Loan from contribution

Hi

Owner wants to contribute 50k and borrow 50k from DB. Instead of actually makings the contribution and then taking it out as a participant loan, can he just put the 50k into his account with a memo that there was a contribution and then taken out as a loan? Thank you, as always, for any insights.

Do I know you?  Looking at almost this exact same scenario.  

From my research, if the plan contains a loan provision, the participant can take a $50K loan from the plan (they will need to make payments on this).  They can then loan that money to the plan sponsor (company/same person). The company can then use that cash to make the required contribution.  On the surface, I don't see anything "wrong" with that, but it feels like there should be since the same $ are being deducted twice. 

My understanding is that the taxation might get ugly, especially if this is a pass-through or S-corp or something.  Owner giving money to the corporation creates corp equity.  The contribution is deductible.  If paid within 5 years, no deemed distribution and no taxation on the loan to the participant owner.  

The Plan cannot loan the corporation money to make the MRC.  In this case, the Plan is loaning the participant, who is loaning the company, who is making the contribution.  My understanding is that if it's a pass-through entity, then there's no difference between owner and company, so this could be a problem depending on the structure.

Thank you Effen. As always, your analytical mind is much appreciated. However, I think your case is more complicated than the one that I am trying to describe. I think I was not fully clear when I posted. The case is that an owner only DB  plan, thr owner (participant) wants to take the max loan allowable of $50,000. The problem is that if he sells some of the pension shares so that he can have the 50,000 cash avaliable to borrow, the plan will incurr a loss, since the market is down. To avoid incurring this loss, instead of withdrawing the loan from the existing plan assets, can he take the 2023 DB contribution (50,000) that he is about to deposit into the plan account, and instead of depositing it in the DB Brokerage account, and then taking it back out as a loan, can he just make out the 50,000 contribution check payable to himself (as if it was first contributed then loaned to himself). He will of course have a loan amortization schedule, loan application, and promissory note to the plan, that will serve as the trail for this contribution/loan. Is this allowable, or must he first actually deposit the 2023 contribution to the plan account? Thank you.

1 hour ago, SSRRS said:

To avoid incurring this loss, instead of withdrawing the loan from the existing plan assets, can he take the 2023 DB contribution (50,000) that he is about to deposit into the plan account, and instead of depositing it in the DB Brokerage account, and then taking it back out as a loan, can he just make out the 50,000 contribution check payable to himself (as if it was first contributed then loaned to himself).

IMO, no. These investments/tail-wagging the dog scenarios are almost always problematic. 

I'm with Bird, do the steps correctly to best protect the sponsor and plan, don't skip step because you think it gets you to the same spot.

1 Loan to participant in accordance with the Plan's loan program.

2 He can do want he wants with the money, including loaning it to the corporation. Let him work out those details with his CPA and or attorney.

3 Have the Plan Sponsor make the MRC (presumably $50K in this case).

That way you have a clear paper trail should the IRS audit the plan.

The root cause for this scheme seems to be that the plan lacks cash available to give to the participant to make the loan.  If so, then the scenario should start with the business making a cash contribution the plan sufficient to cover the MRC which would put the plan in the position to issue a loan check.  That would provide a documented trail of the sequence of events.

The idea of writing a check to himself is a stretch in an attempt to circumvent the lack of availability of cash in the plan.  This supposes that there is $50,000 in the business checking account (for the contribution) that would cover a check to his personal bank account (for the loan).  If there are not separate checking accounts, would a bank even cash a check from an account payable to the account upon which it is written?  If the bank will not honor the check, is it a valid financial transaction?

Trying to net the contribution and loan into a single transaction is vulnerable to an interpretation of events, and the IRS likely will have its own view of what transpired.  Consider that the IRS could view the result of the net transaction as if the business funded the contribution by the having participant give the plan a promissory loan note secured by his vested balance in the plan, and then consider the potential consequences.

@Lou S.'s suggestion to have a clear paper trail is on point.  If the plan has the cash to make the loan, the paper trail should methodically step through the participant takes the loan, the participant makes the proceeds of the loan available to the business, and the business funds the MRC. 

If the plan does not have the cash to make the loan, the paper trail should include methodically step through the business funds the MRC, the participant takes the loan, and if necessary, the participant makes the proceeds of the loan available to the business.

This is not advice of an kind, nor a recommendation.

Frankly, this whole scenario has a whiff of a business in trouble and possibly with a plan that it cannot afford.  Prudence would add taking steps to evaluate how assure the business and the plan can function within common norms.

It sounds like the owner just wants to skip some proper transactional steps and get the cash where it ultimately will end up, and just create a "memo" to document since there wouldn't be the transactional paper trail. I don't know how an IRS or DOL auditor might feel about that and do not think it's a good idea.

20 minutes ago, CuseFan said:

It sounds like the owner just wants to skip some proper transactional steps and get the cash where it ultimately will end up, and just create a "memo" to document since there wouldn't be the transactional paper trail. I don't know how an IRS or DOL auditor might feel about that and do not think it's a good idea.

That's how I see it. And remember the MRC needs to be funded in cash. I would think that even the IRS bought the "memo" argument they might challenge the MRC as being in the form of a Promissory Note instead of a cash contribution. Just another argument for having a clean paper trail of events.

Sounds like there's no "cash" to begin with.

I may be conservative on this, but I always advised clients that if a business owner took a loan from the plan with the intention of loaning those funds back to the plan sponsor, and then immediately did loan the money to the company, the IRS would have a very strong case to claim that this was an indirect loan to the plan sponsor which is a prohibited transaction.  At a minimum, the business owner (after taking the loan from the plan) should loan a different amount at a different time and under different repayment terms if trying to establish that these two transactions were independent and totally separate.

On 4/22/2024 at 12:51 PM, cathyw said:

I may be conservative on this, but I always advised clients that if a business owner took a loan from the plan with the intention of loaning those funds back to the plan sponsor, and then immediately did loan the money to the company, the IRS would have a very strong case to claim that this was an indirect loan to the plan sponsor which is a prohibited transaction.  At a minimum, the business owner (after taking the loan from the plan) should loan a different amount at a different time and under different repayment terms if trying to establish that these two transactions were independent and totally separate.

I always cautioned that such an arrangement was potentially a PT - as an indirect loan.  

Thank you ALL. Your informative insights and knowledge is much appreciated.