Assuming a plan allows loans to be repaid over 5 years, what is the re

[Guest SAG]

Assuming a plan allows loans to be repaid over 5 years, what is the required maturity date of a loan that was taken out to refinance a previous loan. There appears to be two possible answers here: reamortize the loan with a maturity date five years from the date the original loan was taken out, or reamortize with a maturity date five years from the date the new loan is taken out.

I guess what it boils down to is whether the second loan is considered a new loan. Any guidance or information would be greatly appreciated.

[Guest GregSelf]

We had a heck of a time finding a ruling on this issue. Finally got a formal opinion from the legal gurus at Corbel. Their opinion was that this is a "gray area". There is no language (maybe proposed?) that dictates this type of situation. We let the clients make the decision and request a CYA letter (preferably signed by a trustee) to keep in our permanent records. It all depends on whether you want to take the aggressive approach or just stay safe. Hope this helps.

[Kirk Maldonado]

I think that if any portion of the original loan was not paid within the original 5-year period, it is taxable. Otherwise, you eviscerate the 5-year limitation.

[MWeddell]

It's definitely a gray area. Because it's a gray area, you may want to opt for the conservative interpretation, even though I think the aggressive one is the better guess for the correct answer.

If the second loan looks like a completely new loan formally, it's probably allowed in my opinion, but consider this an aggressive interpretation. The second loan "by its terms, is required to be repaid within 5 years" in compliance with Code Section 72(p)(2)(B)(i). Even if the second loan is viewed as a "renegotiation, extension, renewal, or revision after December 31, 1986 of an existing loan" it is treated as a new loan on the date of such renegotiation, extension, renewal, or revision. Conf. Cmte. Report for TRA''86 and TRA '86 Section 1134(e). This issue was not addressed in Section 72(p) regulations. There are other arguments for this position, but that's long enough for this posting!

The counterargument against allowing the second loan to have its own 5-year period is based on a statement in the TEFRA Conf. Cmte. Report: "If a repayment period of less than 5 years is subsequently extended beyond 5 years, it is intended that the balance payable under the loan at the time of the extension is to be treated as distributed at the time of the extension." However, that statement doesn't apply to a complete renegotiation or renewal of a loan which, by its terms, does comply with Code Section 72(p) and it's less recent than the TRA '86 legislative history.

[Guest sacobb]

I tend to agree with Kirk. I recently attended a seminar in which the speaker (a benefits attorney) was of the position that paying off another loan with a new loan is a refinance as the new loan documents do not equal the amount of money that was issued with the new loan (i.e. the Prom Note says its for $15,000 but you only received a check for $10,000). Extending beyond the maturity of the original loan violates the terms of that promissory note and possibly the 5 year rule.

[Disco Stu]

If your loan program allows participants to have more than one loan outstanding at a time, I don't think that the second loan necessarily has to be viewed as a refinancing. Maybe this is just a form over substance matter, but if a participant can legitimately qualify for the second loan, there is nothing in the regs that mandates what the proceeds of the loan have to be used for. They could buy a car with it, or they could use it to pay down an existing loan. If you have qualms about the form of the transaction (I personally don't), just make the two steps more distinct.

In my view the grey area occurs when the loan program only allows for one loan at a time. I have heard plenty of arguements on either side of the refinancing arguement in that case.

[Guest Bill]

But there's a big difference between a second loan and a re-financed first loan. With second loan you are still paying off the first one within the 5 years. I agree with those that think any re-financing that extends the loan beyond the original 5 year period causes the loan to be a taxable distribution. Also, if you're refinancing are you correctly determining the amount available by reducing for any outstanding loan balances in the last year? I've seen plans ignore that issue on a "re-finance".

[Disco Stu]

I agree that there's a difference between a 2nd loan and a refinanced 1st loan. The question as it was posed said that a second loan was taken out. I guess we'll have to assume for the purposes of the discussion that the eligiblity for the 2nd loan was determined properly.

What I specifically (and humbly) don't agree with is the assertion made in the post by sacobb that says that if you completely repay the first loan with part of the proceeds from the second loan, that the first loan somehow still exists and the 5 year repayment requirement is from the date of the first loan.

[MWeddell]

There's no doubt that the original loan must be repaid within 5 years to avoid it be treated as a taxable distribution. However, the second loan repays the first loan.

At a minimum, the second loan has to look like a new loan formally.

I also agree with the postings that the issue is more clear if the plan allows for two loans simultaneously so the participant and take the second loan, cash that check, and then pay off the first loan with some of the proceeds.