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409a as collateral for loan


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7 replies to this topic

#1 Beemer

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Posted 14 December 2011 - 03:26 PM

A client wants to use their 409a plan as collateral for a personal loan. This would create a taxable distribution, correct?

Thanks for any help.

#2 jpod

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Posted 14 December 2011 - 03:33 PM

I doubt it, because most likely the deferred comp. accrued under the arrangement cannot be assigned in this fashion in the first place, so what the lender and borrower may think is good collateral really isn't.

#3 QDROphile

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Posted 14 December 2011 - 04:53 PM

Although overshadowed by section 409A, constructive receipt and economic benefit concepts still apply. Is the ability to use the deferred compensation to obtain a loan an economic benefit that would cause some amount to be taxable? I agree with jpod tha that the practicalities of the situation make it unlikely.

#4 Beemer

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Posted 14 December 2011 - 05:29 PM

The client's information came from the bank. The bank told them they could have the loan, but their 409a would be taxable.

#5 Beemer

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Posted 15 December 2011 - 10:42 AM

According to the IRS Nonqualifed Deferred Compensation Audit Techniques Guide (02-2005), "For example, the employee may borrow, transfer, or use the amounts as collateral, or there may be some other signs of ownership exercisable by the employee, which sould result in current taxation for the employee"

#6 jpod

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Posted 15 December 2011 - 11:59 AM

But that analysis assumes he CAN use it as collateral, and I am willing to bet you that the documentation for the plan says he CAN'T (if the document was thoughtfully drafted by someone with tax law knowledge).

#7 XTitan

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Posted 16 December 2011 - 11:13 AM

For context, the complete quote from the Audit Guide is -

When examining the answers and documents received in response to these questions, look for indications that --

a. the employee has control over the receipt of the deferred amounts without being subject to substantial limitations or restrictions. If the employee has such control, the amounts are taxable under the constructive receipt doctrine. For example, the employee may borrow, transfer, or use the amounts as collateral, or there may be some other signs of ownership exercisable by the employee, which should result in current taxation for the employee

That doesn't say that the employee may borrow; it says that if there is language in the plan that says that an employee may borrow, there is constructive receipt and current taxation.

Since final 409A regs came out after the publication of the audit guide, if the plan is subject to 409A, you might want to review the language in 1.409A-3(f) as well.
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#8 Beemer

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Posted 16 December 2011 - 11:14 AM

The attorney at the bank says that the agreement is silent on the pledging/collateral issue. The attorney also said this was a taxable event.