Defaulted Loan - VCP?

[Dougsbpc]

We administer a plan whereby the client did not provide us the information timely. Upon completing the valuation we see the two owner participants defaulted on their loans last year.

Has anyone had experience with trying to correct this through VCP?

The only part that worries me about VCP is to have the client pay the fee and our fees only to have the IRS reject the request because they did not feel correction was warranted. For example they feel the participants should have made payments and the missed payments were not the result of employer error.

Thanks.

[Guest Sieve]

When you make application under VCP either to reamortize or to move the default to the current year (if 5 years has passed since loan origination), you have to make tyhe case in the application that the default was not the employees' fault. It presumably will be harder to do that if the employees are owners/fiduciaries. But, if you feel you can make the argument--giving the client the caveat that you cannot guarantee success of the application--then go with it. If you do not seek and get correction, then you have a 1009 to issue for a past year, and with that comes taxes, penalties & interest for the taxpayer--and a potential disqualified plan (if there was no distributable event). The client has to make the choice--trying to properly correct will cost them something, whether the attempt is successful or not, or else the condequences of a deemed distribution will follow.

[pixmax]

Since the loans were to owners, they were also prohibited transactions. Form 5330 should be filed and the 15% excise tax paid for each year that the loans were (are) outstanding, until repaid to the plan.

[four01kman]

I seem to recall the Service or DOL issued procedures on precisely this kind of issue. Something like the amount of the loan and accrued interest is treated as a "distribution" for income tax purposes for the year in which the loan became defaulted. Sorry I don't have the precise cite.

[Guest Sieve]

pixmax -- Why file 5330? They're participant loans, which are exempted from PT applicablility, and DOL's fiduciary compliance program (VFCP) allows correction of a partcipant loan which becomes a PT by following the IRS VCP for bad loans. There also is a PTE exempting corrections under VFCP from PT sancitons.

four01 -- Correctable under VCP.

[pixmax]

pixmax -- Why file 5330? They're participant loans, which are exempted from PT applicablility, and DOL's fiduciary compliance program (VFCP) allows correction of a partcipant loan which becomes a PT by following the IRS VCP for bad loans. There also is a PTE exempting corrections under VFCP from PT sancitons.

four01 -- Correctable under VCP.

If the plan makes loans to individuals who are disqualified persons then the loan is a prohibited transaction under 4975. A disqualified person includes a 50% owner. Under EPCRS fix it guide, review potential mistake #9 (do participant loans conform to the requirements of the plan document and IRC 72p). Under 9(b)(5) Review the disqualified person's acutal loan repayments to determine if he or she is following the loan document's terms. The law treats amounts not timely paid according to the loan's termas as unsecured loans and prohibited transacations. Corrective Action - if a loan is a prohibited transaction, then the disqualified person must pay back all amounts outstanding on the loan (principal and interest) to the plan. Excise taxes under 4975 apply until the loan is fully repaid. The disqualified person pays the excise taxes on Form 5330. Correction Programs Available - The IRS does not have a correction program that provides relief from the excise taxes owed under Code 4975. The disqualifed person must pay all excise taxes owed with respect to the prohibited transaction.