Plan Administrator Failed to Deduct Loan Payments

[Guest Sara H]

I have just noticed that the Plan Administrator of one of our clients has failed to deduct and remit loan repayments for one of their participants. Loan repayments should have begun 6/01 and the loan was for 2 years. I know that according to the regulations a 1099-R should be issued for the participant and they should begin to make loan repayments. I have 2 questions:

1) Does loan have to be repaid by the end of the 2 years or can it be extended because it is less than the 5 year maximum?

2) Is there any way around having to issue the 1099?

[KIP KRAUS]

It is my understanding that the effected employee has two options.

1.Make the full payment of the outstanding loan payments to bring the loan up-to-date, or

2.Have the loan re-amortized for the remainder of the two-year period at the original loan interest rate, which would make the loan payments higher.

The plan administrator should be able to assist you in this matter.

There are regulations that provide guidance on this issue, but i can't recall the exact regs.

[stephen]

Why didn't the affected participant say anything about the loan repayments not coming out of their paycheck?

[Guest Sara H]

I asked the plan adminstrator the same thing & she didn't know why he didn't say anything.

Is it really OK to just reamortize the loan so that the payments are completed by the original loan maturity date and then not issue a 1099-R?

[stephen]

I think it is ok to reamortize and not issue a 1099.

KIP KRAUS-

I would like to know why the loan couldn't be reamortized for two years from this point forward since it wouldn't extend beyond the 5 year maximum.

I do think the interest would have to be calculated from the original loan date and incorporated in the outstanding balance.

[KIP KRAUS]

Stephen;

It’s my understanding that the loan cannot be extended beyond the original two-year period based on my conversations with a Vanguard representative whom I relied on to give me this information on an employee.

It makes sense to me.

[Mike Preston]

Boy, 72(p) is confusing.

The relevant regulation citation appears to be 1.72(p)-1, Q&A-4 and Q&A-10.

At least, that would be the cite if dealing with a loan that was issued 1/1/2002 or later.

The key issue appears to be the timing of a default, if any, under the loan.

Under the reg, the actual default takes place on a date defined as the date that a payment was missed moved forward with reference to a "cure period." The cure period may not extend beyond the last day of the calendar quarter following the calendar quarter in which a payment was missed.

So, if the loan was taken out sometime in June of 2001, with quarterly payments, and the first payment was due on 10/1/01 (not likely, but it is worth checking), the end of the cure period could be as late as 3/31/2002. In this case, you look to the loan's provisions to determine how much the participant must pay to bring the loan current. Have that payment made by 3/31/2002 and the participant should be ok.

However, if the loan was taken out in June of 2001 and the repayment provisions of the loan call for the first payment to be made on or before 9/30/2001, then the last date the cure period could end would have been 12/31/2001.

But the reg wasn't really in effect for this loan, because it was taken out before 1/1/2002.

So we are back to where we started: how does the plan define a default? If a default took place in 2001, the 1099 must be issued.

If a default didn't take place, the loan should be attended to so that a default doesn't take place.

Look at the loan document and the plan's loan procedures. See what they say about a default and how to avoid a default.

I would not think that reamortization, whether over a new two-year period, or ending on the original due date would satisfy the definition of avoiding a default. On the other hand, if the participant is incapable of paying the amount of money that would allow a default to be avoided, maybe the participant can take out a new loan.

Now it gets fun.

You would think that since the new loan is being negotiated after 1/1/2002 that the new regs would apply. But the new regs didn't specify how to treat multiple loans, etc. That Q&A (number 20) was "reserved".

At the same time that the IRS issued the final regs under 72(p), they also issued proposed regs under 72(p) that dealt with, among other things, Q&A-20.

So it seems that you can, if you want, follow the rules of Q&A20 in the proposed regs to decide whether a new loan, to replace the old loan, would satisfy the rules.

In that case, a reamortization that doesn't extend beyond the due date of the original loan would certainly meet the criteria.

But that, in and of itself, unless you can avoid a default under the original loan, won't avoid the 1099.