Cure period applicable to 5 year max loan?

[Guest NoraLenderB]

If I am reading the Treasury regulation right, the cure period that a plan may provide seems to apply only where a participant has missed one or more of their loan repayments. So, basically, the cure period is for curing loans that do not satisfy the level amortization requirement in operation due to the missed repayments. Do I have that right??? If so, then does the cure period not apply to extend the time to repay where a participant has passed their 5 year maximum loan repayment date, since the maximum repayment period is a separate requirement from the level amortization?

On that note, for a 5 year loan, from which date is the 5 year period counted? From the date the loan is issued from the plan? Or the date of the first scheduled loan repayment? (I thought it was the date the loan was issued from the plan, but it seems not everyone is in agreement on this point....)

Assuming that a 5 year loan is amortized from the loan distribution date so that it is scheduled to be repaid before the fifth anniversary of the loan issue date, what result where the participant has missed loan repayment(s) and has not made up the missing payment(s) by the end of the 5 year period? (Assume no leaves of absence.) Is the outstanding amount plus interest deemed distributed? Or is the entire original amount of the loan deemed distributed because it was not repaid within 5 years, even though it was scheduled to be repaid within 5 years?

[Bird]

Assuming that a 5 year loan is amortized from the loan distribution date so that it is scheduled to be repaid before the fifth anniversary of the loan issue date, what result where the participant has missed loan repayment(s) and has not made up the missing payment(s) by the end of the 5 year period? (Assume no leaves of absence.) Is the outstanding amount plus interest deemed distributed? Or is the entire original amount of the loan deemed distributed because it was not repaid within 5 years, even though it was scheduled to be repaid within 5 years?

It's not deemed anything. The cure period can extend beyond the original 5 year period, IMO.

[Guest Pennysaver]

It's not deemed anything. The cure period can extend beyond the original 5 year period, IMO.

Bird, you may want to rethink your opinion - see Treasury Regulation §1.72(p)-1, Q&A-10. The regulation permits a plan to allow for a cure period with respect to IRC 72(p)(2)©. IRC 72(p)(2)© is the requirement for level amortization and payments no less frequently than quarterly. The requirement that a loan be repayable within 5 years is under IRC 72(p)(2)(B). If the cure period could extend the 5 year repayment period, then the regulation would have referenced IRC 72(p)(2)(B) as well as 72(p)(2)©, but it does not. Based on the regulation and the IRC, it does not appear that the cure period can extend beyond the maximum repayment period.

Nora, the maximum repayment period is counted from the date the loan is issued. When you amortize the loan repayments for a 5 year period, be sure that the final payment is scheduled for a date that is no later than the fifth anniversary of the loan.

Your question about what portion is deemed distributed after the end of the maximum repayment period is a good one. It would seem logical that so long as the loan's terms complied with the maximum repayment period, then anything still owing after the expiration of the maximum repayment period is due to a missed payment, yes? In which case, only the outstanding amount of the loan plus accrued interest is deemed distributed. But if the loan's terms do not comply with the maximum repayment period, then the loan does not comply with IRC 72(p)(2)(B), and the entire amount of the loan will be a taxable distribution.

If anyone has a contrary interpretation, or, even better, a citation, please let me know.

[Kevin C]

I agree with Bird and refer you to the first paragraph of 1.72(p)-1 Q&A 10. The level amortization requirement of 72(p)(2)© requires level payments over the term of the loan. We are talking about a loan that initially satisfies the loan rules, so the amortization schedule complies with the rules for maximum length of the loan. The failure here is failing to make payments according to the terms of the loan; see the question for Q&A 10.

A-10: (a) Timing of deemed distribution. Failure to make any installment payment when due in accordance with the terms of the loan violates section 72(p)(2)© and, accordingly, results in a deemed distribution at the time of such failure. However, the plan administrator may allow a cure period and section 72(p)(2)© will not be considered to have been violated if the installment payment is made not later than the end of the cure period, which period cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.

If they wanted to say the cure period could not extend beyond the original five year period, this is where it should be. Instead, it defines the maximum length of the cure period based on the date the required installment is due. If the missed installment is, for example, the final weekly payment of a five year loan, then to me, this clearly extends the cure period beyond the end of the original five year period for the loan.

[Guest Pennysaver]

We are talking about a loan that initially satisfies the loan rules, so the amortization schedule complies with the rules for maximum length of the loan. The failure here is failing to make payments according to the terms of the loan; see the question for Q&A 10.

Per Treas. Reg. §1.72(p)-1, Q&A-4(a), loans are required to comply with IRC 72(p) and Treas. Reg. §1.72(p)-1, Q&A-3 both in form and in operation. Merely satisfying the 5 year repayment period requirement in form is not sufficient; you must satisfy it in operation as well. Since this requirement is under IRC 72(p)(2)(B), and the cure period provided for under Treas. Reg. §1.72(p)-1, Q&A-10 only treats IRC 72(p)(2)© as not being violated, if you allow missed payments to be repaid after the 5 year repayment period has expired, you have violated IRC 72(p)(2)(B) in operation, regardless of the fact that Treas. Reg. §1.72(p)-1, Q&A-10 will treat the repayment of the missed payments as not violating IRC 72(p)(2)©. If you want to avoid an operational violation of IRC 72(p)(2)(B), the cure period needs to end at the same time as the 5 year repayment period ends.

[Kevin C]

I think you overlooked the last part of Q&A 4 (a)

If the loan initially satisfies the requirements of section 72(p)(2)(A), (B) and © and the enforceable agreement requirement of paragraph (b) of Q&A-3 of this section, but payments are not made in accordance with the terms applicable to the loan, a deemed distribution occurs as a result of the failure to make such payments. See Q&A-10 of this section regarding when such a deemed distribution occurs and the amount thereof and Q&A-11 of this section regarding the tax treatment of a deemed distribution.

[Bird]

Thanks Kevin! I hate to think how much time (and clients' and participants' money) is utterly wasted on this issue.

[masteff]

On that note, for a 5 year loan, from which date is the 5 year period counted? From the date the loan is issued from the plan? Or the date of the first scheduled loan repayment? (I thought it was the date the loan was issued from the plan, but it seems not everyone is in agreement on this point....)

The preamble of the reg references "repayment terms that are commercially reasonable". I would state the banking industry standard practice as: a certain repayment period commencing reasonably promptly after the date of disbursement. For a plan loan, I wouldn't let the delay between the disbursement of the loan and the commencement of payment be more than 30-45 days, preferably within one to two pay periods. Keep in the mind that the allowable cure period is based on a calendar year quarter... exact days get rounded out when you have a calendar quarter of leeway.

So, assuming you don't have an unreasonable delay, I would look at the amortization schedule. If you have monthly payments, then your amort sched should have no more than 5*12=60 payments; semi-monthly, 5*24=120 payments, etc.

(And yes, this practice has been thru successful IRS and DOL plan audits.)

[QDROphile]

In a public IRS telephone conference today on the subject of plan corrections the IRS made it very clear that its position is that the cure of the defect must be completed within the 5-year amortization limit to avoid taxation, and the 5-year clock starts at the time of the plan loan. The written materials are typically available on the IRS websie. The written materials state the IRS position, and the oral presentation removed any doubt about interpretation of the written material (i.e. "cure" means that all of the loan payments, as revised to correct missed payments, must be made within the original 5-year term.

[movedon]

Not the first time the person speaking on one of these phone conferences said somthing stupid and wrong.

[Kevin C]

EPCRS correction and correcting the loan before it becomes deemed are two different things and two different sets of rules. Rev. Proc. 2008-50 is very clear that its loan corrections are only available during the original maximum time period for the loan. But, you don't get to EPCRS until after the loan has already been deemed at the end of the cure period. EPCRS is not available when regulations or the code provide for a correction (Rev. Proc. 2008-50, section 6.08). Until the end of the cure period, you are under the regulations. Once the cure period has ended and the loan is deemed, you are under EPCRS if you want to correct.

[Guest NoraLenderB]

Thank you for all the responses.

Kevin C. and Pennysaver, I was looking through the old message threads on this site, and was interested to see that two years ago it looks like Kevin C. initially had the same position as Pennysaver about the cure period not extending past the 5 year anniversary because the regulations refer only to the cure period in the context of 72(p)(2)© and not 72(p)(2)(B): http://benefitslink.com/boards/lofiversion...php/t45148.html

If you look at the end of that old thread, it seems the IRS addressed this issue, at least informally, a while back. Too bad they never made that position formal. However, it seems like the recent IRS phone forum QDROphile posted about has negated that old informal position anyway? So that seems to mean that we are back to the cure period not extending beyond the maximum 5 year loan period.

QDROphile, I looked online for the phone forum materials but can only seem to find the written materials and transcripts from last year's phone forums. Could you possibly post a link to this year's phone forum materials and transcript?

[BG5150]

Too bad they never made that position formal.

Boy, if I had a nickel for every time I said that about a retirement plan issue, I could probably retire...

[QDROphile]

The written materials for the 9/7 program were delivered to registrants. There is a lag before the materials and program transcript are posted on the IRSS website.