Reasonable rate of interest

[bzorc]

Received the following question from an auditor friend of mine, who is trying to wrap up a 12/31/20 plan audit before Friday:
 

Got a plan that dropped its interest rate down to 1% due to the pandemic....not sure why they did this, but we are not sure that this would be considered "reasonable rate of interest" per IRS standards and that if it is determined that it is not, then isn't there a risk that the "Loans" would be considered distributions?  We have a call into the client to see why they did this and if anyone weighted in in terms of ERISA allowability. 

Any thoughts on this one?

 

[ESOP Guy]

My understanding has always been they would have to show that rate is what is commercially available given the risks of the loan.  

You can find plenty of threads debating what kind of loan is commercially available compared to plan loans.   There are after all over collateralized.   There is 0% chance of the plan to lose money on this loan.   It can only lower the borrower's balance.  

So I have always said, with plenty here disagreeing, that you should compare to a loan that is fully secured by the borrower's own account balances.  My credit union will give me a loan that is secured by one of my own CDs at CD rate plus 2%.   So I don't see how you ever get to 1%.  

[Peter Gulia]

Consider (politely) reminding an independent qualified public account of the audit’s purpose.

An audit might include some audit procedures designed to test whether the plan was administered according to the plan’s governing documents.

An audit might include some audit procedures designed to evaluate whether the plan’s financial statements need a reserve for income taxes because the plan (i) did not meet the conditions for tax-qualified treatment, and (ii) had a net of taxable income after counting deductions, including those for distributions and for other proper expenses.

Even if no reserve for income taxes is needed, an audit might include some audit procedures designed to evaluate whether the plan’s financial statements need a disclosure that the plan does not get tax-qualified treatment.

But an ERISA § 103 audit is not a compliance-assurance engagement.  The purpose is to report a finding about whether the plan’s financial statements are fairly stated.

Even if a too-low interest rate might have made a participant loan a distribution, that might not always tax-disqualify the plan.  Or if it does, the plan’s financial statements could disclose that the plan does not (or might not) get tax-qualified treatment.  Doing so might help make the plan’s financial statements fairly stated.

Even if a too-low interest rate might have made a participant loan a non-exempt prohibited transaction, a plan’s financial statements could report or note related-party and prohibited transactions.  Doing so might help make the plan’s financial statements fairly stated.

And considering that a too-low interest rate for some participant loans likely would not preclude a “clean” report that the plan’s financial statements are fairly stated, an auditor might consider some tolerance if the fiduciary furnishes a plausible explanation about how the fiduciary set the loan interest rate within the ERISA and Internal Revenue Code rules.

[fmsinc]

Isn't this covered under imputed interest by the IRS?  

See https://turbotax.intuit.com/tax-tips/tax-payments/irs-tax-rules-for-imputed-interest/L7UbulHpC#

[Luke Bailey]

I agree with Peter.