Tilley v. C.I.R., 2008 WL 2796058, 44 E.B.C. 2405 (2008) (distribution following termination of employment includible in income under § 72(p) and subject to § 72(t) 10% penalty on early distribution on the expiration of the 90 day grace period to repay the loan); Plotkin v. C.I.R., T.C. Memo 2001-71 (2001) (money purchase plan loan to sole shareholder violated the five year payment requirement and in addition to being a taxable distribution under § 72(p) would also be subject to the additional 10% early distribution tax under § 72(t)).

[87]    Treas. Reg. § 1.72(p)-1, Q&A 14.

[88]    Treas. Reg. § 1.72(p)-1, Q&A 12.  See also, Treas. Reg. § 1.402(c)-2, Q&A 4(d), Treas. Reg. § 1.401(k)-1(d)(6)(ii), and Notice 93-3, 1993-1 C.B. 293.

[89]    Treas. Reg. § 1.72(p)-1, Q&A 13; Treas. Reg. § 1.402(c)-2, Q&A 9(a).

[90]    Plan loan procedures typically provide for various events of default.  The most basic one is failure to make payments when due.  Some administrators treat loans as being in default if payments are not made for three months, since that is the period after which they will be considered to be taxable distributions.  Another common event of default is termination of employment.  Termination of the plan will often cause an event of default.  Once an event of default has occurred the admini­strator may foreclose (unless otherwise prohibited from doing so) by offsetting the account balance.  A foreclosure is generally treated as a distribution.  Foreclosure occurs when the participant's account balance is offset by the loan amount.

[91]    Treas. Reg. § 1.72(p)-1, Q&A 13(b).

[92]    Treas. Reg. § 1.402(c)-2 Q&A 4(d); Treas. Reg. § 1.72(p)-1, Q&A 12; Notice 93-3, 1993-1 C.B. 293. 

[93]    Treas. Reg. § 35.3405‑1T, Q&A F‑4 & F-5.              

[94]    Treas. Reg. § 1.402(c)‑2, Q&A 9; Notice 93‑3, 1993-1 C.B. 293.

[95]    IRS Notice 93‑3 § III(b)(3), 1993-1 C.B. 293.

[96]    Treas. Reg. § 1.72(p)-1, Q&A 15.  To the extent that a loan constitutes a deemed distribution that results in income at the time the loan is made, withholding is required for such deemed distribution regardless of whether there is other cash or other property to withhold from.  Id.

[97]    PLR 8910034; PLR 8950008.

[98]    Treas. Reg. § 1.401(a)(31)-1, Q&A 16 ("A plan administrator is permitted to allow a direct rollover of a participant note of a plan loan to a qualified trust"). See also, PLR 9617046 (Jan. 31, 1996) (newly-transferred employees rolled over loan notes from one plan to another plan, with the transferee plan requiring the participant to acknowledge that transferee plan is new obligee; IRS held that the transfer of a loan note as a direct rollover under § 401(a)(31) could be made and would not be a taxable distribution under Code § 402(a) or 72(p); also since substantive terms of loan have not changed, not considered a revision or renegotiation of the loan and therefore not a new loan under § 72(p); PLR 9729042 (direct rollover of note is permissible, and will not be a taxable distribution).  See, also, Treas. Reg. § 1.402(c)-2, Q&A 9; 23 BNA Tax Mgmt. Compensation Plan. J. 195 (Aug. 4, 1995); 18 BNA Pen. Rptr. 2118 (Nov. 30, 1992); 92 TNT 235-3 (Nov. 24, 1992).  It is not clear from the regulations if a direct rollover of a note would be considered like a new loan from the transferee plan.

[99]   A deemed distribution is not eligible to be rolled over to an eligible retirement plan since it is not considered a distribution.  Treas. Reg. § 1.72(p)-1, Q&A 12.

[100]   Code § 402(c)(3)(C) as added by the Tax Cuts and Jobs Act of 2017 § 13613.

[101]  12 CFR § 226.3(g).

[102]  Although an IRA does not explicitly fit within the definition of disqualified person under Code § 4975(c)(2), the Conf. Rep. to ERISA, Rep. No. 43-1280 at 501, and PLR 8849001 support the view that transactions between the IRA and the IRA owner are prohibited transactions.

[103]  Code § 408(e)(2)(A) and (B).  See, also, Code § 408(e)(4).

[104]  See, e.g., In re Egebjerg, 574 F. 3d 1045 (9th Cir. 2009) (holding that a 401(k) loan is not a debt since the participant is merely paying it to himself, and Egebjerg could not include his payments on the participant loans as deductions for calculating monthly disposable income for the means test).  See also, Welmerink, "Cleaning the Mess of the Means Test: The Need for a Case-by-Case analysis of 401(k) Loans in Chapter 7 Bankruptcy Petitions," 41 Golden Gate U.L. Rev. 121 (Fall 2010). 

[105]  Treas. Reg. § 1.415-6(b)(3)(ii).

[106]  Treas. Reg. § 1.411(d)-4, Q&A 1(d)(4).

[107]   Rev. Proc. 2016-51, §§ 6.02(6) & 6.07.  This relief was originally provided in Rev. Proc. 2006-27, §§ 6.02(6) & 6.07.

[108]  Rev. Proc. 2016-51, § 6.07(2)(a) & (3).  See Rev. Proc. 2016-51, § 6.02(6) that for defaulted loans the employer should pay a portion of the correction payment equal to the interest that accumulates as a result of such failure (generally determined at a rate equal to the greater of the plan loan interest rate or the rate of return under the plan).

[109] Rev. Proc. 2016-51, § 6.07(1).

[110] Form 14568-E (Model VPC Compliance Statement for Plan Loan Failures), § IIA & B, provides that if the affected participant is either a key employee under Code § 416(i)(1) (e.g., an officer earning over $175,000 in 2018) or an owner-employee under Code § 401(c)(3), relief will be limited to reporting the deemed distribution in the year of correction instead of the year of failure.

[111] See also Rev. Proc. 2016-51, § 6.07(2)(a), that the IRS can deny correction to entirely avoid a deemed distribution if it deems appropriate, e.g., where the loan failure is not caused by employer action. 

[112]  Rev. Proc. 2015-27, at § 4.13 and Rev. Proc. 2017-4, App. A .08.

[113]  Rev. Proc. 2018-4, at § 2.03(4) (eliminating specific reduced VCP fees, beginning in 2018); Rev. Proc. 2018-4, at § 2.03(1) and App. A .09 (beginning in 2018, VCP user fees now based on plan assets).