Defaulted loan for the owner - PT?

[AlbanyConsultant]

This came up because a local CPA asked our advice for an audit his (not ours!) client is going through.  The owner of the business (an s-corp) took a loan that satisfied all the 72(p) loan provisions when he took it out.  He never made a single repayment, and the CPA is still carrying it as a plan asset for the face loan amount.  Oh, did I mention that the loan was taken 20+ years ago?

 

No doubt this is bad.  But we in the office can't agree on where the badness starts...

 

Is this a PT?  Where?  When?  Is it different because it's an owner?  I've heard that they have a "higher standard", but unless this owner is a fiduciary (which of course he is), I don't think that's generally true.

 

Thanks.

[BG5150]

If it was 20 years ago, I don't think the loan could even be made.  When did they change the rules to allow owners of S-Corps to even take loans?

[Belgarath]

January 1, 2002.

I seem to recall that prior existing loans became "non prohibited" as of 1/1/2002 as well. I'm not sure if the IRS would apply this relief to years prior to 2002 or not.

[AlbanyConsultant]

I can't believe I had forgotten about the S-corp owner restrictions... wow.  Thanks for the reminder.  So maybe that's the problem.

 

That situation doesn't (hopefully) come up too often anymore.  What about where the loan was only taken recently?  When does non-payment create a PT, if it does at all?

[Belgarath]

Facts and circumstances. It has to be a "bona fide" loan. If auditor determines that there was never any intention to repay the loan, then there could be a PT, as the 72(p) rules then do not apply.

I've not actually seen a live case where this occurred, so I have no direct experience as to whether PT is actually asserted, or disqualification for prohibited distribution (if distribution otherwise not allowed under terms of the plan), etc.