Improper Loan

[Guest At Peace]

Have a plan that does not allow loans to participants - however, in 2002 the owner decided to take a loan for $50,000 - (less than 50% of his account balance). (He is making payments)

Does anyone know the correction procedure for this operational error (or is it a prohibited transactions)?

I can't find anything that is specific in EPCRS. Closest I found was in relation to Hardships - -

Thanks for your input and expertise!

[Belgarath]

It's a prohibited transaction. But I think you may be able to correct under the Voluntary Fiduciary Compliance (VFC) program. Take a look at Section 7.B.1 of the VFC program. It may be that this will work for your situation.

[QDROphile]

Failure to follow terms of the plan is a qualification error. Look into EPCRS again.

[Guest At Peace]

Thanks for the responses.

I looked at VFC 7.B.1. - this seems to address a loan to a party-in-interest with improper interest rate. Although I believe that the correction for an improper loan may be the same - pay the loan in full.

If we could take advantage of VFC under this option, then might can file for the exemption under PTE 2002-51. (?)

Since this is an operational error (failure to follow terms of plan), then if we use the SCP (correction I believe would be to pay the full amount back to plan - although I still can't find anything specific in EPCRS), then could avoid notifying IRS - and have client pay the penalty for prohibited transactions.

Additional thoughts or ideas are welcome!

[Guest jashendo]

If you could correct under SCP, then you would not have to notify IRS under EPCRS. But either IRS or DOL is going to know about the occurrence. IRS will receive 5330 and excise tax, unless you use VFC (successful VFC submission automatically qualifies for exempotion from excise tax so long as further conditions of 2002-51, such as fair market interest rate, are satisfied -- no separate application is needed); DOL will obviously hear about it if you go the VFC route, and, in any event, the loan will (should) be disclosed on the 5500.

Two things to keep in mind when deciding on a course of action --

First, loans are "pyramiding" transactions for excise tax purposes. That is, assuming full correction in 2003, then on his 2002 Form 5330, the owner would owe the 15% tax on the "amount involved", and on his 2003 Form 5330 the owner would owe two 15% taxes (total of 30%) on the amount involved. (A second transaction is deemed to have occurred on 1/1/03.)

Second, depending upon the facts, there may be additional prohibited transactions. For example, if the owner were also the plan fiduciary who made the decision to make the loan (to himself), then that decision constituted a separate prohibited transaction from the loan itself. Sometimes, additional steps are required in or

der to correct in such a case.

[Belgarath]

7.B.1 is actually for a loan at a proper interest rate to a party-in-interest. But there are so many issues here that I'd strongly recommend that the client employ legal counsel.

For example, I agree that there is no specific EPCRS correction listed, that I know of, for this situation. Even if you think EPCRS is available, can you use SCP, or must you do a submission to IRS? And even IF you can avoid excise tax on the prohibited transaction under VFC, you still have the issue of a distribution (because it wasn't a valid participant loan) from the plan, with tax and premature distribution penalty if applicable.

You're going to have to notify the IRS in one form or another no matter what you do here. Even if you take the approach you can use SCP, (which I'm inclined to doubt, but could be wrong) you'd still have to either file under VFC to avoid the prohibited transaction excise tax, or you'd have to file a 5330 to pay the tax. So this one can't just be swept under the rug.

[Guest At Peace]

Thanks for all the responses and info!

Probably will go with the VFC and the 2002-51 exemption. It sounds like the best route overall.

Why do plan sponsors do this kind of thing to themselves? I'll never understand it!!!