Delinquent Loan Payments Due to Employer Error

[Guest pjrieck]

What options does a plan sponsor have if a loan is technically in default and a deemed distribution should be issued because of the plan sponsor's failure to withhold loan payments?

[jane123]

Hi Patrick,

I had a similar situation a few weeks ago

The loan must be treated like any other loan that is in defualt. The PAs failure to withhold payments does not excuse the particiant frrom repaying the loan. He/she received pay slips and is able to tell if payments were bing deducted. If they were not, thne he/she could have corrections made or send in the payments

Hope this helps.

jane

[mbozek]

It is not the particpant's responsibility to review the withholding allowances and as any one would know paryroll depts are not the most cooperative or reliable dept of the employer. I think the employer would have legal liability for the taxes for failure to withhold. But there is a way which can be used the avoid the tax-reform the contract. The PA could treat the loan as never having been made because the employee did not accept the funds under a bona fide claim of right but agreed to pay back the money under the terms of the note. I dont know of any case in which the employee would be taxed on the loan proceeds because the employer who is not a party to the loan failed to initiaite withholding on the loan. ( Of course the IRS will not penalize the plan for treating the loan as a distribution.) The problem is that the employee would have to refund the loan proceeds to the plan before a new note could be issued and most participants cant refund the loan proceeds. Recinding the loan requires retention of expert tax counsel and the attendent cost but there is precedent for rescinding transactons under the IRC. One caveat - rescinding a contract works only if the rescission occurs in the same year as year the loan is issued.