Participant filed chapter 7 bankruptcy early in 2009, so his attorney advised him to stop making payments on his plan loan. We know that we need to report this as a taxable distribution. The participant wants to know when he can take out a new loan. I do realize that he may not be "credit worthy", but besides that, what other restrictions do we need to consider? If the plan only allows one outstanding loan, does this mean that he cannot ever get another loan?

My understanding is it will be deemed distributed (meaning it becomes taxable income for the individual) but remains an open loan (unless your plan provides for the defaulted loan to be offset which is the standard terminology generally referring to when the defaulted loan balance is reduced to zero). So no new loans until the current one is repaid (with the payment(s) going into an after-tax source).

even if the plan allowed for more than one loan, as Masteff indicated, the defaulted loan is still an 'open loan' accruing interest [in other words you are supposed to keep track of things on 'paper'] the maximum new loan is recuded by an outstanding loans, so depending on the individuals balance and the amount of the defaulted loan, it could very well be the individual would not be able to take a new loan.

I disagree that a defaulted loan is treated as an open loan for all purposes. The regs indicate otherwise. (Treas. Reg. Section 1.72(p)-1, Q&A-19.) It is specifically treated as an outstanding loan for purposes of determining the amount of a subsequent loan following default, but it should not be treated as an outstanding loan from a plan perspective (thus eliminating the ability of a participant with a defaulted loan to take another loan if the plan limits the number of loans to one per participant) unless the document so provides.

Corbel's EGTRRA document specifically asks if the participant is allowed to take a new loan if they've had a defaulted loan. The pretty much clears up any ambiguity on the issue.

Is that in the prototype? The IDP? Where?

In the prototype it is question 69.3d4 in the checklist. The choice selected appears as the final sentence of the Loan Policy document.

Thanks, K2. (I rarely see a checklist anymore . . .)

It is an Corbel Prototype.

I don't see that item on my Corbel document checklist. Which document version do you see that on?

Tom - are you saying that even if the plan limits the loans to ONE loan at a time that the participant can infact take an additional loan provided that the account has sufficeint loan security?

I have looked through the document and i don't see the wording that was pointed out in the other repsonses

Some comments:

1. Until repaid (by actual repayment or offset), the loan is considered outstanding with interest accruing for purposes of applying the IRC loan limits to a second loan.

2. The application of the IRC loan limits to multiple loans and refinanced loans can be tricky. Reading the IRS regulations is a must.

3. The plan document (or loan policy) should dictate whether a second loan is allowed. But in any case, note that under IRS regulations, until the first is loan is repaid, the second loan will not be treated as a 72(p) loan unless the second loan is repaid by legally enforceable payroll withholding or additional security is provided for the second loan.

4. Don't lose track of plan asset/fiduciary duty issues (i.e., duty to collect and hold money owed to a trust) -- more of a DOL perspective (assuming a bona fide loan in the first place).

5. Bankruptcy adds its own layer of complexity (regarding automatic stays and discharge of the loan as debt).

It's the PPD language type, version 1.0.