Loan amoritzed over 4 years; small baalnce at maturity; default immediately or apply cure period?

[R. Butler]

Participant takes a loan in May 2000. The maturity date is June 2004. Particpant missed a couple of payments at some point in time & in June 2004 was a month or 2 behind. The loan document echo's the law as far as cure period goes. Should this participant default unpaid balance in June 2004 because loan has hit maturity or should participant get the benefit of the cure period?

Thanks in advance for any guidance.

[E as in ERISA]

At what "point in time" were the payments missed? Wouldn't the cure period have ended after the calendar quarter following that "point in time"?

[rcline46]

Participant didn't 'miss' payments, only was late. Since not beyond 5 years must continue to make payments until loan paid. No default.

[E as in ERISA]

Its not the five year rule I'm concerned about. I think that the "level amortization" rule requires that if you miss/are late on a couple of payments in a quarter, then you need to be all caught up the following quarter (with the mised/late payments and all the following quarters' payments) or you have a default. I don't think that you can keep rolling the missed payments forward so that you're never more than a quarter behind.

[rcline46]

Let's be practical. Did the recordkeeper tell the plan administrator the loan was in arrears and had to be caught up by date x? Was the PA notified of their liability? Is it in writing?

If the loan is paid within the 5 years I really don't think the IRS is going to disqualify or penalize the plan, and if you 'cure' the loan with the missing payments no one will raise a stink under audit. IMHO

[FundeK]

From the IRS & ABA Section of Taxation May Meeting 2003

Question:

§72(p) – Taxation of Plan Loans Employer maintains a defined contribution plan that provides loans to its participants. The plan provides for a sixty-day cure period for missed installment payments. An employee takes out a five-year plan loan, and fails to make his last installment payment. Would permitting the employee to cure the missed payment after the five-year term but within the cure period for the loan violate the requirement of §72(p)(2)(B)?

Proposed response:

No. Curing a missed payment after the term of the plan loan but within the cure period provided by the plan and within the limitations prescribed by Treas. Reg. 1.72(p)-1, Q&A-10 would not violate the requirement of §72(p)(2)(B) of the Code. Payments made within the cure period are deemed to relate back and considered made on the day the installment payment was due.

IRS response:

The IRS agrees with the proposed answer. The plan can use a cure period even at the end of the sixty-month period.

[R. Butler]

Its not the five year rule I'm concerned about. I think that the "level amortization" rule requires that if you miss/are late on a couple of payments in a quarter, then you need to be all caught up the following quarter (with the mised/late payments and all the following quarters' payments) or you have a default. I don't think that you can keep rolling the missed payments forward so that you're never more than a quarter behind.

Just to clear up the initial question a littlle bit. The recordkeeper wants to default the loan, not because a payment was made outside of the cure period. They want to default the loan because at the maturity date there is still a balance.

I don't know that I agree there was a default due to failure to make a required payment within the cure period. Any payment participant makes is going to be applied to the oldest payment due. Isn't that true even in commercial loans? If I miss the $300 August payment on my student loan, but I pay $300 in September, student loan co. applies that $300 to the August payment. I'm not 60 days behind on August & paid for September, I'm 30 days behind on September.

[E as in ERISA]

I'm assuming that a couple of payments were missed mid-stream and then the participant just continued making regular payments without ever making up those payments until the very end?

Here's Pam Perdue's discussion of what happens when a participant has one missed payment but then resumes making the other payments. She agrees that may technically be a violation of the level amortization rule at the time of the missed payment (or end of cure, if applicable). The participant's argument is that it is "substantially" level amortization even if one or two payments is missed.

See "Is a “Loan” Includible in Income as a Result of a Single Missed Payment?"

http://www.pamelaperdue.com/Articles___Out...oan_article.htm

[R. Butler]

I'm assuming that a couple of payments were missed mid-stream and then the participant just continued making regular payments without ever making up those payments until the very end?

Here's Pam Perdue's discussion of what happens when a participant has one missed payment but then resumes making the other payments. She agrees that may technically be a violation of the level amortization rule at the time of the missed payment (or end of cure, if applicable). The participant's argument is that it is "substantially" level amortization even if one or two payments is missed.

See "Is a “Loan” Includible in Income as a Result of a Single Missed Payment?"

http://www.pamelaperdue.com/Articles___Out...oan_article.htm

Thanks. Its been a long, long day, so I may very well be missing something, but it seems to me Ms. Perdue doesn't really give a definitive answer. In fact by citing the court case she provides strong reasoning against saying default. Again its been a long day & I may be missing something.

In any case, thats not really my issue here. The recordkeeper is strictly focusing on the maturity date. The post by FundeK more directly addresses my issue.

Thanks again.

[E as in ERISA]

I agree if that you then you are allowed use a cure period to go past maturity. So if you take the position that your payments are "substantially" level for purposes of the level amortization rule and consider that satisfied, then I don't see the need to default for the other.

[Bird]

There is no default. The recordkeeper needs Prozac.

[R. Butler]

There is no default.  The recordkeeper needs Prozac.

Prozac maybe a little too far. Here the recordkeepers reasoning

"This is the explanation that we received from our law department on our loan monitoring:

Section 72(p)(1)(A) sets forth the general rule that an amount received as a loan from a qualified employer plan will be treated as having been received by the participant as a distribution under such plan, unless the loan satisfies certain requirements. Specifically, Section 72(p)(2)(B) provides that a loan must be repaid within 5 years unless such loan is utilized to acquire a principal residence.

The regulations promulgated under Section 72(p) explain that "a deemed distribution occurs at the first time that the requirements of Q&A-3 of this section are not satisfied, in form or in operation." See Treas. Reg. 1.72(p)-1, Q&A-4. Furthermore, "f the loan initially satisfies the requirements of Section 72(p)(2)(A), (B) and © and the enforceable agreement requirement ... but payments are not made in accordance with the terms applicable to the loan, a deemed distribution occurs as the result of the failure to make such payments. See Q&A-10 of this Section regarding when such a deemed distribution occurs and the amount thereof."

Q&A-10 reflects that if an installment payment is not made in violation of Section 72(p)(2)© (the level amortization requirement as opposed to the 5 year term limit under Section 72(p)(2)(B)), a deemed distribution will occur at the time of such failure unless the plan administrator allows a cure period. In that instance, "Section 72(p)(2)© will not be considered to have been violated if the installment payment is made not later than the end of the cure period, which period cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due." In other words, a cure period may apply to prevent a default in the event the loan fails to satisfy the level amortization repayment requirement (due to a missed payment) but it does not apply to extend the term of a loan beyond the 5 year statutory limit."

I don't necessarily agree with there conclusion, but I fought the good fight & just probably will come out on the short end of the stick this time.

[ccassetty]

I agree with rcline46. The participant should be allowed to pay off the loan.

[rcline46]

(opinion of legal counsel deleted in good taste)

If a default and deemed distribution made, it does NOT remove the need for the additional payments!!! That can only happen when there is a distributable event.

So, the participant still has to repay the loan.

And now there is a 'cost basis' established which will complicate future distributions! That is NOT a good result. Lawyers are not thinking this through, and they don't have to administer the plan in the future.

[Bird]

In other words, a cure period may apply to prevent a default in the event the loan fails to satisfy the level amortization repayment requirement (due to a missed payment) but it does not apply to extend the term of a loan beyond the 5 year statutory limit."

I believe the above is the conclusion of the legal department, and not a conclusion in the regs. It certainly shouldn't be the latter, because the IRS doesn't agree. (And I don't see how one could leap to that conclusion from the preceding text!) From a recent Sal Tripodi seminar: in a Q&A session with the ABA on May 9, 2003, the IRS said that the cure period DOES apply to the last loan payment. Q&A 1.

Oh, I see FundeK has already provided the cite and the text! Did the attorneys see that?! The sad thing is, they are wrong and they are the only ones getting paid here!

[R. Butler]

Oh, I see FundeK has already provided the cite and the text!  Did the attorneys see that?!  The sad thing is, they are wrong and they are the only ones getting paid here!

I did refer the recordkeeper's legal department to the Q&A FundeK posted. I actually have a conference call with them today, but I don't expect that they will change their position. I may disagree with their position, but again I do follow the reasoning. Although that Q&A may give us incite, it is informal guidance. I know there is informal guidance on other issues that I disagree with & do not follow.

I had to take this issue up with the recordkeeper simply because they never stated this position in any of their policies. It is not stated in loan distribution papers & since we prepared the loan document based on the recordkeeper's known policies, there isn't anything in the document limiting the cure period in these situations. The participant was not notified until there was already a default. Given all this, I felt this issue was worth taking up.

[FundeK]

The original post indicated the loan was issued in May 2000 and had a maturity date of June 2004 (4 year loan?) If so, does your loan policy allow for refinancing?

If the loan is still within the cure period, why not refinance and allow the participant to make up the two missed payments. Just extend the loan 2 months, you will not be extending it past the 5 year limit.

Would the attorneys allow this?

[R. Butler]

The original post indicated the loan was issued in May 2000 and had a maturity date of June 2004 (4 year loan?)  If so, does your loan policy allow for refinancing?

If the loan is still within the cure period, why not refinance and allow the participant to make up the two missed payments.  Just extend the loan 2 months, you will not be extending it past the 5 year limit. 

Would the attorneys allow this?

It was a 4 year loan. I didn't look into the specific thing you suggest, but it wouldn't make sense to me that they would allow that. Thats the heart of the issue. The recordkeeper's position is that there is no cure period. Once the loan reached the maturity date the loan is in default. If the recordkeeper was allowing for a cure period the participant could just pay the loan off.

I may take a stab at the suggestion anyway, just try to trick them into into inconsistent position.

Thanks.

[FundeK]

R Butler: From your post on Sept 10th

In other words, a cure period may apply to prevent a default in the event the loan fails to satisfy the level amortization repayment requirement (due to a missed payment) but it does not apply to extend the term of a loan beyond the 5 year statutory limit

I was thinking that the Client was concerned with extending the loan beyond the maximum statutory limit of 5 years, not the maturity date.

Where does it say you can't extend past the maturity date if the loan was not issued for a term of 5 years?

Can you convince them that the last payment can extend past the maturity date if it is made within the cure period, not to exceed the 5 year maximum limt?

Good Luck!!

[R. Butler]

Can you convince them that the last payment can extend past the maturity date if it is made within the cure period, not to exceed the 5 year maximum limt?

That is a good point that I just missed. Their ultimate conclusion rests on the maturity date, but as you point out the reason they gave me focuses on the 5 year limit. I'll will try that. Thanks.

[E as in ERISA]

The argument is that the "five year" rule only applies to the terms of the loan as initially drafted; if there is later a problem with payments, the term of the loan is not an issue. It is only a level amortization rule and the cure period rule applies.

72(p)(2)(B) only says that the loan has to be "repayable" within 5 years -- i.e., that the loan "by its terms is required to be repaid within 5 years." Q&A 4 of the regulations indicates that you have a deemed distribution if that requirement is not met "at the time the loan is made."

Q&A 4 says that once payments start, then you apply the rules regarding failure to make payments in Q&A 10.

Q&A 10 is not concerned about the amount (72(p)(2)(A)) or the 5 year rule (72(p)(2)(B)). It is only concerned about level amortization (72(p)(2)©). And it considers those rules met as long as the payments are made within the cure period.