Late Loan Offset

[401(k)athryn]

Good day! We are in the process of taking over a 401(k) Plan and I have just discovered that there is an outstanding loan balance for a participant who terminated employment in 2017.  She continued making payments until June of 2018, then no more payments.  The prior TPA should have had the loan offset as of 9/30/2018, the end of the cure period. 

I will need to offset the loan now, but it has been accruing interest since last June.  I will request that the recordkeeper (Hancock) offset the loan using the balance on 9/30/2018, which is the date that this should have been done.  Do you agree?  I don't think it is fair to the participant to have to pay any additional interest.  Also, I do not see anything in EPCRS about a late loan offset and I don't want the participant to have to redo 2018 taxes, so do you think it is okay to have this reported as 2019 taxable income even though it should have been 2018 income?

Any guidance would be appreciated!

 

[Bird]

Also consider the practical matter that JH will only:  1) deem it using current values, or 2) write it off completely with no reporting.  At least that's what I was told late in 2018.

I can rationalize the additional earnings with the fact that it is being reporting a year late.  

Not necessarily the "right" way to handle it...

[401(k)athryn]

I'm pretty sure that I can get John Hancock to prepare the 1099-R with any amount that I give them.  I don't think it needs to be the current balance. 

As far as the earnings,  since it was not the participant's fault that the loan offset is being reported late, I do not see how it is okay that she should have to pay taxes on the additional interest.  It was large loan so the additional interest is approx. $2,000.

Does anyone else think that a current balance would be acceptable?

[duckthing]

1 hour ago, 401(k)athryn said:

I'm pretty sure that I can get John Hancock to prepare the 1099-R with any amount that I give them.  I don't think it needs to be the current balance. 

I got the same response Bird did, within the last few months. I was advised by JH that they can only prepare a 1099-R for a deemed/offset loan as of the current date, and that their 1099-R process is completely automated so they have no way to create one manually for this situation. I ended up having them just close the loan out on their system and we issued the 1099-R ourselves.

Offhand, I agree with not adding the accrued interest on the loan since 9/30/18 to the amount to be reported on the 1099-R. Our loan procedures documents say something under the section about loan defaults along the lines of "interest will continue to accrue until you have a distributable event" -- assuming your plan permits distributions immediately upon termination, that distributable event happened when the participant terminated whether or not the 1099-R was issued timely. If anyone has seen guidance to the contrary I'm interest to see it!

I'm not sure if there's anything in RP 2019-19 that would let you report this in 2019 rather than 2018 without going to VCP, but it might be worth a look.

[justanotheradmin]

Have you read the updated EPCRS publication? Revenue Procedure 2019-19?

Typically I would say if you are issuing the 1099-R for 2018, then yes, the interest stopped in 2018. If showing it as taxable in 2019, I would include the accrued interest. 

Page 33, Section 6.02 - But if the failure is the employer's fault, the employer should really pay the difference in the interest. I doubt that will actually happen, but it's worth considering. 

[401(k)athryn]

19 hours ago, justanotheradmin said:

Have you read the updated EPCRS publication? Revenue Procedure 2019-19?

Typically I would say if you are issuing the 1099-R for 2018, then yes, the interest stopped in 2018. If showing it as taxable in 2019, I would include the accrued interest. 

Page 33, Section 6.02 - But if the failure is the employer's fault, the employer should really pay the difference in the interest. I doubt that will actually happen, but it's worth considering. 

Thanks! I read the new procedure.  It refers to deemed distributions.  Perhaps a dumb question - Can I assume that they are also talking about "loan offsets", which is the situation with my client?  In other words, I thought a deemed distribution only occurs when there is no distributable event.  If that is the case, I'm not seeing any guidance in the new Rev. Proc.

But, if we assume that any reference to a "deemed distribution" also applies in my case, then it says that "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)."  So, I would be fine with the 1099-R being issued for 2019, but am still concerned about the extra interest that has accrued from 10/1/2018 - now, as the end of the cure period was 9/30/2018. 

I'm not sure who is ultimately responsible for defaulting a loan, but it is not the participant.  As a TPA, we monitor and have defaults processed.   The prior TPA of this plan is no longer involved and I certainly don't expect them to take responsibility.  Not even trying to get them involved.

I have reached out to John Hancock and will see if they can default this loan year using the 9/30/2018 balance and just wipe out the additional interest.  I'll let you know!

 

 

[Luke Bailey]

I would have thought EPCRS would be clearer on this, but I think the provision of 2019-19 that is applicable here is 6.07(2), which says:

(2) Plan loan failures treated as deemed distributions under § 72(p). Unless
correction is made in accordance with section 6.07(3) (to the extent applicable), a deemed
distribution under § 72(p)(1) in connection with a failure relating to a plan loan to a participant
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.  In this case, 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).
 

I think that you have two separate things here, 401(k)athryn, i.e. the deemed distribution that occurred under the 72(p) regs in 2018 and should have been reported as 2018 income, and the plan loan offset that will occur at some point (presumably, soon) when you actually report the defaulted loan as distributed and take it off the plan's books.

The way I read 6.07(2) above, although it is in EPCRS, you're not really correcting, but merely dealing with a reporting issue. Section 6.07(2) seems to be saying that if you missed it for the right year, 2018, you can report the deemed distribution in current year (i.e., 2019), but the plan would need to pay "any applicable income tax withholding" (which is probably $0).

As I recall, the 72(p) regs simply provide that interest accruing after the date a loan is deemed is not taxable to the participant (either as additional deemed distributions or at the time of the loan offset), even though it continues to accrue until the date of the loan offset for purposes of blocking additional loans). The 72(p) regs also say, of course, that the loan is deemed distributed as of the end of the calendar quarter following the calendar quarter of the first missed payment (if the default is not cured). There does not seem to be a rule either in the 72(p) regs or Rev. Proc. 2019-19 that changes this result (i.e., requires the accrual of additional taxable interest) on a deemed loan that was not timely reported, from the deemed date to the date of reporting.

It might make sense to keep accruing taxable interest until the date as of which you report the deemed amount, but since that is not provided for in the 72(p) regs and 2019-19 does not specifically address, seems to me at least an open issue.

Just saying. Others may have different view.

[ldr]

Kathryn, please keep us posted.  I am dealing with the same situation and it's also a John Hancock plan.  Participant left 09/15/2017 which was also the date of his last loan payment.  He still has all his money in the plan - never took a distribution.  As of 12/31/2017 his loan was in default.  In 2018, all that happened was that John Hancock accrued interest to his loan.  I figured all this out in the course of doing their 2018 annual report just last week.  I contacted JH and found out that this falls under "loan offset" and that we had to get a Trustee signed form asking for the offset, which we have done and sent in to them.

However, it did not occur to me to ask them to make the 1099-R they will issue for 2019 to be just the loan balance as of the date of the last payment and to not include the accrued interest.  It was a large loan, and they accrued over $1,200 in 2018 alone to the outstanding balance.

So please let us know how your situation turns out!