Delinquent loan reporting for active participant

[pbarrett]

We have a takeover plan (401k) that has numerous participant loans. When a loan is made, the funds are actually withdrawn from the participant's mutual fund. A loan account is set up to track payments and is considered an asset of the plan.

We have found two participants who took loans in '99. Both participants stopped making loan payments in 2001. Both employees are still employed. The employer felt sorry for them because they are paid very little and felt it was the right thing to do because "it was really on their money anyway." We are now going to report the loans as defaulted. My questions are:

1.) Do we report the outstanding loan as of the date of the last payment and add interest on? 2.) Do we just carry the balance and accrue interest (don't report) every year? 3.) When the participant quits, how do we then report it? We cannot adjust basis because on both participants hardship withdrawals have taken place so the only remaining asset is our loan account. 4.) Am I correct in thinking you cannot rewrite a loan in default unless you are still in the cure period?

Please help!! We're trying to get the 1099R out at least by the 2/28 deadline. I know we should have had the employees copy out already.

Thanks,

Pat

[mbozek]

Is the employer aware that you are proposing to issue a 1099-R for 2001 to show that distribution occured after default. This will result in the employees' having to pay back taxes and penalities which was not the result the employer intended when it allowed the employees to cease making contributions. After default the loan balance is treated as an after tax contribution.