401 K deemed loan

I have a loan out on my 401k.  In May I was out of work for two weeks and did not receive a paycheck.

So, one payroll deduction was missed of $ 93.61.   I received a letter from Wells Fargo regarding the missed payment and that if I did not bring the loan current the loan would default and then become a taxable distribution.  The letter stated I should call them, which I did.  The person who took my called stated they were unsure how I was to make a payment since this was a payroll deduction and they would call me back, if I had to do anything because is was a payroll deduction.  ( The person was not sure) I gave them my cell  number.

I received a 1099R so obviously the loan was deemed. I called 401 K and stated they were supposed to call and tell my how to correct the problem. They are telling me they call a office number at my work and left a detailed message on how to correct the matter????I did not  get that message.

They are telling me there  is noting that can be done once the loan is deemed. 

Can anything be done so I do not have to pay the tax on the loan????I am still making payment via payroll deductions.

 

 

 

Do you still have that letter?  It would be helpful to know exactly what they said.  It would also be helpful if you tell us the date you took out the loan, the original scheduled last payment date and how often you are paid.  If you have any paperwork on the loan, it should address when the loan would go into default.  You will also need information on the plan loan procedures. It may be part of the plan document or it may be a separate document.  If you don't have a copy, ask your employer for a copy.  The IRS regulations spell out the maximum time period for having loans with missed payments go into default and become taxable.  The plan can use a shorter time period. 

 

See what information you can get and let us know what you find out.  In most cases, a single missed payment shouldn't cause a loan to be deemed, but we need more information before anyone can tell you if your loan was handled properly.

 

if you missed one pmt but have continued to make other pmts you are probably ok.

when you returned to work you made a loan pmt. this can be applied to the one you missed. and this goes on and on until you would use up the maximum period of loan.(assuming there is a min cure period available which is generally the quarter following

see example 1 in the IRS memo

https://www.irs.gov/pub/irs-wd/201736022.pdf

 

Office of Chief Counsel Internal Revenue Service

memorandum

Number: 201736022

Release Date: 9/8/2017

CC:TEGE:EB:QP4

PRENO-125977-17

UILC: 72.16-01

date: August 30, 2017

to: David A. Conrad

Area Counsel, (Mountain States Area Denver)

(Tax Exempt & Government Entities Division Counsel)

from: Stephen B. Tackney

Deputy Associate Chief Counsel, (Employee Benefits)

(Tax Exempt & Government Entities)

subject: Section 72(p) loan cure period

This Chief Counsel Advice responds to your request for assistance. This advice may not be used or cited as precedent.

ISSUES

You have asked how a cure period, as described in § 1.72(p)-1, Q&A-10(a), is applied for a participant who fails to make installment payments required under the terms of a plan loan. To help address your question, we will analyze two different factual situations.

For both factual situations, assume the following:

(a) the taxpayer is a participant in a § 401(k) plan that permits plan loans;

(b) on January 1, 2018, the participant receives a loan from the plan in an amount that does not exceed the limit provided under § 72(p)(2)(A);

(c) the loan, which is not a home loan, is repayable in five years (the last installment payment is due December 31, 2022), as required under

§ 72(p)(2)(B);

(d) level installment payments are due at the end of each month over the repayment term of the loan (the first installment payment is due January 31, 2018), as required under § 72(p)(2)(C);

PRENO-125977-17 2

(e) the loan is evidenced by a legally enforceable agreement, as required under § 1.72(p)-1, Q&A-3(b); and

(f) the plan allows for a cure period, as described in § 1.72(p)-1, Q&A-10(a), permitting a participant to make up a missed installment payment by the last day of calendar quarter following the calendar quarter in which the required installment payment was due.

Situation 1. The participant timely makes installment payments from January 31, 2018, through February 28, 2019. The participant misses the March 31, 2019 and April 30, 2019 installment payments. The participant makes installment payments on May 31, 2019 (which is applied to the missed March 31, 2019 installment payment) and June 30, 2019 (which is applied to the missed April 30, 2019 installment payment). On July 31, 2019, the participant makes a payment equal to three installment payments (which is applied to the missed May 31, 2019 and June 30, 2019 installment payments, as well as the required July 31, 2019 installment payment).

Situation 2. The participant timely makes installment payments from January 31, 2018, through September 30, 2019. The participant misses the October 31, 2019, November 30, 2019, and December 31, 2019 installment payments. On January 15, 2020, the participant refinances the loan and replaces it with a new loan (the replacement loan)

equal to the outstanding balance of the original loan (the replaced loan), including the three missed installment payments. Under the terms of the replacement loan, the replacement loan is to be repaid in level monthly installments at end of each month through the end of the replaced loan’s repayment term, December 31, 2022. For

purposes of this example, assume that the replacement loan satisfies the requirements of § 72(p)(2)(A) through (C) and § 1.72(p)-1, Q&A-3 and Q&A-20.

CONCLUSIONS

Situation 1. The participant’s missed installment payments do not violate the level amortization requirement under § 72(p)(2)(C) because the missed installment payments are cured within the applicable cure period. Accordingly, there is no deemed

distribution of the loan due to the missed installment payments.

Situation 2. The participant’s missed installment payments do not violate the level amortization requirement under § 72(p)(2)(C) because the missed installment payments are cured within the applicable cure period by the refinancing of the loan. Accordingly, there is no deemed distribution of the loan due to the missed installment payments.

LAW

Section 72(p)(1) provides that if a participant receives (directly or indirectly) a loan from a qualified employer plan, the amount of the loan will be treated as having been received by the participant as a distribution from the plan. Section 72(p)(4) generally defines a qualified employer plan as a § 401(a) qualified plan, a § 403(a) annuity plan,

or a § 403(b) plan.

PRENO-125977-17 3

Section 72(p)(2) generally provides that § 72(p)(1) shall not apply to a loan to the extent that the loan meets the requirements of § 72(p)(2)(A) through (C).

Section 72(p)(2)(A) generally provides that a loan, when added to the outstanding balance of all other loans from all plans of the employer, must not exceed the lesser of:

(i) $50,000, reduced by any excess, if any, of (I) the highest outstanding balance of loans from the plan during the 1- year period ending on the day before the date on which such loan was made, over

(II) the outstanding balance of loans from the plan on the date on which such loan was made; or

(ii) the greater of (I) half of the present value of the participant’s vested accrued benefit, or (II) $10,000.

Section 72(p)(2)(B) provides that the loan must, by its terms, be required to be repaid within 5 years. An exception to this repayment term requirement is provided for home loans used to acquire the principal residence of the participant.

Section 72(p)(2)(C) provides that the loan must require substantially level amortization of the loan (with payments not less frequently than quarterly) over the term of the loan.

Section 1.72(p)-1, Q&A-3(a) provides that a loan from a qualified employer plan to a participant will not be a deemed distribution if the loan satisfies § 72(p)(2)(A) through (C) and is evidenced by a legally enforceable agreement. Section 1.72(p)-1,Q&A-3(b) describes the enforceable agreement requirement and provides that the agreement

must specify the amount and date of the loan and the repayment schedule.

Section 1.72(p)-1, Q&A-4, provides that, for purposes of § 72, a deemed distribution occurs at the first time that the requirements of § 1.72(p)-1, Q&A-3 are not satisfied, in form or in operation. Further, if a loan initially satisfies the requirements of § 1.72(p)-1, Q&A-3, but payments are not made in accordance with the terms of the loan, then a § 72(p)(1) deemed distribution of the loan occurs as a result of the failure to make such payments (see § 1.72(p)-1, Q&A-10, regarding when such a deemed distribution occurs and the amount of the deemed distribution, and § 1.72(p)-1, Q&A-11, regarding the tax

treatment of a deemed distribution).

Section 1.72(p)-1, Q&A-10(a) provides that a failure to make any installment payment when due violates the level amortization requirement in § 72(p)(2)(C) and results in a deemed distribution at the time of such failure. However, the regulations also provide that a plan administrator may allow a cure period (lasting not later than the last day of the calendar quarter following the calendar quarter in which the required installment payment was due).

PRENO-125977-17 4

Section 1.72(p)-1, Q&A-10(b) provides that if a loan, when made, satisfies the requirements of § 1.72(p)-1, Q&A-3, but there is a failure to pay an installment payment required under the loan (taking into account any cure period permitted in § 1.72(p)-1, Q&A-10(a)), then the amount of the deemed distribution is equal to the entire outstanding balance of the loan (including any accrued interest) at the time of such

failure.

Section 1.72(p)-1, Q&A-20(a)(1) provides that a participant may refinance a loan if the loans collectively satisfy the amount limitations of § 72(p)(2)(A) and the replaced loan and the replacement loan each satisfy the requirements of § 72(p(2)(B) and (C) and § 1.72(p)-1. Section 1.72(p)-1, Q&A-20(a)(1) provides that a refinancing includes any

situation in which one loan replaces another loan.

ANALYSIS

For Situation 1 and Situation 2, the cure period permitted in the plan does not extend beyond the period set forth in § 1.72(p)-1, Q&A-10(a) (that is, the applicable cure period does not extend beyond the last day of the calendar quarter following the calendar quarter in which the missed installment payment was due).

In Situation 1, under the cure period, the two missed installment payments (March 31, 2019, and April 30, 2019) have separate cure periods because they occur in separate calendar quarters. For the missed March 31, 2019 installment payment, the cure period

ends June 30, 2019, and for the missed April 30, 2019 installment payment, the cure period ends September 30, 2019. Each missed installment payment is cured within that missed installment payment’s applicable cure period. The missed March 31, 2019

installment payment is cured by installment payment made on May 31, 2019. Likewise, the missed April 30, 2019 installment payment is cured by the installment payment made on June 30, 2019. However, the May 31, 2019 and June 30, 2019 installment payments are missed because those installment payments are applied to the earlier

missed installment payments (March 31, 2019 and April 30, 2019). The missed May 31, 2019 installment payment and the missed June 30, 2019 installment payment have a cure period that ends September 30, 2019. The missed May 31, 2019 installment

payment and the missed June 30, 2019 installment payment are cured by the payment made on July 31, 2019 (which is applied to the missed May 31, 2019 and June 30, 2019 installment payments, as well as the required July 31, 2019 installment payment).

Accordingly, under § 1.72(p)-1, Q&A-10, the level amortization requirement under § 72(p)(2)(C) is not violated and there is no deemed distribution from the missed March 31, 2019, April 30, 2019, May 31, 2019, and June 30, 2019 installment payments.

In Situation 2, the three missed installment payments (October 31, 2019, November 30, 2019, and December 31, 2019) have the same cure period, which ends March 31, 2020, because they occur in the same calendar quarter. The replacement loan created by the refinancing of the replaced loan on January 15, 2020, pays off the entire outstanding balance of the replaced loan (which includes the three missed installment payments) within the missed installment payments’ cure period. Accordingly, under § 1.72(p)-1, Q&A-10, the level amortization requirement under § 72(p)(2)(C) is not violated for the replaced loan and there is no deemed distribution from the three missed installment payments.

This Chief Counsel Advice does not address the tax consequences of the scenarios discussed in this writing, except as expressly provided, including the tax consequences of a § 72(p)(1) deemed distribution.

Please call Patrick Gutierrez at ---------------------- or Clare Diefenbach at (202) 317-4102

if you have any further questions

 

.

Just as an aside if they did declare your loan a deemed distribution (properly which needs to be addressed first) that raises issues about the payments you are currently making.  By making the loan deemed you paid taxes on the loan principal.  However, they are still  putting loan payments into the plan.  Those payments should be creating an after-tax basis in your account.  You don't have to pay taxes twice on the loan coming out of the plan- once when it was deemed and again when the cash your putting into the plan is paid to you. 

In a sense I am getting ahead of things.  You should primarily focus on the other advise and figure out what happened and was it deemed properly. 

Only if you determine it was deemed properly should you start to follow up on how the payments are being accounted for by the plan. 

if the loan was improperly deemed it still can be fixed, so saying nothing can be done is not correct. I'd go out to the IRS website and print their memo indicating each succeeding loan payment would cover the missed payment and ask them why this wasn't followed.

and again, if you indeed continued to make payments, then whoever 'deemed' the loan should bear the cost of VCP filing

 

https://www.irs.gov/retirement-plans/fixing-common-plan-mistakes-plan-loan-failures-and-deemed-distributions

The Fix

Employers may get relief from these adverse consequences through the Employee Plans Compliance Resolution System (EPCRS) by correcting the failures. Use the Voluntary Correction Program (VCP) to correct these mistakes on a voluntary basis.

There are three correction methods for participant loans that do not comply with IRC Section 72(p). If successful, the use of VCP removes the IRC Section 72(p) deemed distribution tax reporting requirements (Rev. Proc. 2016-51). These corrections are only allowed if the normal maximum period for repayment of the loan has not expired. The IRS reserves the right to limit the use of the correction methods to situations that it considers appropriate, for example, where the loan failure is caused by employer action.

of course if no 1099 has been filed yet I imagine they can simply fix the silly thing at their end and proceed on with life, but without knowing more...

Tom, OP said a 1099 was issued. 

If you did indeed only miss one payment, then almost certainly the the loan should not have been defaulted and the 1099 was issued in error.  There are a few possibilities, all of them to do with incompetence.  Could have been your payroll department didn't restart the actual deposits, or deposited to the wrong person or who knows what.  Just be prepared for a long slog through the bureaucracy and don't give in if you are sure you are right.

Unfortunately we do get some posts from participants who are convinced that something happened when it really didn't, so be 100% sure your paystubs are showing the loan payments. First step is comparing them to your 401(k) account statements.

I realize a 1099 was issued. but the deadline for filing the1096 isn't until the end of the month.

so if they haven't filed that, then the IRS doesn't 'know' about the 1099 yet. so there is a chance you simply crush kill destroy the form and get on with life.

A corrected 1009-R for $0.00 can be filed cancelling the original 1099-R.

I'm a little slow getting back here, but I received some additional information from the OP via PM.

The loan start date was 12/1/2015 and it was a 60 month loan. The final payment was scheduled for 12/19/2020.  The letter was dated 11/2/2017 and says:

Quote

We are  writing you regarding the status of your participant loan in the ********* 401(k) plan. In order to prevent the default of your loan with a payment of $93.61, you must either bring the loan payments current or pay off the entire loan balance by December 31, 2017.  Your payment must be received at least 7 business days before the due date to allow for sufficient processing time.  Failure to take action will result in your loan being treated as a taxable distribution.

The letter also mentions what needs to be done if you have terminated employment, or if you are on a qualified military leave.  It looks like a form letter covering several different situations.

Payments were made each pay period after the missed pay period in May 2017 and those payments show up on the Wells Fargo website. 

The OP will ask her employer to ask WF for a written explanation of why the loan was defaulted.  l think it will be helpful to know if they deemed the loan because the missed payment caused the loan to extend beyond the original 5 year period, if they deemed it because they are still treating the missed May 2017 payment as outstanding, or if they have a different reason.  Hopefully, they will also review the situation and see if they still think it should have been deemed.

My limited experience with large firms is that they initially resist when you ask them to correct an incorrect 1099-R, even if the 1099-R is obviously wrong.  In the cases I've dealt with, it took a detailed explanation of why the form was incorrect and getting high enough up the food chain to get someone to act.

Maybe it was deemed because somebody realized that the loan payoff date was after 60  months.

I'd think if only 1 payment was missed (in May), then it couldn't have been much beyond the 5 year limit on the loan if that was the case, and the total loan balance wouldn't amount to much.

in other words, it doesn't sound like the 5 years were up.

Maybe this has already been covered, but I thought the statutory default was to require one quarter's worth of payments to be made each quarter. If missed in one quarter, you have until the end of the following quarter to make them up. In this case, he did not make a full quarter's worth of payments, and never made them up. Strictly speaking, this loan should be defaulted, no? I would say they defaulted one quarter too late (Missed quarter was Q2 2017). 

11 minutes ago, 401king said:

Maybe this has already been covered, but I thought the statutory default was to require one quarter's worth of payments to be made each quarter. If missed in one quarter, you have until the end of the following quarter to make them up. In this case, he did not make a full quarter's worth of payments, and never made them up. Strictly speaking, this loan should be defaulted, no? I would say they defaulted one quarter too late (Missed quarter was Q2 2017). 

Or one could argue he was always just 1 payment behind and payroll was entering the dates wrong.

24 minutes ago, 401king said:

Maybe this has already been covered, but I thought the statutory default was to require one quarter's worth of payments to be made each quarter. If missed in one quarter, you have until the end of the following quarter to make them up. In this case, he did not make a full quarter's worth of payments, and never made them up. Strictly speaking, this loan should be defaulted, no? I would say they defaulted one quarter too late (Missed quarter was Q2 2017). 

The other way to put what Lou is saying that by the time the 1st payment is made in the quarter following the quarter with the missed payment the missed payment was paid.  Of course that means the current quarter is missing a payment.  But that is made up the first payment the next quarter and so on and on. 

You could go on like that until the end of the loan and have only one missed payment at that time and no default. 

I guess what 401king is positing is that one payment was missed and they defaulted the loan because that particular payment was never made up.  But as Lou S. notes, the participant could/would/should just be one payment behind all the time and it's no big deal - happens all the time. 

17 hours ago, Kevin C said:

In order to prevent the default of your loan with a payment of $93.61

This doesn't exactly make sense although I guess they are describing the loan rather than an action.

The whole thing is so lame that it makes you wonder if Wells Fargo has figured out a way to make money on loan defaults.