Excess/Defaulted Loan

Last summer a participant took a maximum loan equal to 50% of their VAB, to be set up for repayments via payroll deductions twice a month.  No repayments have been made to date.  The outstanding balance of the loan went over 50% of the VAB once the first repayment was missed due to accrued interest, though eventually it went down below 50% due to continued deferrals.  It's a PT if a loan for an amount exceeding 50% is taken and a Form 5330 should be filed for the excess - is it also a PT if the loan's initial amount is OK but the 50% max is breached due to accrued interest from non-payment?  If this is a PT, does a 5330 need to be filed even if the OB went below 50% before the end of the year?  Hopefully not, since the excise tax in this case would be far less than $100.

It seems that section 6.07(3)(d) of Rev. Proc. 2021-30 permits self-correction of loans whose IRS maximum cure period has expired (this occurred on this loan 12/31/21) if the participant pays a lump sum for the missed payments with interest to bring the loan current.  So it appears the loan becoming a deemed distribution won't be an issue if the participant does this, even if it happens in the following year.      

I suspect that the employer neglected to set up the automatic payroll deductions for the repayments, and I remember hearing that the employer may be liable for some of the repayments?  Does anyone have any info on this, or know where I can read about it?        

It's surprising to see that some of the major recordkeepers do not add interest for missed payments onto outstanding loan balances - I thought they were required to do so.  

The 50% limit is applicable to the time the loan is issued, not for the full life of the loan.

And yes this is correctable under EPCRS in many cases.

Some record keepers accrue the interest but but don't "post it" unless a payment is made or distribution made.

In addition to the excellent insights from Lou, I wanted to add that this is something that is also covered by the DOL's Voluntary Fiduciary Correction program ("VCP"). Although it is extremely dated and the DOL has it on its regulatory agenda to update it, the existing program is what it is. You have two routes to go here: (1) use the VCP program, do the filing, pay the amount of the excise tax to the participant's account balance and get a no-action letter from the DOL or file and pay the excise tax on a form 5330 and then self-correct the error under EPCRS. I recall that the Rev Proc for EPCRS provides, at least as applied to delinquent remittance of employee contributions, that the correction is made through VFC first. It may also be the case as applied to a loan that is not timely repaid primarily due to the error on the part of the recordkeeper to initiate loan repayments via payroll deduction.

As a follow up, the loan was for $20k and was taken for the purchase of a primary residence, so the term is 30 years.  Regarding self-correction, it would appear the expiration of the maximum IRS cure period would be considered 'insignificant' for EPCRS purposes since the plan has never had a problem like this before, and the $20k is less than 1% of the plan's assets.  Being that it's insignificant, does this mean that theoretically the participant (employer?) can leave this unattended for the whole term of the note without consequence?  I'm guessing a 1099 would eventually have to be issued for the earlier of the participant's year of termination when an offset occurs, or the note's maturity date, for an amount that includes accrued interest to that point.  Am I understanding all of this correctly?

As an aside, prior to taking the loan, the participant took a maximum inservice distribution - it's very likely she never had the intention of paying back the loan and saw it as a way to get even more $ out of the plan, regardless of the possible tax consequences.  I imagine a quick fix would be for the employer to just set up payroll deductions for the repayments missed to date (plus interest) and then follow the original amortization schedule.  Thank you in advance for any assistance.

11 hours ago, mming said:

Being that it's insignificant, does this mean that theoretically the participant (employer?) can leave this unattended for the whole term of the note without consequence? 

Another requirement to be eligible to use SCP is that the employer must have processes and procedures in place to promote overall compliance. Intentionally ignoring a loan that they know is in default is not promoting overall compliance.

11 hours ago, mming said:

I imagine a quick fix would be for the employer to just set up payroll deductions for the repayments missed to date (plus interest) and then follow the original amortization schedule. 

That, or re-amortize the outstanding balance into level payments over the remaining term of the loan.

The law in most (all?) states allows an employee to terminate any payroll withholdings other than those required by law (such as federal and state taxes). So the employer can not force the employee to repay the loan, even via payroll. If the employee asks the employer to stop withholding loan payments though, be prepared to deem the loan as soon as the cure period expires.

Thanks Corey, and I now realize I forgot to also thank the previous responders - I appreciate all the assistance.