Correction of Loan Defects

[Guest Jeff Kropp]

An employer failed to take loan repayments from paid disability leave, and thus the loans will not be repaid in five years. It was also discovered that some ex-employees separated from service in prior years with outstanding loans that were not treated as deemed distributions (not reported as taxable event, etc.).

The employer proposes to reamortize the loans for current employees and treat outstanding loans held by ex-exmployees as a deemed distribution in 2000. IRS guidance does not specifically describe how to correct loan defects. Setting aside the issue of whether we will correct under APRSC or VCR, are there any thoughts on our proposal? I am fairly certain that excise taxes will still apply and that some amended returns (1099-Rs and individual tax returns) may be necessary (to the extent an employee left prior to 1999).

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