Loan Default due to Clerical Error

[Cynchbeast]

Participant in plan has an outstanding loan from 2008 (maturity = July, 2013). For 2 years, payments were made timely, but upon receiving Y/E data for 2012 we have discovered that she stopped paying on the loan in 2011 and made no payments during 2012.

Participant and plan sponsor both honestly thought it had been paid in full. We believe it was an honest mistake on both their parts, due to changes in payroll and no one paying attention.

The obvious answer is to declare a deemed distribution, and for her to repay the remaining balance plus interest. This would come to approximately $20,000 and since she is under 59 1/2, we are looking at a sizeable tax hit.

My questions are:

1) Do we have flexibility in how she repays the loan? Can we re-write it or must it be repaid by the original maturity date (07/2013)? Can we reduce the interest rate (was 7.0% but at current prime new loan would be 5.25%)

2) Is there any way to get around the deemed distribution and consequent tax hit? Would this qualify for EPCRS?

Again, it appears to have been an honest error. Granted participant should have known that she hadn't repaid nearly all the loan and that it wasn't being taken out of her checks, but as is all too commonly the case, no one was paying attention.