Owner defaulted on loan

[BG5150]

I have an owner who defaulted on a loan a few years back. My recollection says that this is a PT--we cannot just do a regular default and have him taxed on the remaining balance.

Where does the code address loans to owners and the consequences of default?

Company is C Corp.

[Belgarath]

Pre-2002, loans to s-corp owners and unincorporated owners were PT's. But EGTRRA changed that for post-2001 loans. See IRC 4975(f)(6)(B).

I'm quite sure I remember the IRS saying that an outstanding loan balance from a pre-2002 loan was no longer a PT starting in 2002, but I can't give you a citation offhand.

So a default by an owner is generally no different than for anyone else, ASSUMING it is a "bona fide" loan that satisfied all the normal participant loan requirements.

[Tom Poje]

pre-2002 it was a prohibited transaction for an owner to take a loan, but EGTRRA eliminated that rule.

I think all you have is improper (nonreporting) of a defaulted loan.

(but maybe someone knows more than I do in regards to this issue.)

section 6.07 of EPCRs says

.07 Rules relating to reporting plan loan failures. (1) General rule for loans.

Unless correction is made in accordance with this section 6.07(2) or (3), a deemed

distribution under § 72(p)(1) in connection with a failure relating to a loan to a participant

made from a plan must be reported on Form 1099-R with respect to the affected

participant and any applicable income tax withholding amount that was required to be

paid in connection with the failure (see § 1.72(p)-1, Q&A-15) must be paid by the

employer. As part of VCP, the deemed distribution may be reported on Form 1099-R with

respect to the affected participant for the year of correction (instead of the year of the

failure. The relief from reporting the participant’s loan as a deemed distribution on Form

1099-R in the year of correction, as described in the preceding sentence, applies only if

the Plan Sponsor specifically requests such relief.

it is possible since the loan is from an owner the IRS may say no to 1099R in the year of correction instaed of year of failure.

[SheilaD]

pre-2002 it was a prohibited transaction for an owner to take a loan, but EGTRRA eliminated that rule.

I think all you have is improper (nonreporting) of a defaulted loan.

(but maybe someone knows more than I do in regards to this issue.)

section 6.07 of EPCRs says

.07 Rules relating to reporting plan loan failures. (1) General rule for loans.

Unless correction is made in accordance with this section 6.07(2) or (3), a deemed

distribution under § 72(p)(1) in connection with a failure relating to a loan to a participant

made from a plan must be reported on Form 1099-R with respect to the affected

participant and any applicable income tax withholding amount that was required to be

paid in connection with the failure (see § 1.72(p)-1, Q&A-15) must be paid by the

employer. As part of VCP, the deemed distribution may be reported on Form 1099-R with

respect to the affected participant for the year of correction (instead of the year of the

failure. The relief from reporting the participant’s loan as a deemed distribution on Form

1099-R in the year of correction, as described in the preceding sentence, applies only if

the Plan Sponsor specifically requests such relief.

it is possible since the loan is from an owner the IRS may say no to 1099R in the year of correction instaed of year of failure.

My question on this subject is not whether the original loan transaction is prohibited. Rather, by failing to meet the requirements that the loan must meet in order to be not a prohibited transaction, does it become a prohibited transaction in the year that the default occurs. The owner of the corporation now has a transaction with the plan that is not exempt from the prohibited transaction rules.