Excess Loan Amounts

A profit sharing plan issues loans in 2017 to two participants, both of which exceeded the maximum amount.  We just found out when we received the year-end data.  The plan has an in-service distribution provision at age 60.  For one participant, who is younger than age 60, the loan taken was for $50,000 but the maximum amount was $15,000.  The other participant, who is older than age 60, took a $13,000 loan but the maximum amount was $10,000.  The client does not want to file a VCP application.

For the younger participant, we advised that the 2017 Form 1099R be issued now for $35,000.  This is a deemed distribution.  The participant will continue to make the scheduled installment repayments until he repays the $15,000 plus interest.  At that point, if he defaults on the remaining $35,000 there will be no tax consequences since it's being reported now.  Obviously, there can't be any withholding now since it's after the fact but according to the EOB if the deemed distribution occurs at the time the loan is actually made, the plan is required to withhold against the loan proceeds.  Any real problem here?

For the older participant, we think there are two options.  The $3,000 excess can be treated as a deemed distribution, and we would follow the same procedure as above.  Alternatively, the excess can be treated as an actual in-service distribution.  In that case, the plan would modify the loan agreement and only carry a loan receivable of $10,000.  But again there would be the issue of missed withholding.  Any opinion on whether one of these options is preferable to the other?

Thanks.

16 hours ago, cathyw said:

For the younger participant, we advised that the 2017 Form 1099R be issued now for $35,000.  This is a deemed distribution. 

Huh?

That participant took a loan for $50,000 but the maximum borrowing amount was $15,000.  Therefore, he had a deemed distribution of $35,000 in 2017.  Form 1099R is due, even though late.

Sounds as if he took an actual distribution; outside the terms of the plan.  This should be corrected.

Good Luck!

On 5/26/2018 at 2:50 AM, ETA Consulting LLC said:

Sounds as if he took an actual distribution; outside the terms of the plan.  This should be corrected.

In other words, you don't really fix it by just treating the excess as a distribution - it's not allowed, period.  I think you still have a loan, albeit one that does not meet the PT exemption for participant loans.  I think the proper course of action is to repay it asap and pay excise taxes.

You're right.  I overlooked the fact that this is also a prohibited transaction.  The excess is still going to be taxable to him as a deemed distribution, but until he pays back the $35,000 there will be an outstanding PT. 

Thanks.

17 hours ago, cathyw said:

You're right.  I overlooked the fact that this is also a prohibited transaction.  The excess is still going to be taxable to him as a deemed distribution, but until he pays back the $35,000 there will be an outstanding PT. 

Thanks.

 

It's not a deemed distribution -- it's an actual distribution.