Takeover 401(k) sub-s plan with owner(participant) loans.

[pbarrett]

We recently took over an existing 401(k) plan. The sponsor is a sub-s corp. While preparing the '99 valuation, I have discovered two loans were made to the owners. Any ideas on how to proceed? The loans were both made in '99. The plan has well over 100 participants so it will also need to have an audit done. Any thoughts would be appreciated.

[R. Butler]

The loans need to be repaid ASAP. It will continue to be a prohibited transaction until it is repaid. A 5330 must be filed. The tax is assessed on the accumulated interest on the loan. Here is where it gets sticky; a separate prohibited transaction has occured for each year the loan is outstanding, therefore for Year 1 tax assessed on the accumulated interest for Year 1; for Year 2 tax is assessed on accumulated interest (Year 1 + Year 2); Year 3 tax is assessed on accumulated interest (Year 1 + Year 2 + Year 3), etc. You can probably file one 5330, but be sure to calculate tax correctly.

Unless the loans are very large the excise tax usually isn't all that bad, your real problem is getting the owners to repay the loan.

Hope this helps.

[QDROphile]

In addition to the prohibited transaction, the plan may be disqualified. If so, attend to the disqualification in an approprite manner. Competent professional assistance for assessment of the problem and execution of the remedy is a good idea.

[MWeddell]

Take a look at the voluntary fiduciary compliance program issued by the DOL in March 2000. Also, consider the IRS prohibited transaction excise tax.

[Guest lforesz]

Does anyone have any information on if the IRS is to forgive pre-2001 loans to owner-employees as part of EGTRRA? I have some information from a well-known law firm that says they will waive penalties if the loan to the owner-employee otherwise satisfied the requirements.

I have other information (including some ASPA) material that says the IRS has been advised to waive the penalties only if the loan was exempt when made and then became non-exempt sometime during the term (i.e. due to a change in corporate status). Does anyone know which is right?

Help!

[Guest merlin]

lforesz-Ibelieve your second paragraph is correct. See the Conference Committee Report on EGTRRA sec 612

[mbozek]

Granting of a individual loans to an owner is not usually grounds to disqualify a plan since it would adversely affect non owner participants. It is a PT subject to the 15% tax. Since loans are now permitted to S corp owner counsel should review whether plan can make a legitimate loan to owner after owner pays off impermissable loan. Owner could use home equity loan or short term bridge loan to pay off impermissible loan from plan until new plan loan become available. I recall reading some IRS announcement regarding remediation of impermissible loans to S Corp owners and partners-- You should check IRS web site.

[Guest Ian Paige]

Originally posted by pbarrett

We recently took over an existing 401(k) plan.  The sponsor is a sub-s corp.  While preparing the '99 valuation, I have discovered two loans were made to the owners.  Any ideas on how to proceed?  The loans were both made in '99.  The plan has well over 100 participants so it will also need to have an audit done.  Any thoughts would be appreciated.    

We ran into this in 1996. Submitted to LosAngeles District Office under walk-in CAP. LA eventually notified us that it was not a qualification issue, just PTs. All owners reversed loans and paid excise tax on interest ("amount involved"), and everything was OK.