Plan loan final regs. ease some restrictions.

• Author: Williams, Rebecca
• Position: Pension plans

The IRS issued final regulations under Sec. 72 (TD 9021) on loans to participants in qualified retirement plans. While the final rules provide greater flexibility, taxpayers should still ensure that a loan from their qualified plan does not become a deemed distribution, resulting in taxable income. The final regulations generally apply to assignments, pledges and loans made after 2003.

Background

Under Sec. 72(p)(2), qualified plan loans are not treated as distributions if they meet the following conditions:

* The loan must be repaid within five years (except home loans);

* The payments must be substantially equal and made at least quarterly;

* The total outstanding balance of all loans cannot exceed the lesser of (1) the greater of half of the present value of the employee's vested benefits or $10,000; or (2) $50,000, reduced by the difference between the highest outstanding loan balance in the preceding 12 months and the current balance (12-month rule).

If the loan does not meet all three requirements, the proceeds will be treated as a deemed distribution includible in taxable income and potentially subject to the Sec. 72(t) 10% penalty as a premature distribution.

New Rules

Multiple loans: In proposed regulations issued July 2000 (TD 8894), the IRS capped qualified plan loans at two per year; it was concerned that plan participants might take additional loans to pay prior ones. Commentators objected to this rule, on several grounds. First, they argued that there were already provisions to protect against such abuse. For example, many plan documents limit loans to two per year; in addition, the 12-month rule provides sonic protection. Commentators also cited several examples in which a participant could legitimately need more than two loans. In the final regulations, the IRS removed the annual limit on the number of plan loans a participant can take.

Repayment after leave of absence: Under Regs. Sec. 1.72(p)-1, Q&A-9(a), an employer can suspend loan repayment during an employee's leave of absence for up to one year, but interest must continue to accrue during the leave and the loan balance must be repaid within five years. The latter can be accomplished either by making larger payments after the employee returns to work, or the employee can continue to pay the same amount as prior to the leave, then make a balloon payment at the end.

If the original loan repayment term is less than five years, the taxpayer can extend the term to five...