Long-awaited regulations proposed on loans from qualified plans.

• Author: Blinka, James R.

As a result of the tremendous tax burden associated with early distributions from qualified retirement plans, many employers have added provisions that allow participants to borrow from retirement plans with no tax consequences. However, Sec. 4975(d) (1) contains strict rules to be certain that these loans are not prohibited transactions subject to the Sec. 4975 excise tax. In addition, Sec. 72(p) treats loans as distributions for income tax purposes, unless the exception provided by Sec. 72(p) (2) is met.

On Dec. 20, 1995, Regs. Sec. 1.72(p)-1 was proposed. The proposed effective date of the final regulations would be for loans made three months after the final regulations are published in the Federal Register; for additional information, see Tax Clinic, "IRS Issues Participant Loan Guidance," TTA, Mar. 1996, p. 152.

Enforceable Agreement Requirement

The loan must be evidenced by a legally enforceable agreement set forth in writing. The agreement must specify the loan's amount, term and repayment schedule.

Deemed Distribution

If the loan's terms do not require repayments that satisfy the repayment term requirement or the level amortization requirement, or the loan was not evidenced by an enforceable agreement satisfying the requirement of the proposed regulations, the entire amount of the loan would be a deemed distribution at the time the loan was made. If the loan satisfies the enforceable agreement requirement, except that the amount loaned exceeds amounts permitted under Sec. 72(p) (2), the amount of the loan exceeding this limitation would be a deemed distribution at the time the loan was made.

To satisfy the repayment term requirement, the loan, by its terms, must be repaid within five years--unless the loan is used to acquire a dwelling unit which, within a reasonable time, will be used as the participant's principal residence (Sec. 72(p) (2) (B)).

To satisfy the level amortization requirement, substantially level loan amortization (with payments not less frequently than quarterly) must be required over the loan's term (except as provided in regulations) (Sec. 72(p) (2) (C)).

Timing of Deemed Distribution

Failure to make any installment payment when due in accordance with the terms of the loan results in a deemed distribution of the entire outstanding loan balance at the time of such failure. The plan administrator may allow a grace period (not beyond the last day of the calendar quarter following the calendar quarter in which the...