Defaulted Participant loan as prohibited transaction

[Guest bwell]

I am dealing with an IRS agent who is claiming that the failure to make payment on a participant loan is a prohibited transaction. Note that he is not claiming that the loan failed to meet the requirements of Section 72(p) or 4975(d)(1), or that there was no intent to repay the loan. He is stating that the failure to make payments called for under the promissory note caused the PT. He claims that this is "the policy of the Service".

Anyone run into this? This seems clearly contrary to the exception in 4975(d)(1).

[E as in ERISA]

Why? The exception only applies if the conditions are met. In the past, loans in default have shown up on the schedules of non-exempt transactions attached to audit reports and Forms 5500. In the preamble to the 2000 72(p) regulations the IRS notes that the DOL does not believe that a loan qualifies for the ERISA version of the PTE exemption if there is not timely payment or collection efforts with respect to loans in default: “In the view of DOL, it is questionable whether a participant loan program … that does not provide for timely repayment of loans (through payroll withholding or otherwise), regular and effective collection efforts following a default… would qualify for the relief provided under section 408(b)(1).” I haven't particularly seen it enforced before, but its not surprising...

[QDROphile]

Put another way, the plan has to act as a commerically reasonable lender. If it just winks at defaults, it is not meeting the terms of the exeception when it makes the loan.

[austin3515]

Is there a recommended best practice?

For example, should a letter be sent demanding repayment? Should it be sent to a collections agency? Etc. etc...