Fix missed loan payments when no paycheck

S-Corp sponsors a SH 401(k) plan, which allows for deferrals, SH match and discretionary PS contributions, and plan loans. 100% shareholder in S-Corp took out a $50,000 plan loan in late 2019, with payments from bi-weekly payroll beginning January 2020. All loan payments were deducted from shareholder’s pay in 2020.

 In 2021, due to cash flow problems, shareholder did not receive several paychecks. He missed paychecks for ten of 26 pay periods in the year. For the pay periods in which the shareholder did not get paid, no loan payments were withheld for those pay periods. (There was at least one loan payment withheld from his pay in each calendar quarter.) In addition, due to cash flow problems, the S-Corp did not remit any withheld loan payments to the retirement plan after January 2021. (All 14 loan payments withheld in 2020 but not previously remitted were remitted to the plan in January 2022. )

In March, 2021, the shareholder sent a personal check for $20,000 payment on the loan. The plan is on FtWilliam document and allows for such additional payments although it does not allow for refinancing.

What are the options to fix this situation?  Can the $20,000 be used to satisfy the loan payments that were missed because no paycheck was issued?  Is it possible to avoid a deemed distribution?

What are other issues that need to be addressed (other than educating the shareholder about missing loan payments)?

Thanks!

For one, if there were loan repayments withheld from a paycheck but not sent to the trust, it's a prohibited transaction, and should be corrected by the employer depositing the withheld amounts along with lost earnings.  The employer also owes a 15% penalty tax on the earnings, payable with the filing of Form 5330. Optionally, the ER can file with the DOL VFCP.

Also, the missed amounts must go on the form 5500 until the year of correction.

Thanks BG5150 - Thanks for your response.  I understand your point about the prohibited transaction issues related to failure to timely remit loan payments withheld from paycheck, but my bigger concern has to do with missed loan payments due to no paycheck issued and what needs to be done (if anything) to fix that.

Did the $20,000 make its way into the plan? It's not clear what happened.  Personally, I would not be concerned that loan payments were not made by payroll deduction, as long as they were made. The concern is if the loan defaulted and it's not clear if that happened or not.

If a 1099 wasn't issued, can't you just correct it under EPCRS?

a) catch up with a lump sum payment then resume payments

b) reamortize the outstanding amount

c) combination of both

I agree with BG5150 on fixing the income tax issue under 72(p). Take a look at Section 6.07(d) of Rev. Proc. 2021-30, page 45.

17 hours ago, BG5150 said:

If a 1099 wasn't issued, can't you just correct it under EPCRS?

a) catch up with a lump sum payment then resume payments

b) reamortize the outstanding amount

c) combination of both

Did I miss something?  I have no idea what happened and don't know if there was a default.  Somehow it seems $20,000 was "paid" but it is in some sort of limbo.

Another note:  If the $20,000 was more than what was owed, check the loan policy.  See if pre-payments are allowed for a part of the loan.  We usually write our loan policies to only allow pre-payment for the whole thing.  Makes administering them a heckuva lot easier.

(I'm assuming that $20,000 check got put into the account to pay off some of the loan)

Thank you for all the replies.  Sorry for my tardy response but my computer crashed and I lost a lot of files.

The 401(k) plan allows for full or partial loan prepayment, but does not allow for refinancing.  The $20,000 was paid into the plan and is not sitting in limbo.

We are trying to understand if that amount can be used to satisfy the payments that were missed due to no paychecks issued for the shareholder for 10 of the 24 pay periods.  The $20,000 will more than cover those missed payments.   (In fact, it would more than cover the payments for the entire year.)

For the other loan payments that were deducted from shareholder's biweekly paychecks, the first two were remitted timely.  The other 12 were remitted as a lump sum (loan payment per amortization x 12) the first week in January.

My preference would be to run a new amortization using the same interest rate, plug in the payments as they were made (including the $20,000 amount), and set the remainder to be paid bi-weekly in the original payment amount beginning in January 2022.  The loan will just pay off earlier when I rerun the amortization.

Because of the $20,000, I am hoping I would not have a default on the loan. 

I like BG150's idea of correcting under EPCRS and his item 'c' - a combination of applying the $20,000 and other loan payments and reamortizing with payments at the same amount as previously calculated.  Does that sound reasonable and correct?

1 hour ago, M Norton said:

Because of the $20,000, I am hoping I would not have a default on the loan. 

I like BG150's idea of correcting under EPCRS and his item 'c' - a combination of applying the $20,000 and other loan payments and reamortizing with payments at the same amount as previously calculated.  Does that sound reasonable and correct?

M Norton, these are two different things, right, and you're OK if either applies? You can apply whatever cash came in (the one payment per quarter that you mention) to the first missed payment, so depending on when during the quarter the first missed payment occurred you may kick the default down the road a quarter, but I think you would have had a default at some point, i.e. a missed payment in a quarter that is not corrected by the end of the next quarter. But then you correct that under EPCRS.

And don't confuse reamortizing the loan with refinancing.  They are different things.

I would show the $20K as a prepayment on scheduled payments.  I doubt you had a default; it would appear he is way ahead of schedule.  I would plug it all into a spreadsheet and make sure actual payments equal or exceed the payment that should have been made.  It's paid off when the spreadsheet says it is.

Thank you all so much!  You have been a great help!

1 hour ago, Bird said:

I would show the $20K as a prepayment on scheduled payments.  I doubt you had a default; it would appear he is way ahead of schedule.  I would plug it all into a spreadsheet and make sure actual payments equal or exceed the payment that should have been made.  It's paid off when the spreadsheet says it is.

But I would make sure regular payments happen going forward.

5 hours ago, Bird said:

I would show the $20K as a prepayment on scheduled payments.  I doubt you had a default; it would appear he is way ahead of schedule.  I would plug it all into a spreadsheet and make sure actual payments equal or exceed the payment that should have been made.  It's paid off when the spreadsheet says it is.

The $20k is probably enough to bring the loan up to schedule, and then some, but it may have been too late to prevent a default in earlier quarter, so need to apply EPCRS.

18 hours ago, Luke Bailey said:

The $20k is probably enough to bring the loan up to schedule, and then some, but it may have been too late to prevent a default in earlier quarter, so need to apply EPCRS.

Not from what I read in the post, if they are using the max cure period:  "All loan payments were deducted from shareholder’s pay in 2020...In March, 2021, the shareholder sent a personal check for $20,000 payment on the loan."

On 1/12/2022 at 12:32 PM, M Norton said:

In 2021, due to cash flow problems, shareholder did not receive several paychecks. He missed paychecks for ten of 26 pay periods in the year. For the pay periods in which the shareholder did not get paid, no loan payments were withheld for those pay periods. (There was at least one loan payment withheld from his pay in each calendar quarter.) In addition, due to cash flow problems, the S-Corp did not remit any withheld loan payments to the retirement plan after January 2021. (All 14 loan payments withheld in 2020 but not previously remitted were remitted to the plan in January 2022. )

In March, 2021, the shareholder sent a personal check for $20,000 payment on the loan. The plan is on FtWilliam document and allows for such additional payments although it does not allow for refinancing.

The above is, at least to me, deeply confusing. But if the $20,000 was intended and accepted as a prepayment for 2021, since there was not going to be reliable withholding in 2021, then you're probably right, i.e., no default. Would need to review the actual timeline and documents.

Greetings everyone, I just wanted to add smoothening to discussion

My conclusion is to attempt to fix the missed loan payments for all four quarters by accelerating payment so they are paid at the same time -- in January 2022. Thus, the shareholder will have received three total months' worth of pay in 2021 (4/3 = 1.33) instead of nothing in six out of 12 months (3/12 = 0.25). And according to moneyzap calculator, the acceleration should preserve any FWOP protection because it would be achieved only if the shareholder had been employed through December 31, 2021 , when K-1s are prepared .