Participant Loan in Excess of $50,000

[Guest cease]

In this day and age, it is difficult for me to understand this, but just the other day a person contacted me with the following issue:

On Feb. 1, 2003, a 35 year old 401(k) plan participant (with a $400,000 vested account balance) received a participant loan from the plan in the amount of $100,000. No additonal propery was used to secure the loan. The participant started to make payments on the $100,000 loan. In 2004, the plan sponsor learned about the $50,000 limit and started to ask questions about what to do.

I have looked at 72(p) and its regs, I have looked at 4975 and its regs and have come up with the following conclusions:

1. The participant received $50,000 too much.

2. $50,000 can remain classified as a loan - since payments have continued to be made, I am not concerned about the status of the loan. I may suggest that the outstanding principal be calculated and the payments then recalculated over the remaining life of the loan.

3. The other $50,000 is a deemed distribution subject to 1099-R reporting and subject to a 10% under 59 1/2 penalty tax. Since this amount comes from a orifut sharing plan with a 401(k) feature, it is not treated as an actual distribution.

4. A prohibited transaction has occured and the plan sponsor is subject to a 15% excise tax for 2003 and 2004 (Assuming that the participant is reported on Form 1099-R in 2004).

5. The 2003 Form 5500 must accurately reflect this prohibited transaction. There would be no loan in default.

I would welcome any input or comments as to whether or not I am looking at this correctly or not. Thanks as usual.

[QDROphile]

You should consider if the plan is disqualified either because of failure to follow plan terms or indirectly by violating the proscription on in-service distributions.