Qualified retirement plan loans.

• Author: Daum, Timothy A.

There are certain situations involving plan loans that can result in adverse tax consequences to a participant, and sometimes can even result in a plan losing its favorable tax status. Sec. 72(p) treats loans from qualified retirement plans as taxable distributions unless certain requirements are met: * The cumulative amount of all loans from the plan (and any other plans maintained by the employer or related employer) may not exceed the lesser of (1) $50,000 (reduced by the amount by which the highest total loan balance during the one-year period preceding the date of the loan exceeds the total loan balance on the date on which the loan is made), or (2) the greater of (a) 50% of the participants vested account balance or (b) $10,000. (If the amount of the loan exceeds 50% of the participant's vested account balance due to the $10,000 minimum, additional collateral should be provided in accordance with Department of Labor guidelines.) * The written terms of the loan must require payment within five years. This requirement does not apply to loans used to acquire a participants principal residence. * The written terms of the loan must require substantially level amortization with payments made not less frequently than quarterly.

The IRS recently issued regulations on plan loans that clarify the proper treatment of defaults. If a loan does not meet any of the above requirements, there are two types of taxable distributions that can occur:(1) a deemed distribution and (2) a distribution of an offset amount.

Deemed Distributions

If the terms of a loan do not require repayment within five years, do not require level amortization with quarterly payments or are not in writing for in such other form approved by the Service), the entire amount of die loan is a deemed distribution at the deemed the loan is made. If the loan terms satisfy all the applicable requirements other than that the amount loaned exceeds the applicable limit, only the amount loaned in excess of the limit will be a deemed distribution.

If the loan initially satisfies all applicable requirements, but payments are not made in accordance with the loan terms, a deemed distribution occurs. The amount of the deemed distribution for failure to make a payment in accordance...