loan never repaid

[Santo Gold]

I don't deal with many plan loans, let alone ones that are as blatantly wrong as this one. Any advice is appreciated.

Small 401(k) plan. One of the owners took a $9,000 loan in January, 2011. Never paid any of it back. When asked about it now, he really had no answer. He doesn't think he can now pay it back and would prefer to simply be taxed on it. He is age 65.

(1) Can he simply not pay it back, pay taxes on the $9,000 (plus the loan interest)?

(2) As long as he is employed, doesn't he have to pay this back? Even if he is subject to taxes, he is still required to pay it back, right? And if he does, that makes it an after-tax contribution, in a plan that does not allow for after-tax contributions. Problem?

(3) Correction has to go through EPCRS as well, I believe.

Any comments on the above are welcome.

Thanks

[MoJo]

I don't deal with many plan loans, let alone ones that are as blatantly wrong as this one. Any advice is appreciated.

Small 401(k) plan. One of the owners took a $9,000 loan in January, 2011. Never paid any of it back. When asked about it now, he really had no answer. He doesn't think he can now pay it back and would prefer to simply be taxed on it. He is age 65.

(1) Can he simply not pay it back, pay taxes on the $9,000 (plus the loan interest)?

(2) As long as he is employed, doesn't he have to pay this back? Even if he is subject to taxes, he is still required to pay it back, right? And if he does, that makes it an after-tax contribution, in a plan that does not allow for after-tax contributions. Problem?

(3) Correction has to go through EPCRS as well, I believe.

Any comments on the above are welcome.

Thanks

1) The loan clearly is in default, and that does make it a taxable "deemed" distribution;

2) Depsite the fact that the it is a "deemed" distribution for tax purposes, the loan itself remains an asset of the plan, and is considered an existing loan for all plan purposes (so, for example, if the plan only allows for one outstanding loan at a time, he is considered as still having a loan outstanding). Theoretically, he is still obligated to repay the loan, although as a practical matter, most don't. If he does, the repayment isn't technically considered "after tax" but more appropriately, he would have a tax basis in his account equal to the amount repayed that was previously taxed as a result of the "deemed" distribution. Tracking that is the issue, and many recordkeepers are deficient in that regards;

3) Not necessarily. It depends on when the tax consequences are to hit (2011 or 2012). Read the provisions of 2008-50.

[QDROphile]

An IRS agent is likely to look at this as a disqualifying distribution rather than a good faith loan gone into default.

[Santo Gold]

I don't deal with many plan loans, let alone ones that are as blatantly wrong as this one. Any advice is appreciated.

Small 401(k) plan. One of the owners took a $9,000 loan in January, 2011. Never paid any of it back. When asked about it now, he really had no answer. He doesn't think he can now pay it back and would prefer to simply be taxed on it. He is age 65.

(1) Can he simply not pay it back, pay taxes on the $9,000 (plus the loan interest)?

(2) As long as he is employed, doesn't he have to pay this back? Even if he is subject to taxes, he is still required to pay it back, right? And if he does, that makes it an after-tax contribution, in a plan that does not allow for after-tax contributions. Problem?

(3) Correction has to go through EPCRS as well, I believe.

Any comments on the above are welcome.

Thanks

1) The loan clearly is in default, and that does make it a taxable "deemed" distribution;

2) Depsite the fact that the it is a "deemed" distribution for tax purposes, the loan itself remains an asset of the plan, and is considered an existing loan for all plan purposes (so, for example, if the plan only allows for one outstanding loan at a time, he is considered as still having a loan outstanding). Theoretically, he is still obligated to repay the loan, although as a practical matter, most don't. If he does, the repayment isn't technically considered "after tax" but more appropriately, he would have a tax basis in his account equal to the amount repayed that was previously taxed as a result of the "deemed" distribution. Tracking that is the issue, and many recordkeepers are deficient in that regards;

3) Not necessarily. It depends on when the tax consequences are to hit (2011 or 2012). Read the provisions of 2008-50.

If it remains as an asset to the plan, does that mean that the loan is still added as a plan asset for 5500 reporting purposes? That would seem odd, continuing to report it as a an asset, since if it is already reported as a distribution. If correct, would you show the loan amount or the loan plus unpaid earnings as the asset amount?

[MoJo]

If it remains as an asset to the plan, does that mean that the loan is still added as a plan asset for 5500 reporting purposes? That would seem odd, continuing to report it as a an asset, since if it is already reported as a distribution. If correct, would you show the loan amount or the loan plus unpaid earnings as the asset amount?

Keep in mind it is *not* reported as a distribution, it is "deemed" distributed SOLEY for income tax purposes - and the resulting tax consequences to the defaulting participant. Your question really is "at what value" is the defaulted loan carried on the books of the plan after it is defaulted and deemed distributed. Some would argue that the value is zero, as the likelihood of it being repaid is nil and at the time of distribution it becomes a nullity, while others would say that until an actual distribution occurs, it's value is par plus accrued interest (which is the amount the participant must repay to wipe the loan off the books).

[12AX7]

If the participant otherwise had a distributable event, then would it be looked at as disqualifying? Could the participant merely say that I want to distribute my loan if otherwise permitted for that specific source of the account?

[QDROphile]

If the participant could have taken a distribution rather than a loan, it might save the day, but I would expect some awkwardness with plan terms that don't quite fit.