Final Regulations Issued: Cure Period for Defaulted Loans

[Dave Baker]

The following article is from Sal Tripodi's TRI Pension Services web site ( http://cybERISA.com ) and is reprinted here with Sal's permission. Copyright 2000 TRI Pension Services, all rights reserved. Post a reply to this thread if you would like to discuss comments or questions about this article with other users of BenefitsBoards.net!

Final Regulations Issued: Cure Period for Defaulted Loans

, Q&A-1 through Q&A-19, and Q&A-21 through Q&A-22, 65 F.R. 46588 (July 31, 2000), provide guidance, in question-and-answer format, on the tax issues relating to participant loans, as set forth in IRC §72(p). A loan is taxed as a distribution unless it satisfies the requirements of §72(p)(2). The regulations finalize two sets of proposed regulations, one issued in 1995 and the other issued in 1998. The 1998 proposed regulations supplemented the 1995 proposed regulations, to provide guidance on the treatment of accrued interest after a plan loan is deemed to be distributed under section 72(p), tax basis issues relating to a deemed distribution, and the effective date of the regulations. Along with these final regulations, the Treasury is issuing a new set of proposed regulations [click] ... to address refinancing transactions, the tax treatment of multiple loans, and military service leave.

Effective date. The regulations are effective for loans made on or after January 1, 2002. See Q&A-22(B) [click]. (The 1998 proposed regulations clarified that the effective date would be no earlier than the January 1 which is at least 6 months following the publication of final regulations.) The plan year of the plan is irrelevant. In other words, all plans become subject to the regulations as of January 1, 2002, even if that date occurs in the middle of a plan year. This effective date does not mean that plans may ignore IRC §72(p) before January 1, 2002. The statutory effective date of §72(p) was for loans made after August 13, 1982 (although the quarterly amortization rule and some changes to the principal residence loans did not apply until after 1986). Between the applicable statutory date of any provision of §72(p) and the regulatory effective date, plan administrators must apply a reasonable, good faith standard of compliance. Compliance with the proposed regulations, or any provisions of these final regulations, before the regulatory effective date would be treated as satisfying the good faith compliance standard. The final regulations follow the proposed regulations very closely, so a detailed analysis is not provided in this summary. Here are some highlights.

Cure period for defaulted loans. The final regulations retain the rules for correcting missed loan payments before a deemed distribution, due to default, must be triggered. The proposed regulations had referred to this as a "grace period," but the final regulations call it a "cure period." Q&A-10(a) of the regulations permits the cure period to run through the end of the calendar quarter that follows the calendar quarter in which the missed installment payment was due. When the loan is in default (taking into account any permitted cure period), the entire balance due is taxable, including accrued interest through the date of default.

Example. A participant is making monthly installments on a loan from the plan. The participant misses the payment due August 31, 2003, and subsequent monthly payments. The provides a 3-month cure period. The cure period for the August 31, 2003, payment ends November 30, 2003. The amount is not paid by then. The taxable distribution is $17,157, which represents the participant's outstanding loan balance, but interest accrued through November 30, 2003. In an alternative scenario, the regulations provide that the plan's cure period ends on the last day of the calendar quarter following the quarter in which the installment payment is missed. In that case, the cure period would not end until December 31, 2003, so there would be an additional month of accrued interest. In the example, the taxable distribution is increased to $17,282.