ramifications of violating Loan program?

[Lori H]

A two participant plan is basically in existence so the trustee can use it as a bank. He currently has 3 loans with balances totaling 31014.88. The highest balance in the past 12 months was 55999.17. The plan does allow for 3 loans and he does make timely payments. However, this month he has paid off one loan, he now has 2 outstanding and is in the process of taking a new loan to pay off high int credit cards. He has been advised that this will violate the plan provisions. He wants to know possible ramifications if the plan got audited. Is it a taxable event? I explained that on the 5500 he has to report his outstanding loan balances and it would look fishy if his balance was high as compared to total plan assets, which is about $200,000.

[Guest Sieve]

Sounds like there may be a violation of the $50,000 amount rule--if so, that's probably a failure to follow the terms of the plan document, and it also has tax consequences.

The other rule that might be a problem is the exclusive benefit rule. But, if there is another non-owner taking advantage of the plan, then I don't know that it would be a problem if the loan provisions are not violated on an on-going basis. It it's an exclusive benefit rule violation, that would disqualify the plan and HCEs & the co. would suffer significant tax consequences. But, just taking loans which are otherwise permissible should not generally be a problem.

[Lori H]

well, there are 2 participants, one of which is terminated, so i don't THINK the exclusive benefit rule would be violated.

yes, the $50,000 rule is clearly violated.

[Kevin C]

There are prohibited transaction issues, too. One of the requirements for the statutory exemption for participant loans is that they are made in accordance with specific provisions regarding such loans set forth in the plan §2550.408b-1(a)(iii).