Participant loan offset not allowed because the balance is over $5,000

[Guest mo again]

A hypothetical participant has taken a loan against his profit sharing balance. Under the terms of the plan, the participant had the ability to withdraw those funds on an in-service basis, but instead elected to borrow them. Now the participant defaults on the loan. My understanding is that an offset would be allowable. However, the IRS reviewer who is reviewing our document is taking the position that an offset would not possible due to 411(a) considerations: i.e. that the offset cannot occur because the balance is over $5,000 and there no was no request from the participant for the offset.

Is anyone aware of any direct evidence to the contrary that can be presented to the reviewer?

Thanks!

[KJohnson]

You may want to look at at the rollover regs.

Example 6 under 1.402©-2 Q&A9 indicates that no offset could be taken from elective contributions in a 401(k) for an active employee because the employee "has not separated from service or experienced any other event that PERMITS a distribution."

I think that you can argue that all you need is an event that "permits" a distribution and in-service distributions are permitted in profit sharing plans.

Wouldn't the 411(a) consideration also be in place for an employee who terminates employment with a $5k plus balance. Is the reviewer stating that you can't have an offset in this instance? That would be contrary to all of the examples in Q&A 9.

[M R Bernardin]

You may want to have the reviewer look at treasury regulation sections 1.411(a)-11©(2)(v) and 1.401(a)-20, Q&A-24, the latter of which suggests that a participant who consents to have his account serve as security for a loan is deemed to have consented to a subsequent offset.

[Guest LMalone]

May we revive this issue? Was a conclusion reached whether or not the participant had to consent to a distribution before the offset could occur?

I've got a situation where the participant has over $50,000 in his account; terminated in 2000; defaulted on the loan and was issued a 1099 for a deemed distribution. So far, so good.

Participant has not yet requested a distribution of his account balance. May the administrator go ahead and offset? I don't think it would matter if this was a 401(k), PSP, or MPP. We know we have a distributable event (termination of employment). It seems the issue is one of consent to the distribution.

A separate question: could he consent only to the offset portion when the plan does not permit partial distributions, only lump sum?

I looked at Reg. 1.401(a)-20, Q&A-24, and it seems to be dealing with spousal consent questions and not my particular issue.

Thanks for any help out there.

[Guest mo again]

FWIW, after we presented the very good points raised by KJohnson and M R Bernardin, the reviewer caved and approved the language.

[Guest Donkey Kong]

I had a pet bat once and it caved. Now I can't find him because it's too dark in there.

[Guest mo again]

Better in the cave than in your belfry.