Accounting for Defaulted Loan

[Cynchbeast]

Let me preface this by saying this is a client who we last prepared a 5500-EZ for in 2010 (under limit), and who came back to us after a few years asking us to clean up the mess he created.

Facts:

• He took a $45,000 loan requiring monthly payments, but has never made regular payments.
• He made a payment of $5,200 right before the loan would have gone into default
• More missed payments caused default as of 09/30/12
• He paid an additional $4,500 on 01/15/14
• He has made no further payments
• Plan is a DB, with NRA age 62; owner is currently 60 years old with a calendar plan year

Questions:

• We plan to declare a deemed distribution and issue a 1099-R. Should the deemed distribution be as of 09/30/12, or should I use the plan year end of 12/31/12?
• How do we treat the loan in subsequent plan years? How do we handle a loan that is not repaid for 2 or three years?
• Any ideas on how to show everything properly on the trust accounting? For DB plans, we do our own accounting in Excel.

[My 2 cents]

A defined benefit plan with participant loans! Ugh!

[GMK]

A plan with participant loans! Ugh!

[Tom Poje]

since, as you describe, it is a mess, use EPCRS and VCP and 1099R in the year of correction not the year of failure. not sure what the worse can happen, maybe the IRS says 1099r in the year of failure.

SECTION 6. CORRECTION PRINCIPLES AND RULES OF GENERAL APPLICABILITY
.01 Correction principles; rules of general applicability
.02 Correction principles.
.03 Correction of an Employer Eligibility Failure.
.04 Correction of a failure to obtain spousal consent
.05 Submission of a determination letter application
.06 Special rules relating to Excess Amounts
.07 Rules relating to reporting plan loan failures
.08 Correction under statute or regulations
.09 Matters subject to excise or other taxes
.10 Correction for 403(b) Plans


.07 Rules relating to reporting plan loan failures. (1) General rules for loans. Unless correction is made in accordance with this section 6.07(2) or (3), a deemed distribution under § 72(p)(1) in connection with a failure relating to a loan to a participant made from a plan must be reported on Form 1099-R with respect to the affected participant and any applicable income tax withholding amount that was required to be paid in connection with the failure (see § 1.72(p)-1, Q&A-15) must be paid by the employer. As part of VCP and Audit CAP, the deemed distribution may be reported on Form 1099-R with respect to the affected participant for the year of correction (instead of the year of the failure). The relief of reporting the participant’s loan as a deemed distribution on Form 1099-R in the year of correction, as described in the preceding sentence, applies only if the Plan Sponsor specifically requests such relief.


Appendix C, form to fill out
SECTION IV. DESCRIPTION OF PROPOSED METHOD OF CORRECTION
If the Plan Sponsor is requesting relief from reporting loans as deemed distributions, then complete Sections IV A, B, or C, as applicable


D. Correction for Deemed Distributions
(check if applicable)
The Plan Sponsor is not eligible to or will not correct in accordance with Parts IV A through IV C of this Appendix C, Part II Schedule 5. The Plan Sponsor proposes that the loans be reported as deemed distributions (using Form 1099 R) for the year of correction instead of the year of the failure. The Plan Sponsor shall pay any applicable income tax withholding amount that was required to be paid in connection with the failure. (See Income Tax Regulations § 1.72(p)-1, Q&A-15.)

EPCRS revproc2013-12.pdf

[Cynchbeast]

Thank you for all the help. Now I understand that the point of EPCRS or VCP is to not only correct the problem but ensure that it does not re-occur - meaning he needs to either payoff the loan or begin making regular payments according to the note.

So the next logical question is what to do if he doesn't make payments. In other words, we declare a deemed distribution and the default continues. Is this the same default? A new default? Is there another deemed distribution?

[Tom Poje]

I believe the issue involves the ability to take a new loan.

even though the loan has been defaulted, it is kept track of on the 'books', but doesn't show elsewhere.

so in the defaulted amount was 45,000, in a short time that amount would hit 50,000 the max outstanding loan at any one time a person could have, so the person could take no new loan.

The IRS doesn't want someone 'beating' the distribution rules by taking a loan for 50,000, then defaulting.

the taking another loan for 50,000 and defaulting again. then taking another loan....