72(p) Question

[Guest meeh3704]

What is the proper correction where an er allows a loan in excess of the max permitted? My research indicates that it must be corrected using VCP. Any thoughts?

[J Simmons]

The loan does have adverse implications for the plan's qualification, so VCP would be one necessary step. The loan is also a deemed distribution that is a prohibited transaction. I would think you'd have the loan, and any interest, repaid. Then file a Form 5330. Also, it probably violated the written plan terms, so you might want to use the DoL's VFCP for the problem too.

[BG5150]

Just remember, the ENTIRE loan is the prohibited transaction, not just the amount over the limit...

[J Simmons]

Yeah, good reminder from the purple-caped Bart Simpson!

[Kevin C]

Just remember, the ENTIRE loan is the prohibited transaction, not just the amount over the limit...

Are you sure about that? Neither the VCP correction method in Rev.Proc. 2006-27, nor the rules in 1.72(p)-1 Q&A 4 require that the entire loan be corrected. Both address only the loan amount in excess of the stautory maximum. If the entire loan is a PT, the IRS doesn't seem to realize it.

[Guest meeh3704]

Under EPCRS, section 6.07(1), it seems as if an employer can self correct, but if it does the participant will receive a 1099-R for the year of the failure and the employer is required to pay any applicable income tax withholding that is required to be paid in connection with the failure. Whereas under a VCP, a 1099-R is issued for the year of the correction. First, in this context, an excess loan, what is the withholding requirement? If the excess loan only affects one participant, it seems a bit excessive to require to file a VCP. On the other hand, if a VCP is not filed, then you have to satisfy the VFCP for the prohibited transaction. Thoughts?

[J Simmons]

Just remember, the ENTIRE loan is the prohibited transaction, not just the amount over the limit...

Are you sure about that? Neither the VCP correction method in Rev.Proc. 2006-27, nor the rules in 1.72(p)-1 Q&A 4 require that the entire loan be corrected. Both address only the loan amount in excess of the stautory maximum. If the entire loan is a PT, the IRS doesn't seem to realize it.

IRC sec 72(p)(2)(A) gives an exception from deemed distribution treatment of a loan from a plan to participant "to the extent that such loan ... does not exceed ... ." So it is not surprising that the 1.72(p) regs would give examples that only the excess is deemed a distribution as IRC sec 72(p)(1) provides.

Rev Proc 2006-27 addresses methods of how to fix a plan so that remains 401a qualified. The general principles of the fixes are to restore the plan to the situation it should have. That notion would suggest that, for 401a qualification, only the excess would need to be returned.

IRC sec 4975 imposes a penalty for engaging in a transaction with a disqualified person that is prohibited, including participant loans per IRC sec 4975©(1)(B). Exempted are loans that meet 6 requirements, one of which is "made in accordance with specific provisions regarding such loans set forth in the plan." IRC sec 4975(d)(1)©. The loan is not exempt to the extent it is so in accord. Simply, the loan is a prohibited transaction unless it meets the 6 exemption requirements. IRC sec 4975(d)(1).

Of course, with a loan, the amount involved--the basis against which the penalty tax is factored--is value of the use of the loaned sum until repaid, i.e. the interest.

[Kevin C]

I did some digging. This type of loan problem is also covered by the DOL's VFCP. It looks like a VCP correction is the main step to correction with the DOL under VFCP. There is language in the preamble that is more clear that only the excess is required to be corrected. It looks like you would need to do both VCP and VFCP.

http://www.dol.gov/ebsa/regs/fedreg/notices/2006003674a.htm

7.3 Participant Loans

(a) Loans Failing to Comply With Plan Provisions for Amount, Duration

or Level Amortization

(1) Description of Transaction. A plan extended a loan to a plan

participant who is a party in interest with respect to the plan based

solely on his or her status as an employee of any employer whose

employees are covered by the plan, as defined in section 3(14)(H) of

ERISA. The loan was a prohibited transaction that failed to qualify for

ERISA's statutory exemption for plan loan programs because the loan

terms did not comply with applicable plan provisions, which

incorporated the requirements of section 72(p) of the Code concerning:

(i) The amount of the loan,

(ii) The duration of the loan, or

(iii) The level amortization of the loan repayment.

(2) Correction of Transaction. Plan Officials must make a voluntary

correction of the loan with IRS approval under the Voluntary Correction

Program of the IRS' Employee Plans Compliance Resolution System

(EPCRS).

(3) Documentation. The applicant is not required to submit any of

the supporting documentation listed in section 6(e), except that the

applicant must provide (i) proof of payment, as described in paragraph

(e)(6) of section 6, and (ii) a copy of the IRS compliance statement.

[Guest meeh3704]

I did some digging. This type of loan problem is also covered by the DOL's VFCP. It looks like a VCP correction is the main step to correction with the DOL under VFCP. There is language in the preamble that is more clear that only the excess is required to be corrected. It looks like you would need to do both VCP and VFCP.

http://www.dol.gov/ebsa/regs/fedreg/notices/2006003674a.htm

7.3 Participant Loans

(a) Loans Failing to Comply With Plan Provisions for Amount, Duration

or Level Amortization

(1) Description of Transaction. A plan extended a loan to a plan

participant who is a party in interest with respect to the plan based

solely on his or her status as an employee of any employer whose

employees are covered by the plan, as defined in section 3(14)(H) of

ERISA. The loan was a prohibited transaction that failed to qualify for

ERISA's statutory exemption for plan loan programs because the loan

terms did not comply with applicable plan provisions, which

incorporated the requirements of section 72(p) of the Code concerning:

(i) The amount of the loan,

(ii) The duration of the loan, or

(iii) The level amortization of the loan repayment.

(2) Correction of Transaction. Plan Officials must make a voluntary

correction of the loan with IRS approval under the Voluntary Correction

Program of the IRS' Employee Plans Compliance Resolution System

(EPCRS).

(3) Documentation. The applicant is not required to submit any of

the supporting documentation listed in section 6(e), except that the

applicant must provide (i) proof of payment, as described in paragraph

(e)(6) of section 6, and (ii) a copy of the IRS compliance statement.

Thanks, Kevin. I agree. With regard to 4975, this particular section would not apply because the loan was made to an owner, director, officer, or hce. I should have indicated such in the original post. thanks for your help.

[Mike Preston]

With regard to 4975, this particular section would not apply because the loan was made to an owner, director, officer, or hce.

Huh?

[Guest meeh3704]

With regard to 4975, this particular section would not apply because the loan was made to an owner, director, officer, or hce.

Huh?

I apologize. I should have said not made to an owner, etc. As I understand 4975, ordinary employees are not considered disqualified persons. Therefore, b/c the loan was not to a disqualified person, 4975 should not apply to this situation.