Loan for Bankrupt Participant

[Guest psgross]

Can we deem a loan for a participant who has filed for bankruptcy and her loan is in default?

[Guest mjb]

no. Under the bankruptcy reform act plan loans are not debts subject to the bkcy law and payments cannot be stayed. Participant must continue to repay loan.

[MoJo]

Uh, pardon my jumping in, but MJB, you are correct in saying that the bankruptcy does NOT stay repayment on the participant loan as it does with respect to other debts of the debtor, but as I read the original post, the loan is in fact in default (that is, payments haven't been made, I presume) and hence, I think you can deem the loan.

[JanetM]

Did the employer stop withholding the payments? How could this happen with active employee?

[Belgarath]

A lot of plans (especially the really small plans) don't do it via payroll withholding.

[Guest mjb]

I read the awkardly worded post as asking if the participant could default on the loan after filing for bkcy by ceasing contributions. I dont know what was meant by deem the loan. If payments cease the loan goes into default under the tax law and the balance is taxed as imputed income. The bkcy amendments dont change that.

The purpose of the changes is to prevent the participant from stopping payroll withholidng on the loan when the bkcy petition is filed. If the loan is in default for non payment at the time of bkcy then the bkcy changes are n/a and the participant has a defaulted loan.

[Guest psgross]

I'll try to "reword" the question. We have a participant who filed for bankruptcy and has a loan in her retirement plan. We received a notice from her attorney indicating that this filing created an automatic stay which prohibits any actions on our part to collect any debt from her.

The notice demands that the company stop all voluntary payroll deductions and deductions for repayment of loans against retirement plans immediately.

The loan is now in default.........can we deem the loan and issue her a 1099 in January of next year?

I thought the new bankruptcy laws didn't affect participant loans and that the participant still had to make payments on the loan.

[Guest mjb]

Under the Bkcy amendments of 05 there is no discharge in bkcy for plan loans and repayments of loans by participants are not eligible for an automatic stay. If the plan permits the participant to discontinue those payments after filing for bkcy the loan goes into default under the IRC and the participant will have imputed income on the balance of the loan. Bkcy law does not prevent taxation of a defaulted loan.