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Qualified Loan Offset - oddball situation


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Several pieces come into play here. Situation - Employer A has a 401(k) plan. Employee X has a participant loan, and terminates employment in December of 2019. However, Employee X continues to make repayments on the loan, as permitted under A's plan. Employee X subsequently goes to work, for Employer B. In May of 2020, Employee X is laid off from employer B, and is a "Qualified Individual" for COVID purposes. Employee X now defaults on the loan with Employer A's plan. Whew!

First, purely with regard to the COVID loan delay provisions under the CARES Act, Assuming employer A's plan will allow the CARES Act delay, would it apply to a terminated participant from a different employer? I incline toward this being an employer decision when they do the amendment, but I'm not certain.

Second, at the very least, there is a delay in the deemed distribution/offset due to the IRS Notice 2020-23 provisions applicable to all loans with due dates during the applicable period. 

Finally, when this loan does default and is offset, is this a "Qualified Loan Offset" under IRC 402(3)(c)? I would tend to interpret the statute that this would only apply if the offset occurred due to the termination with Employer A, and not because of a termination with a subsequent employer. Thoughts? Other observations? 

(ii)Qualified plan loan offset amountFor purposes of this subparagraph, the term “qualified plan loan offset amount” means a plan loan offset amount which is treated as distributed from a qualified employer plan to a participant or beneficiary solely by reason of—

(I)
the termination of the qualified employer plan, or
(II)
the failure to meet the repayment terms of the loan from such plan because of the severance from employment of the participant.

 

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8 hours ago, Belgarath said:

I incline toward this being an employer decision when they do the amendment

That seems right to me, Belgarath. I would note that unlike some other issues one could think of, where a rule would be hard to administer for a plan of a different employer, in this case it would not seem any more burdensome, because the plan with the loan knows what it needs to know, i.e., that there is a loan that qualifies for the relief permitted under the statute.

 

8 hours ago, Belgarath said:

Second, at the very least, there is a delay in the deemed distribution/offset due to the IRS Notice 2020-23 provisions applicable to all loans with due dates during the applicable period

I have struggled with understanding the impact of 2020-23 on loans. Doesn't this just amount to the offset occurring on July 1 instead of June 30? If so, is that a big deal?

8 hours ago, Belgarath said:

I would tend to interpret the statute that this would only apply if the offset occurred due to the termination with Employer A, and not because of a termination with a subsequent employer. Thoughts? Other observations?

 

8 hours ago, Belgarath said:

Finally, when this loan does default and is offset, is this a "Qualified Loan Offset" under IRC 402(3)(c)? I would tend to interpret the statute that this would only apply if the offset occurred due to the termination with Employer A, and not because of a termination with a subsequent employer. Thoughts? Other observations? 

(ii)Qualified plan loan offset amountFor purposes of this subparagraph, the term “qualified plan loan offset amount” means a plan loan offset amount which is treated as distributed from a qualified employer plan to a participant or beneficiary solely by reason of—

(I)
the termination of the qualified employer plan, or
(II)
the failure to meet the repayment terms of the loan from such plan because of the severance from employment of the participant.

For posterity, the Code section is IRC sec. 402(c)(3)(C).

Yeah, in the absence of regulations or other guidance, which I don't recall any existing, we're just guessing, but "failure to meet the repayment terms of the loan from such plan because of the severance from employment of the participant" probably was intended to mean, basically, a loan acceleration clause where employer only accepts repayment if done through payroll withholding, and the withholding agreement terminates on severance from employment. Here, the first employer let the loan continue to be paid after termination, and the reason it is accelerated is the former employee's failure to make payment, which, even if termination with the second employer counted, which it probably  doesn't, might or might not be "solely by reason of" the separation from second employer.

Anyway, there's a good chance the borrower will get to treat the loan offset distribution as a CRD, right? Gives him or her even more time, I would think.

 

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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Working backwards, I think the answer to whether it is offset or not depends on the plan's distribution provisions.  If the participant is entitled to a distribution (e.g., in this case, either immediately following termination of employment or at least in the next year...but NOT if the plan calls for a one-year break in service) then it is offset as an effective distribution.

As far as the impact of Notice 2020-23, I think it means that loan payments aren't "due" until July 15 which, if you use the "end of the next quarter" default provisions, means the loan defaults Dec 31 if payments aren't made.  

For the first Q, I agree it depends on what is in the amendment the employer adopts.

Ed Snyder

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Thanks Luke.

Not sure I understand your offset comment? Under IRS Notice 2020-23, if the loan is in default as of 7/15, then the maximum cure period is the end of the clendar year quarter following the calendar year quarter of the default. So December 31.

Yes, I botched the typing of the Code reference, thanks for correcting.

As to the CRD issue, I agree, but I wasn't getting into that aspect, just trying to nail down the loan issues. 

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4 hours ago, Belgarath said:

Not sure I understand your offset comment? Under IRS Notice 2020-23, if the loan is in default as of 7/15, then the maximum cure period is the end of the clendar year quarter following the calendar year quarter of the default. So December 31.

Belgarath, I have to admit I may not have total clarity on the impact of Notice 2020-23, but when I reviewed the language to me it seemed unclear whether what was postponed until 7/15 was deeming the loan or the end of the cure period. There is no example or clarification, of course, in 2020-23, but it seemed to me that what it was postponing was the plan's required action under 72(p), which is the deeming. I guess you can look at it and say the IRS is intentionally conflating the end of the cure period with the act of deeming by the plan, and I will admit that that is the only way it makes much sense, since postponing the earliest date on which the 1099-R could be issued does not provide much relief to the employer or the participant. So you're probably right on the meaning and intent, but it seems to me the language in Notice 2020-23 is not a model of clarity as to what it is intended to accomplish regarding participant loans. I mean, it does not mention "cure period," if I recall correctly. The main problem I have is that the participant's obligation to repay the loan is not a required action regarding income tax payment or reporting, for which IRS can extend deadline. The only tax obligation that is implicated and that the IRS can extend the date for is the plan administrator's.

But again, common sense says that your interpretation is probably correct.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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