Participant loan default due to incorrect employer withholding

[Belgarath]

Haven't seen this one, although it perhaps isn't all that rare. And I have no other details other than the following.

Employer merged with another business at some time in the past. The other business had a plan that allowed participant loans, and those loans were transferred to plan of new employer. To make a long story short, the participant loans were originally set up for weekly withholding, and the new employer had bi-weekly payroll, but continued to withhold, on a bi-weekly basis, the original weekly amount. So under-withheld by 50%.

So, even though the loan was correctly set up, withholding was incorrect. It is now WELL past the original 5-year limit - by a year and a half, and there is still an outstanding balance.

Since they are beyond the original 5-year maximum period, under Revenue Procedure 2013-12, Section 6.07(2)(a), it appears that this can't be "fixed" - even under VCP. It is just a deemed distribution, no correction available.

Is there any other solution that I'm missing? I know that the listed corrections in the Revenue Procedure are not the EXCLUSIVE corrections, and I wondered if anyone had submitted under VCP to attempt to correct such a situation anyway.

As a practical matter, since the loan was mostly paid off and the deemed distribution would be small, I suspect the employer would just make the participant "whole" outside the plan, because the cost of VCP filing and correction would exceed the cost to make the participant whole.

[Peter Gulia]

If the plan's administrator tax-reports deemed distributions, is there an argument to be made that the failure to administer the plan according to its and related documents' terms is so slight that the plan is not tax-disqualified?

(I recognize that considering only that tax question, ignores the ERISA consequences of the fiduciary breach.)