Loan Basis after Deemed Distribution

[GU]

On 12/3/2023 at 3:39 PM, Paul I said:

Let's now consider what happens if the participant remains active and begins making loan repayments for the deemed loan:

• The plan begins to credit repayments of principal and interest against outstanding balance of the promissory note that includes the interest that accrued after the loan was declared a deemed distribution.
• The amount of the deemed distribution is considered as after-tax basis for the participant.
• The interest on these repayments is treated no differently that the way interest was treated before the deemed distribution.  It is interest received as income to the plan.  The interest repaid by the participant does not create additional basis in the account (just like how income on after-tax contributions does not create additional basis for the participant).

Some loan policies may address the plan accounting which can impact the accounting of the above scenarios, but these policies should not create additional basis for the participant.

Practitioners who have many, many years in the business may remember when interest on personal loans, credit card interest, and interest on plan loans were all deductible.  Those were the days where loan interest was the equivalent of a pre-tax deferral.

I was looking for this kind of information so I'm glad to find a page of people that seem to know what they are talking about. 

 

How do we reconcile the lines above with the example given in 1.72(p)-1  Q&A-21  which says:
 

Quote

Q-21: Is a participant's tax basis under the plan increased if the participant repays the loan after a deemed distribution?

A-21:

(a) Repayments after deemed distribution. Yes, if the participant or beneficiary repays the loan after a deemed distribution of the loan under section 72(p), then, for purposes of section 72(e), the participant's or beneficiary's investment in the contract (tax basis) under the plan increases by the amount of the cash repayments that the participant or beneficiary makes on the loan after the deemed distribution. However, loan repayments are not treated as after-tax contributions for other purposes, including sections 401(m) and 415(c)(2)(B).

(b) Example. The following example illustrates the rules in paragraph (a) of this Q&A-21 and is based on the assumptions described in the introductory text of this section:

Example.

(i) A participant receives a $20,000 loan on January 1, 2003, to be repaid in 20 quarterly installments of $1,245 each. On December 31, 2003, the outstanding loan balance ($19,179) is deemed distributed as a result of a failure to make quarterly installment payments that were due on September 30, 2003 and December 31, 2003. On June 30, 2004, the participant repays $5,147 (which is the sum of the three installment payments that were due on September 30, 2003, December 31, 2003, and March 31, 2004, with interest thereon to June 30, 2004, plus the installment payment due on June 30, 2004). Thereafter, the participant resumes making the installment payments of $1,245 from September 30, 2004 through December 31, 2007. The loan repayments made after December 31, 2003 through December 31, 2007 total $22,577.

(ii) Because the participant repaid $22,577 after the deemed distribution that occurred on December 31, 2003, the participant has investment in the contract (tax basis) equal to $22,577 (14 payments of $1,245 each plus a single payment of $5,147) as of December 31, 2007.