When is a loan in default?

[Guest DWARD]

Does the IRS or the DOL have any definitive regulations (guidance)for a Loan Default? Does a specific amount of time have to pass before the loan is in default? Is a Plan Administrator the only person who can deem a loan in default? Thanks to all who can give guidance on this issue. DSW

[MWeddell]

The promissory note or loan agreement when the loan was issued will state when a loan is in default.

The DOL does not have any specific guidance.

The IRS on 7/31/2000 issued final and proposed regulations under Code Section 72(p) on when a loan is deemed to be a distribution for tax purposes, which is similar to your question. Although plans may set stricter rules, the loan is treated as a taxable distribution when there's a whole calendar quarter with no payments. The first year of unpaid leave may be ignored and payments aren't required if the participant is on leave because of U.S. military duty.

[R. Butler]

I agree with MWeddell. Failure to make a payment when due in accordance with the terms of the loan is generally considred a default at the time of the missed payment. However, the plan administrator may allow a grace period, and the default will not occur until the last day of that grace period. The grace period cannot extend beyond the last day of the calendar quarter following the quarter in which the payment was due.

You should start with the loan document and perhaps the loan agreement signed by the participant. Does the loan program or loan agreement provide a grace period? If it does use that grace period. If the document and/or agreement is silent then the plan administrator may use grace period set forth in IRS Reg. §1.72(p)-a,Q-10.

I would reccomend defining the grace period in the loan document just to avoid confusion.

[Dave Baker]

The 2000 final regs are here: http://www.benefitslink.com/taxregs/72p-final.shtml

[card]

Additional question on this issue: What if the 5 year limit intervenes before the grace period ends? Which controls? That is, can the grace period be used to avoid the 5 year limit for immediate taxation of the outstanding balance?

card

[MWeddell]

IRS regulations under Section 72(p) provide that the 5-year limit still applies even if loan payments weren't made due to a grace period (unless of course the the loan was for the participant's prinicipal residence so that the 5-year limit didn't apply in the first place).