401k Plan Loan Default

Plan is a 401k PSP pooled account. The trustee and her spoiuse both took out 2 loans a piece and defaulted on both of them. One in 2022 and one in 2023. Their CPA issued the appropriate 1099s.  There is a zero balance showing for their loans.  They want to pay the balances off. Can they do that?  Plan doc says the following:   TYIA! 

If the loans were distributed as a benefit offset, then there's nothing to repay. The plan would have discharged the loans.

If they were "only" deemed distributions, then the notes still "exist" and the sponsors could get some tax basis by repaying them with all the accrued interest.

You may consider doing a little more research to clarify the situation.

You mention that the plan has a pooled account.  It is possible that the loans were treated as an investment of the plan and not treated as a loan earmarked from a participant's account.  If a loan is treated solely as an investment, then it was a bad investment for the plan but not a distribution to the participant.  It is unlikely this was the case, particularly since the CPA issued 1099Rs, but it could have been how the loans were issued.  The terms and promissory note for the loans should help clarify this.

What code did the CPA put on the 1099Rs?  If it was code L, then the loans were reported as a deemed distribution and the loans continue until they are repaid or offset.  If it was code M, then the loans were reported as offset and the loans ceased to exist.  Keep in mind that for an offset to occur, the funds would have to be available for a payment from the plan either as a withdrawal, RMD or distribution at the time of the offset.

You also may want to see if and how the loans were reported on the 5500.  Were they included in or excluded from the assets?  If they are included in the assets, that would support an argument that the loans continue to exist.  If they are excluded, that doesn't support an argument that they do or do not exist.

Consider the direction in which the preponderance of the evidence points (deemed or offset) before they deposit anything into the plan.

14 hours ago, Paul I said:

You may consider doing a little more research to clarify the situation.

You mention that the plan has a pooled account.  It is possible that the loans were treated as an investment of the plan and not treated as a loan earmarked from a participant's account.  If a loan is treated solely as an investment, then it was a bad investment for the plan but not a distribution to the participant.  It is unlikely this was the case, particularly since the CPA issued 1099Rs, but it could have been how the loans were issued.  The terms and promissory note for the loans should help clarify this.

What code did the CPA put on the 1099Rs?  If it was code L, then the loans were reported as a deemed distribution and the loans continue until they are repaid or offset.  If it was code M, then the loans were reported as offset and the loans ceased to exist.  Keep in mind that for an offset to occur, the funds would have to be available for a payment from the plan either as a withdrawal, RMD or distribution at the time of the offset.

You also may want to see if and how the loans were reported on the 5500.  Were they included in or excluded from the assets?  If they are included in the assets, that would support an argument that the loans continue to exist.  If they are excluded, that doesn't support an argument that they do or do not exist.

Consider the direction in which the preponderance of the evidence points (deemed or offset) before they deposit anything into the plan.

 

Thank you Paul.  They  were coded as M on the 1099s. The loans were excluded from the assets, both on the 5500 and on their yearly valuation.  Yes, the loans were treated as loans earmarked from the participants' accounts.