Error in Administrating Loan Rate

[KCoursey]

Newbie here looking for advice.

We have a client who has had an established loan policy for the last several years. Within the loan policy it states that the loan rate will be prime plus 2%. However, the trustee/custodian only charged prime plus 1% for all loans through the time it was recently discovered. This was an administrative error on the trustee/custodian side. Upon discovering the error, all new loans were issued with the correct rate. The client would like to retroactively amend the loan policy to reflect the loan rate actually used during that erroneous time period.

Questions:

1. Would self-correction as described above be sufficient in this case?

2. Would VCP filing be a better option?

3. If VCP, we are having trouble determining where it fits under Form 14568-E - Appendix C Part II Schedule 5. There is no clearly defined option, as the loans were not in default and did not violate the terms of 72(p).

Any advice would be greatly appreciated.

[QDROphile]

4. Doesn't this situation point out that the loan terms are bogus?

If 2% was a legitimate rate, 1% is not, so you can't amend to legitimize 1%. If 1% is a legitmate rarte, then 2% is not and the loan terms are bad.

[Peter Gulia]

Isn't the fiduciary (not necessarily tax) correction making prudent efforts to collect the interest the plan (and, one assumes, each participant's account) was entitled to?

(Isn't the plan entitled to the amounts the borrower agreed to pay? Or did the service provider also generate mistaken loan agreements?)

Is the correction category "Loans Failing to Comply with Plan Provisions"?

[KCoursey]

All prior loan agreements and amortization schedules were done on the basis of prime plus 1%.

The fiduciary is also the plan sponsor in this case. They have specifically stated they would prefer not to go back and obtain more money from participants who took loans during this time.

[Belgarath]

"If 2% was a legitimate rate, 1% is not, so you can't amend to legitimize 1%. If 1% is a legitmate rarte, then 2% is not and the loan terms are bad."

I don't necessarily agree with this. It is not uncommon for local commercial lending institutions to have different rates. So the fact that you initially select a given rate does not necessarily mean every other rate is invalid. But maybe I'm misinterpreting what you are saying.

I offer no opinion as to the allowable "fixes" because I haven't recently reviewed the Revenue Procedure regarding this specific question.

[austin3515]

This is total nonsense and should not be relied upon, but I'd clean it up and move forward. Nothing wrong with Prime+1%. I personally would have changed the loan policy (I think it would have been a better story), but either way I would not go crazy. Now if this is a very large plan with an audit, etc. perhaps my answer changes. But if we're talking about a 50 participant plan with a dozen loans, there are only so many hours in the day! Perfection is a very tough standard to meet.

[Briandfox]

Here are some of my thoughts:

1. Are the loans at issue past 5 years from issuance? If so, I don't think there is a Schedule 5 VCP option and if you approach through VCP you would be requesting retroactive amendment of the loan program because all the loans you would be seeking to correct are past the 5 year term and were technically defaulted on.

2. If the loans at issue are within the 5 year term, then the VCP approach would be under D. on schedule 5 and these would be treated as loans that are defaulted. The correction would be to reamortize under what was the "program" and the missed interest would be made up going forward.

3. If you don't go VCP, do you have the original promissory notes and loan amortization schedules for the participants? If so does the note state the interest rate that was relied upon and was it signed by the participant and a plan representative? If that is the case, and there was some audit risk you should keep this if the issue comes up so there is some backup of the lower interest rate.