Participant Loan Corrections - EPCRS

[austin3515]

Participant took a loan out in 2010 and the repayments were so small they did not even cover interest (new client, mind you ).

Does anyone have a problem with the participant taking out a second loan to get "caught up" on the old loan as part of the correction? We're doing a VCP submission to ask for tax relief (the participant got a letter from the IRS b/c the old recordkeeper sent out a 1099 defaulting the loan). Purely reamortizing the loan does not work because the participant would not be able to "survive" on what would remain in their net paycheck. So we want to pay-down part of the loan with a new loan. Making a lump-sum catch-up payment is clearly provided for in EPCRS, but what they don't address is whether or not a new loan might be used to come up with the lump-sum payment.

[masteff]

If you treat both the current loan and the new loan as outstanding, do they "collectively satisfy" the maximum allowable loan limits? If so, then I think you're golden. If it would violate the limits, then I'd think you'd want explicit permission under the VCP. 1.72(p)-1 Q&A-20(a)(2) is actually entitled "Loans that repay a prior loan and have a later repayment date". Without going back to the preamble for the intent when the reg was rewritten a decade ago, the effect was in part to relieve the old problem of a participant in a plan that only permitted a single loan having to get temporary outside funds (eg a bridge loan from a 3rd party).

[austin3515]

Because what you are saying is this is REALLY a refinancing transaction? We don't qualify for a refinanced new 5 year term. He's eligible for a 2nd loan of $10,000 - we wanted to take that loan, pay down the "bad loan" such that the payments involved are more manageable.

When I read the Q&A you sited, in particular in the examples, they are referring more to a true refinancing. Has the IRS ever indicated, perhaps in a Q&A, that if loan proceeds are taken as a cash check, but cash is then used to pay off the original loan, that this is a refinancing transaction? I suppose I can see the point that this would be an effective way to circumvent the rules on refinancing. Perhaps, as you suggest, that is why they worded it the way that they did. Curious to know if this interpretation is solidified anywhere though.

[BG5150]

What someone does with the proceeds of a second loan is up to them.

As long as the document allows for two loans, I think you are good.

[austin3515]

There was a time when I would have said the same (up until this morning), but I think Masteff is onto something. What do other people think?

I actually believe I have heard this interpretation before. Sort like a "deemed refinancing."

[masteff]

I looked closer at the examples. Q&A-20 example 1, paragraph ii illustrates the (a)(2) rule I was talking about. In their scenario, the replaced plus replacement loans combined violate the loan limit but I could easily make up numbers that work. You'll have to apply your actual scenario to see where you fall out. It's only if you violate the limit that you need to calc whether the 1st loan gets paid off w/in its longest permissible term (which they cover in example 1 paragraph iii). Unfortunately you indicated the available $10K would pay down (implying it would not pay off) the old loan, so you might be out of luck.

Two other thoughts... 1) Q&A-19 is a problem for you. You have to get additional security for a subsequent loan when a loan is in default. You really need the Service to bless your ideal scenario in your VCP. 2) If your position on the VCP is adminstrative error, then focus on the end result since the Service has the ability to bless something that stretches a rule. But that begs the question of what to do in the meantime... personally, I'd calc the payment(s) in my ideal scenario (2nd loan to pay down the 1st and reamortize 1st under original term) and have the participant start paying that (treating currently them as payments on a defaulted loan). If the Service ultimately refuses, then the participant has merely built basis; but if they accept, then you're right on track.

And here are the proposed and final Q&A-20 regs w/ preamble (they don't add great insight):

http://benefitslink.com/src/taxregs/72p-proposed-2000.html

http://benefitslink.com/src/taxregs/72p-final-2002.html