Is this a Qualified Plan Loan Offset (QPLO)?

Participant in her 40's terminated in 2017 with an outstanding loan in an ongoing 401(k) Plan.  She continued to make loan payments and was current with repayments when she elected to receive a distribution from the plan in the form of rollover to her traditional IRA in October 2020.  The total amount of her distribution, i.e., her total account balance, was offset by the outstanding loan balance, and the remaining amount was rolled over to her IRA.  Two 2020 Forms 1099-R were issued in January 2021.  The rolled over amount was reported on one 1099-R with $0 taxable in Box 2 and distribution code "G" in Box 7.  The other 1099-R reported the loan offset amount as taxable in Box 2 and used distribution code "1L" in Box 7.  The participant is now asking for the plan sponsor to issue a corrected 1099-R for the loan offset using distribution code "1M" to indicate that the offset was a Qualified Plan Loan Offset (QPLO).  She wants to avoid the early distribution penalty on her tax return.  No withholding was deposited for either the loan offset amount or the rollover amount.

Side note:  the 401(k) Plan did not allow for Coronavirus Related Distributions (CRD) or Coronavirus Related Loans (CRL) in 2020.

I read up on QPLO requirements, but have not seen an example similar to this situation.  Yes, the participant was current with the terms of the loan, but the offset occurred well after 12 months from her severance from employment date.  Did this loan offset qualify to be a QPLO and reported using the "1M" distribution code?

Not a QPLO. See Example 2 in 1.402(c)-3 which is almost the same situation.

1 hour ago, C. B. Zeller said:

Not a QPLO. See Example 2 in 1.402(c)-3 which is almost the same situation.

Hi, C.B.

Thank you.  Please know that with bvhea's permission, I am taking over his portion of the conversation.  

We wondered whether the answer could be found in that example.  Re-reading section (iv)[B] Offset because of severance from employment, it seems the difference between the two situations is that in bvhea’s question, the loan offset was not made “…solely by reason of the failure to meet the repayment terms of [the] plan loan because of severance from employment….”  In Example 2, Employee A had stopped making loan repayments and was beyond the cure period.  In our case, the participant had made all monthly loan payments due up until her distribution was made, and the loan offset occurred because she took her full distribution from the plan.  Does the 12-month period from severance status of the participant supersede the loan's current status at the time of offset?

Also, as a question of wording clarification, when Example 2 says, “Plan Y offsets the unpaid $3,000 loan balance against Employee A’s account balance on July 1, 2021…” does the mean Employee A received a total distribution of his account balance?

JenniferOhio is right on the mark by explaining the differences in the examples. It is simply stated in 402(c)(3)(C)(ii) that a QPLO must be due to plan termination or default. Since the situation bvhea describes is neither, it is not a QPLO and the participant cannot avail themselves of the extended rollover period described in 402(c)(3)(C)(i).

Since the extended rollover period went into effect I have often wondered whether it is actually better for the terminated participant to default outstanding loans upon termination, since in many cases this provides the participant with a period considerably longer than 60 days to marshal the resources necessary to successfully rollover the offset loan. Then again, all participants are in different situations and what may good for one may actually be a burden for another.

One lesson learned here from the participant's (or anyone who advises participants) point of view is that it may be better to leave the funds in the old plan and continue to make payments until the loan is paid off.

The key is that you have to have the offset within 12 months of termination of employment. There's a safe harbor that if the offset occurs within 12 months of severance from employment it qualifies, without having to get into the details of exactly why it did not default sooner. See Treas. reg. 1.402(c)-3(a)(2)(iv)(B). Most folks will meet these conditions. The only way not to is to keep making payments on the loan (in the minority of plans that allow that) for 12 months or more, and then stop. Don't do that!