401K audit - Participant loan in default

[Guest Lin]

Per plan document, loan is considered in default at the end of calendar quarter following the calender quarter when the payment is due.

One participant failed to make any repayment from June to September (more than 3 months) and was considered as in default by the system.

However this person restarted repayments in September but by 12/31/08 his outstanding balance is still larger than the balance per amortization schedule, and the variance is lager than 3 months' of payments.

The system still has this as loan (indicated "default".) Should this loan still be reported as a loan or a deemed distribution (tax needs to be withheld)?

Any input would be appreciated - Thanks!

[J Simmons]

The September payment probably solved the one due in June, the 2nd quarter. The other 3rd quarter payments--if any--would likely apply to those coming due, in order: July, then August and finally September. If by December 31, any of those payments had not been made, then yes the loan would be in default at the end of the 4th quarter. (Note, this explanation is what the regs require, the loan policy and promissory note might call for default sooner.)

It should be reported as deemed distribution for the year when default occurs.

[masteff]

Just to expand on John's answer... you don't judge if it's in default by current balance vs the amortization schedule balance. You judge it by the timing of the payments. So the ultimate question is... did the payments in quarter B fully cover the payments missed in quarter A? So payments missed in June (quarter A) were potentially made up in September (quarter B); but did Sept fully cover June's missed payments? If not, then the loan is in default. Then do the same for missed payments in July-Sept (quarter A) compared to late payments in Oct-Dec (quarter B).