[Federal Register Volume 65, Number 147 (Monday, July 31, 2000)]
[Rules and Regulations]
[Pages 46588-46596]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-18815]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8894]
RIN 1545-AE41
Loans From a Qualified Employer Plan to Plan Participants or
Beneficiaries
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations relating to loans
made from a qualified employer plan to plan participants or
beneficiaries. These final regulations provide guidance on the
application of section 72(p) of the Internal Revenue Code. These
regulations affect administrators of, participants in, and
beneficiaries of qualified employer plans that permit participants or
beneficiaries to receive loans from the plan, including loans from
section 403(b) contracts and other contracts issued under qualified
employer plans.
DATES: Effective Date: These regulations are effective July 31, 2000.
Applicability Date: For dates of applicability, see Sec. 1.72(p)-1,
Q&A-22 (a) through (c)(2).
FOR FURTHER INFORMATION CONTACT: Vernon S. Carter, (202) 622-6070 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains final regulations (26 CFR Part 1) under
section 72 of the Internal Revenue Code of 1986 (Code). These
regulations provide guidance concerning the tax treatment of loans that
are deemed to be distributed under section 72(p). Section 72(p) was
added by section 236 of the Tax Equity and Fiscal Responsibility Act of
1982 (96 Stat. 324), and amended by the Technical Corrections Act of
1982 (96 Stat. 2365), the Deficit Reduction Act of 1984 (98 Stat. 494),
the Tax Reform Act of 1986 (100 Stat. 2085), and the Technical and
Miscellaneous Revenue Act of 1988 (102 Stat. 3342).
On December 21, 1995, a notice of proposed rulemaking (EE-106-82)
was published in the Federal Register (60 FR 66233) with respect to
many of the issues arising under section 72(p)(2). The preamble to the
1995 proposed regulations requested comments on certain issues that
were not addressed. Following publication of the 1995 proposed
regulations, comments were received and a public hearing was held on
June 28, 1996. One of the issues on which comments were requested and
received was the effect of a deemed distribution on the tax treatment
of subsequent distributions from a plan (such as whether a participant
has tax basis as a result of a deemed distribution). After reviewing
the written comments and comments made at the public hearing,
additional proposed regulations addressing this issue were published
January 2, 1998 (REG-209476-82), in the Federal Register (63 FR 42).
Written comments were received on the 1998 proposed regulations, but no
public hearing was requested. After consideration of all comments
received on both the 1995 and the 1998 proposed regulations, the
proposed regulations are adopted as revised by this Treasury decision.
Explanation of Provisions
Section 72(p)(1)(A) provides that a loan from a qualified employer
plan (including a contract purchased under a qualified employer plan)
to a participant or beneficiary is treated as received as a
distribution from the plan for purposes of section 72 (a deemed
distribution). Section 72(p)(1)(B) provides that an assignment or
pledge of (or an agreement to assign or pledge) any portion of a
participant's or beneficiary's interest in a qualified employer plan is
treated as a loan from the plan.
Section 72(p)(2) provides that section 72(p)(1) does not apply to
the extent certain conditions are satisfied. Specifically, under
section 72(p)(2), a loan from a qualified employer plan to a
participant or beneficiary is not treated as a distribution from the
plan if the loan satisfies requirements relating to the term of the
loan and the repayment schedule, and to the extent the loan satisfies
certain limitations on the amount loaned. For example, except in the
case of certain home loans, the exception in section 72(p)(2) only
applies to a loan that by its terms is to be repaid over not more than
five years in substantially level installments.
For purposes of section 72, a qualified employer plan includes a
plan that qualifies under section 401 (relating to qualified trusts),
403(a) (relating to qualified annuities) or 403(b) (relating to tax
sheltered annuities \1\), as well as a plan (whether or not qualified)
maintained by the United States, a State or a political subdivision
thereof, or an agency or instrumentality thereof. A qualified employer
plan also includes a plan which was (or was determined to be) a
qualified plan or a government plan.
---------------------------------------------------------------------------
\1\ With respect to coverage under Title I of the Employee
Retirement Income Security Act of 1974 (88 Stat. 829) (ERISA), the
Department of Labor (DOL) has advised the IRS that an employer's
tax-sheltered annuity program would not necessarily fail to satisfy
the Department's regulation at 29 CFR 2510.3-2(f) merely because the
employer permits employees to make repayments of loans made in
connection with the tax-sheltered annuity program through payroll
deductions as part of the employer's payroll deduction system, if
the program operates within the limitations set by that regulation.
---------------------------------------------------------------------------
Summary of Comments Received and Changes Made and Summary of the
Final Regulations
In general, comments received on the proposed regulations were
favorable and, accordingly, the final regulations retain the general
structure and substance of the proposed regulations, including a wide
variety of examples illustrating the rules in the final regulations.
However, commentators made a number of specific recommendations for
modifications and clarifications of the regulations. The comments are
summarized below, along with the IRS' and Treasury's consideration of
those comments.
A. Cure Period for Missed Payments
The 1995 proposed regulations stated that the section 72(p)(2)(C)
requirement that repayments be made in level installments at least
quarterly would not
[[Page 46589]]
be violated if payments are not made until the end of a grace period
that the plan administrator may allow, but only to the extent the grace
period does not continue beyond the last day of the calendar quarter
following the calendar quarter in which the required installment
payment was due. Commentators suggested that the proposed regulations
should specify how the grace period is to be established, such as
whether the grace period must be contained in the plan document, a
separate loan program that is deemed to be a part of the plan document
pursuant to DOL 29 CFR 2550.408b-1(d)(2), or the summary plan
description, and whether it is permissible for a plan to have grace
periods on a participant by participant basis (so long as this did not
discriminate in favor of the highly compensated employees).
Some commentators requested that a plan participant have a
reasonable period of time (such as up to 30 days) to cure a default
after the plan administrator has sent a notice of default, and that the
section 72(p) regulations mandate that the plan administrator send a
notice of default within a reasonable period of time (such as 30 days)
after it has discovered the default. These commentators suggested that
grace and cure periods might be conditioned upon the plan administrator
having an appropriate procedure in place for timely identification of
defaults and curing defects. Some commentators requested that final
regulations permit a plan administrator to use his or her discretion,
under special circumstances, to provide a grace period of up to one
year from the date of a missed payment.
Many of these suggested changes relate to legal requirements other
than section 72(p), such as the application of the fiduciary
requirements of ERISA \2\ and Federal and state laws that apply to
debtors and creditors. The 1995 proposed regulations allowed a grace
period up to the end of the next following quarter. Thus, a plan could
select a grace period of, for example, 30 days or 90 days and could
provide a special notice to the participant concerning the grace
period. Thus, many of the suggested changes would involve the
imposition of new and complicated rules for which there is no apparent
basis in section 72(p) and which would in any case be difficult to
enforce and to administer. Accordingly, the final regulations retain
the same rules as the proposed regulations. However, the final
regulations use the term cure period instead of grace period.
---------------------------------------------------------------------------
\2\ The Department of Labor has advised the IRS that, with
respect to plans covered by Title I of ERISA, the administration of
a participant loan program involves the management of plan assets.
Therefore, fiduciary conduct undertaken in the administration of
such a loan program must conform to the rules that govern
transactions involving plan assets. See, generally, ERISA sections
403, 404, and 406. Fiduciary conduct in the administration of a loan
program would include decisions concerning the rules governing the
program, including establishing standards to govern the
appropriateness of making any particular loan and the appropriate
treatment of any defaulted loan. Further, absent an exemption, any
loan between a plan covered by Title I of ERISA and a party in
interest to the plan (including plan participants and beneficiaries)
would constitute a prohibited transaction under section 406(a)(1)(B)
of ERISA. DOL has promulgated a regulation at 29 CFR 2550.408b-1
providing guidance regarding the statutory exemption contained in
section 408(b)(1) of ERISA for plan loans to parties in interest who
are participants or beneficiaries. Further, some loans by plans
(whether or not covered under Title I of ERISA) may constitute
prohibited transactions under section 4975(c)(1)(B) of the Internal
Revenue Code. Under section 102 of Reorganization Plan No. 4 of
1978, (43 FR 47,713) (1978), the Secretary of Labor has jurisdiction
to promulgate regulations under section 4975(d)(1) of the Internal
Revenue Code, which provides a limited exemption to the prohibition
of section 4975(c)(1)(B) of the Internal Revenue Code.
---------------------------------------------------------------------------
The final regulations also include a new cross-reference to section
414(u)(4), (relating to military service) which was added to the Code
by the Small Business Job Protection Act of 1996 (110 Stat. 1755).
B. Treatment of Loans After Deemed Distribution
The 1998 proposed regulations provide that once a loan is deemed
distributed under section 72(p) of the Code, interest that accrues
thereafter on that loan is not included in income and, for purposes of
calculating the maximum permitted amount of any subsequent loan, a loan
that has been deemed distributed is considered outstanding until the
loan obligation has been satisfied. The majority of the comments on
this issue urged that the positions taken in the 1998 proposed
regulations addressing post-default interest be adopted in the final
regulations. Some commentators asked that the regulations provide
further guidance on or revise the treatment of interest that accrues on
a loan that is a deemed distribution under section 72(p), as described
in Q&A-19 of the 1998 proposed regulations. Commentators noted that, in
the case of a plan that has chosen to permit additional loans after a
default that has not been cured, the rule in the proposed regulations
requiring interest to be taken into account in determining the maximum
amount of any subsequent loan would involve costs to make system and
procedural changes to calculate the accrued interest on the defaulted
loan for this limited application. Other commentators urged that
participants be taxed on the additional interest after a default,
either annually or as an accumulated amount at the time of a loan
offset, as an incentive for the participant to repay the loan.
One commentator raised the issue of how a deemed distribution would
be taken into account in a plan with a graded vesting schedule.
The final regulations generally adopt the rules in the proposed
regulations, but the regulations have been revised to indicate that a
deemed distribution is not taken into account as a distribution for
purposes of the requirements of Sec. 1.411(a)-7(d)(5) (relating to the
determination of a participant's account balance if a distribution is
made at a time when the participant's vesting percentage may increase).
C. Enforceable Agreement and New Technologies
The 1995 proposed regulations required that a loan be evidenced by
a legally enforceable agreement and that the legally enforceable
agreement be set forth in writing or in another form approved by the
Commissioner. Commentators asked whether a participant needs to sign a
loan agreement document and whether loans made electronically, such as
over phone or voice response units, would be permitted.
Some comments requested elimination of the requirement that a loan
be evidenced by a legally enforceable agreement. However, the final
regulations retain this requirement. There is, arguably, no difference
between a loan that is not legally enforceable and a cash distribution
that the employee is permitted to return to the plan. The final
regulations clarify that, as long as a signature is not required in
order for the loan to be enforceable under applicable law, the
agreement need not be signed.
The final regulations also require the agreement to be set forth in
a written paper document or in another form approved by the
Commissioner. However, the final regulations also treat this
requirement as satisfied if the loan agreement is set forth in any
electronic medium that satisfies certain standards. The standards in
these final regulations for use of an electronic medium for a loan are
the same as the standards for use of an electronic medium for a consent
to a distribution under Sec. 1.411(a)-11(f)(2). 65 FR 6001 (February 8,
2000). Specifically, a loan agreement will not fail to satisfy section
[[Page 46590]]
72(p)(2) of the Code merely because the loan agreement is in an
electronic medium reasonably accessible to the participant or the
beneficiary under a system that is reasonably designed to preclude
anyone other than the participant or the beneficiary from requesting a
loan, that provides the participant or the beneficiary with a
reasonable opportunity to review the terms of the loan and to confirm,
modify, or rescind the terms of the loan before the loan is made, and
that provides the participant or the beneficiary, within a reasonable
period after the loan is made, with a confirmation of the loan terms
through a written paper document or an electronic medium.\3\ If an
electronic medium is used to provide confirmation of the loan terms,
the electronic medium must be reasonably accessible to the participant
or the beneficiary and the electronic confirmation must be provided
under a system reasonably designed to give the confirmation in a manner
no less understandable to the participant or the beneficiary than a
written paper document. Also, the participant or the beneficiary must
be advised of the right to request and to receive a copy of the
confirmation on a written paper document without charge.
---------------------------------------------------------------------------
\3\ Neither the regulations regarding use of electronic medium
under section 411 nor these regulations apply for purposes of
satisfying the requirements of section 417, including the
requirement of section 417(a)(2)(A) that spousal consent be
witnessed by a notary public or plan representative.
---------------------------------------------------------------------------
The Electronic Signatures in Global and National Commerce Act (114
Stat. 464) (the Electronic Signatures Act) was signed on June 30, 2000.
Title I of the Electronic Signatures Act, which is generally effective
October 1, 2000, applies to certain electronic records and signatures
in commerce. In the Notice of Proposed Rulemaking that appears in this
issue of the Federal Register, comments are requested on the impact of
the Electronic Signatures Act on these regulations and on any future
guidance that may be needed on the application of the Electronic
Signatures Act to plan loan transactions.
D. Mortgage Investment Program
Some commentators requested that the special rule in the 1995
proposed regulations under which section 72(p) would not apply to loans
made under a residential mortgage investment program be revised to
eliminate the requirement that the loans also be available to
nonparticipants. This special rule is not based on an explicit
statutory provision, but is based on legislative history \4\ indicating
the understanding that section 72(p) was not intended to apply to loans
made in the ordinary course of a bona fide residential mortgage
investment program. The IRS and Treasury have concluded that there is a
risk that the intent of the section 72(p)(2) limitations might be
thwarted if a category of loans extended solely to participants were
not subject to section 72(p). However, the extension of this
requirement to otherwise bona fide mortgage investment programs that
were in effect at the time the 1995 proposed regulations were issued
would be inappropriate and, accordingly, the final regulations permit
plans with these preexisting programs to continue to make such loans.
The special rule in the final regulations is not intended to provide
guidance on whether, or to what extent, a plan that is covered by Title
I of ERISA may make such residential mortgage loans available to
participants or beneficiaries of the plan without violating the
provisions of Title I of ERISA.\5\
---------------------------------------------------------------------------
\4\ H.R. Conf. Rep. No. 97-760, 97th Cong., 2d Sess. 620 (1982),
1982-2 C.B. 672 and S. Rep. No. 97-494, 97th Cong., 2d Sess. 319,
321 (1982).
\5\ See, for example, PTCE 88-59.
---------------------------------------------------------------------------
E. Other Changes
The requirement that a loan be repaid within five years does not
apply to a loan used to acquire a dwelling unit which will within a
reasonable time be used as the principal residence of the participant.
For this purpose, the 1995 proposed regulations provided that a
principal residence has the same meaning as a principal residence under
section 1034. To reflect the repeal of section 1034 \6\ and the use of
the same term in section 121, the final regulations provide that a
principal residence has the same meaning as a principal residence under
section 121.\7\
---------------------------------------------------------------------------
\6\ Section 1034 was repealed by section 312(b) of the Taxpayer
Relief Act of 1997 (Public Law 105-34) (111 Stat. 788).
\7\ Like the 1995 proposed regulations, the final regulations
(at Q&A-7) apply the tracing rules of section 163(h)(3) of the Code
to trace whether a loan is a principal residence plan loan. Notice
88-74 (1988-2 C.B. 385), sets forth certain standards applicable
under section 163(h)(3).
---------------------------------------------------------------------------
F. Effective Date of Final Regulations
Both the 1995 and the 1998 proposed regulations were proposed to
apply for assignments, pledges, and loans made on or after the first
January 1 that is at least six months after the issuance of final
regulations. Under certain limited conditions, the 1998 proposed
regulations permitted loans made before this proposed general effective
date to apply Q&A-19, relating to interest accruing after a deemed
distribution, and Q&A-20, relating to basis resulting from repayments
after a deemed distribution. Comments on these transition conditions
were generally favorable, but one commentator requested that plan
sponsors be permitted to rely on these rules for loans made before the
general effective date if any reasonable and consistent method had been
used to report deemed distributions before the general effective date.
The rules in the 1998 proposed regulations for pre-effective date loans
included carefully considered, specific conditions in order for such
loans to be able to rely on Q&A-19 and Q&A-20 (including several
detailed examples illustrating the application of these transition
conditions) and these rules have been retained in the final
regulations.
Commentators also requested that the general effective date be the
first January 1 that is at least 6 or 12 months after the date of the
final regulations to allow for proper redesign and testing of plan loan
administration systems. Consistent with the proposed effective date and
these comments, the final regulations are applicable to assignments,
pledges, and loans made on or after January 1, 2002.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because the
regulations does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was submitted
to the Chief Counsel for Advocacy of the Small Business Administration
for comment on its impact on small business.
Drafting Information
The principal author of these regulations is Vernon S. Carter,
Office of Division Counsel/Associate Chief Counsel (Tax Exempt and
Government Entities). However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
[[Page 46591]]
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read,
in part, as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.72-17A is amended as follows:
1. Paragraphs (d)(1), (d)(2) and (d)(3) are redesignated as
paragraphs (d)(2), (d)(3) and (d)(4), respectively.
2. New paragraph (d)(1) is added.
The addition reads as follows:
Sec. 1.72-17A Special rules applicable to employee annuities and
distributions under deferred compensation plans to self-employed
individuals and owner-employees.
* * * * *
(d) * * * (1) The references in this paragraph (d) to section
72(m)(4) are to that section as in effect on August 13, 1982. Section
236(b)(1) of the Tax Equity and Fiscal Responsibility Act of 1982 (96
Stat. 324) repealed section 72(m)(4), generally effective for
assignments, pledges and loans made after August 13, 1982, and added
section 72(p). See section 72(p) and Sec. 1.72(p)-1 for rules governing
the income tax treatment of certain assignments, pledges and loans from
qualified employer plans made after August 13, 1982.
* * * * *
Par. 3. Section 1.72(p)-1 is added to read as follows:
Sec. 1.72(p)-1 Loans treated as distributions.
The questions and answers in this section provide guidance under
section 72(p) pertaining to loans from qualified employer plans
(including government plans and tax-sheltered annuities and employer
plans that were formerly qualified). The examples included in the
questions and answers in this section are based on the assumption that
a bona fide loan is made to a participant from a qualified defined
contribution plan pursuant to an enforceable agreement (in accordance
with paragraph (b) of Q&A-3 of this section), with adequate security
and with an interest rate and repayment terms that are commercially
reasonable. (The particular interest rate used, which is solely for
illustration, is 8.75 percent compounded annually.) In addition, unless
the contrary is specified, it is assumed in the examples that the
amount of the loan does not exceed 50 percent of the participant's
nonforfeitable account balance, the participant has no other
outstanding loan (and had no prior loan) from the plan or any other
plan maintained by the participant's employer or any other person
required to be aggregated with the employer under section 414(b), (c)
or (m), and the loan is not excluded from section 72(p) as a loan made
in the ordinary course of an investment program as described in Q&A-18
of this section. The regulations and examples in this section do not
provide guidance on whether a loan from a plan would result in a
prohibited transaction under section 4975 of the Internal Revenue Code
or on whether a loan from a plan covered by Title I of the Employee
Retirement Income Security Act of 1974 (88 Stat. 829) (ERISA) would be
consistent with the fiduciary standards of ERISA or would result in a
prohibited transaction under section 406 of ERISA. The questions and
answers are as follows:
Q-1: In general, what does section 72(p) provide with respect to
loans from a qualified employer plan?
A-1: (a) Loans. Under section 72(p), an amount received by a
participant or beneficiary as a loan from a qualified employer plan is
treated as having been received as a distribution from the plan (a
deemed distribution), unless the loan satisfies the requirements of
Q&A-3 of this section. For purposes of section 72(p) and this section,
a loan made from a contract that has been purchased under a qualified
employer plan (including a contract that has been distributed to the
participant or beneficiary) is considered a loan made under a qualified
employer plan.
(b) Pledges and assignments. Under section 72(p), if a participant
or beneficiary assigns or pledges (or agrees to assign or pledge) any
portion of his or her interest in a qualified employer plan as security
for a loan, the portion of the individual's interest assigned or
pledged (or subject to an agreement to assign or pledge) is treated as
a loan from the plan to the individual, with the result that such
portion is subject to the deemed distribution rule described in
paragraph (a) of this Q&A-1. For purposes of section 72(p) and this
section, any assignment or pledge of (or agreement to assign or to
pledge) any portion of a participant's or beneficiary's interest in a
contract that has been purchased under a qualified employer plan
(including a contract that has been distributed to the participant or
beneficiary) is considered an assignment or pledge of (or agreement to
assign or pledge) an interest in a qualified employer plan. However, if
all or a portion of a participant's or beneficiary's interest in a
qualified employer plan is pledged or assigned as security for a loan
from the plan to the participant or the beneficiary, only the amount of
the loan received by the participant or the beneficiary, not the amount
pledged or assigned, is treated as a loan.
Q-2: What is a qualified employer plan for purposes of section
72(p)?
A-2: For purposes of section 72(p) and this section, a qualified
employer plan means--
(a) A plan described in section 401(a) which includes a trust
exempt from tax under section 501(a);
(b) An annuity plan described in section 403(a);
(c) A plan under which amounts are contributed by an individual's
employer for an annuity contract described in section 403(b);
(d) Any plan, whether or not qualified, established and maintained
for its employees by the United States, by a State or political
subdivision thereof, or by an agency or instrumentality of the United
States, a State or a political subdivision of a State; or
(e) Any plan which was (or was determined to be) described in
paragraph (a), (b), (c), or (d) of this Q&A-2.
Q-3: What requirements must be satisfied in order for a loan to a
participant or beneficiary from a qualified employer plan not to be a
deemed distribution?
A-3: (a) In general. A loan to a participant or beneficiary from a
qualified employer plan will not be a deemed distribution to the
participant or beneficiary if the loan satisfies the repayment term
requirement of section 72(p)(2)(B), the level amortization requirement
of section 72(p)(2)(C), and the enforceable agreement requirement of
paragraph (b) of this Q&A-3, but only to the extent the loan satisfies
the amount limitations of section 72(p)(2)(A).
(b) Enforceable agreement requirement. A loan does not satisfy the
requirements of this paragraph unless the loan is evidenced by a
legally enforceable agreement (which may include more than one
document) and the terms of the agreement demonstrate compliance with
the requirements of section 72(p)(2) and this section. Thus, the
agreement must specify the amount and date of the loan and the
repayment schedule. The agreement does not have to be signed if the
agreement is enforceable under applicable law without being signed. The
agreement must be set forth either--
[[Page 46592]]
(1) In a written paper document;
(2) In an electronic medium that is reasonably accessible to the
participant or the beneficiary and that is provided under a system that
satisfies the following requirements:
(i) The system must be reasonably designed to preclude any
individual other than the participant or the beneficiary from
requesting a loan.
(ii) The system must provide the participant or the beneficiary
with a reasonable opportunity to review and to confirm, modify, or
rescind the terms of the loan before the loan is made.
(iii) The system must provide the participant or the beneficiary,
within a reasonable time after the loan is made, a confirmation of the
loan terms either through a written paper document or through an
electronic medium that is reasonably accessible to the participant or
the beneficiary and that is provided under a system that is reasonably
designed to provide the confirmation in a manner no less understandable
to the participant or beneficiary than a written document and, under
which, at the time the confirmation is provided, the participant or the
beneficiary is advised that he or she may request and receive a written
paper document at no charge, and, upon request, that document is
provided to the participant or beneficiary at no charge; or
(3) In such other form as may be approved by the Commissioner.
Q-4: If a loan from a qualified employer plan to a participant or
beneficiary fails to satisfy the requirements of Q&A-3 of this section,
when does a deemed distribution occur?
A-4: (a) Deemed distribution. For purposes of section 72, a deemed
distribution occurs at the first time that the requirements of Q&A-3 of
this section are not satisfied, in form or in operation. This may occur
at the time the loan is made or at a later date. If the terms of the
loan do not require repayments that satisfy the repayment term
requirement of section 72(p)(2)(B) or the level amortization
requirement of section 72(p)(2)(C), or the loan is not evidenced by an
enforceable agreement satisfying the requirements of paragraph (b) of
Q&A-3 of this section, the entire amount of the loan is a deemed
distribution under section 72(p) at the time the loan is made. If the
loan satisfies the requirements of Q&A-3 of this section except that
the amount loaned exceeds the limitations of section 72(p)(2)(A), the
amount of the loan in excess of the applicable limitation is a deemed
distribution under section 72(p) at the time the loan is made. If the
loan initially satisfies the requirements of section 72(p)(2)(A), (B)
and (C) and the enforceable agreement requirement of paragraph (b) of
Q&A-3 of this section, but payments are not made in accordance with the
terms applicable to the loan, a deemed distribution occurs as a result
of the failure to make such payments. See Q&A-10 of this section
regarding when such a deemed distribution occurs and the amount thereof
and Q&A-11 of this section regarding the tax treatment of a deemed
distribution.
(b) Examples. The following examples illustrate the rules in
paragraph (a) of this Q&A-4 and are based upon the assumptions
described in the introductory text of this section:
Example 1. (i) A participant has a nonforfeitable account
balance of $200,000 and receives $70,000 as a loan repayable in
level quarterly installments over five years.
(ii) Under section 72(p), the participant has a deemed
distribution of $20,000 (the excess of $70,000 over $50,000) at the
time of the loan, because the loan exceeds the $50,000 limit in
section 72(p)(2)(A)(i). The remaining $50,000 is not a deemed
distribution.
Example 2. (i) A participant with a nonforfeitable account
balance of $30,000 borrows $20,000 as a loan repayable in level
monthly installments over five years.
(ii) Because the amount of the loan is $5,000 more than 50% of
the participant's nonforfeitable account balance, the participant
has a deemed distribution of $5,000 at the time of the loan. The
remaining $15,000 is not a deemed distribution. (Note also that, if
the loan is secured solely by the participant's account balance, the
loan may be a prohibited transaction under section 4975 because the
loan may not satisfy 29 CFR 2550.408b-1(f)(2).)
Example 3. (i) The nonforfeitable account balance of a
participant is $100,000 and a $50,000 loan is made to the
participant repayable in level quarterly installments over seven
years. The loan is not eligible for the section 72(p)(2)(B)(ii)
exception for loans used to acquire certain dwelling units.
(ii) Because the repayment period exceeds the maximum five-year
period in section 72(p)(2)(B)(i), the participant has a deemed
distribution of $50,000 at the time the loan is made.
Example 4. (i) On August 1, 2002, a participant has a
nonforfeitable account balance of $45,000 and borrows $20,000 from a
plan to be repaid over five years in level monthly installments due
at the end of each month. After making monthly payments through July
2003, the participant fails to make any of the payments due
thereafter.
(ii) As a result of the failure to satisfy the requirement that
the loan be repaid in level monthly installments, the participant
has a deemed distribution. See paragraph (c) of Q&A-10 of this
section regarding when such a deemed distribution occurs and the
amount thereof.
Q-5: What is a principal residence for purposes of the exception in
section 72(p)(2)(B)(ii) from the requirement that a loan be repaid in
five years?
A-5: Section 72(p)(2)(B)(ii) provides that the requirement in
section 72(p)(2)(B)(i) that a plan loan be repaid within five years
does not apply to a loan used to acquire a dwelling unit which will
within a reasonable time be used as the principal residence of the
participant (a principal residence plan loan). For this purpose, a
principal residence has the same meaning as a principal residence under
section 121.
Q-6: In order to satisfy the requirements for a principal residence
plan loan, is a loan required to be secured by the dwelling unit that
will within a reasonable time be used as the principal residence of the
participant?
A-6: A loan is not required to be secured by the dwelling unit that
will within a reasonable time be used as the participant's principal
residence in order to satisfy the requirements for a principal
residence plan loan.
Q-7: What tracing rules apply in determining whether a loan
qualifies as a principal residence plan loan?
A-7: The tracing rules established under section 163(h)(3)(B) apply
in determining whether a loan is treated as for the acquisition of a
principal residence in order to qualify as a principal residence plan
loan.
Q-8: Can a refinancing qualify as a principal residence plan loan?
A-8: (a) Refinancings. In general, no, a refinancing cannot qualify
as a principal residence plan loan. However, a loan from a qualified
employer plan used to repay a loan from a third party will qualify as a
principal residence plan loan if the plan loan qualifies as a principal
residence plan loan without regard to the loan from the third party.
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q&A-8 and is based upon the assumptions described
in the introductory text of this section:
Example. (i) On July 1, 2003, a participant requests a $50,000
plan loan to be repaid in level monthly installments over 15 years.
On August 1, 2003, the participant acquires a principal residence
and pays a portion of the purchase price with a $50,000 bank loan.
On September 1, 2003, the plan loans $50,000 to the participant,
which the participant uses to pay the bank loan.
(ii) Because the plan loan satisfies the requirements to qualify
as a principal residence plan loan (taking into account the tracing
rules of section 163(h)(3)(B)), the plan loan qualifies for the
exception in section 72(p)(2)(B)(ii).
Q-9: Does the level amortization requirement of section 72(p)(2)(C)
apply when a participant is on a leave of absence without pay?
A-9: (a) Leave of absence. The level amortization requirement of
section
[[Page 46593]]
72(p)(2)(C) does not apply for a period, not longer than one year (or
such longer period as may apply under section 414(u)), that a
participant is on a bona fide leave of absence, either without pay from
the employer or at a rate of pay (after income and employment tax
withholding) that is less than the amount of the installment payments
required under the terms of the loan. However, the loan (including
interest that accrues during the leave of absence) must be repaid by
the latest date permitted under section 72(p)(2)(B) (e.g., the
suspension of payments cannot extend the term of the loan beyond 5
years, in the case of a loan that is not a principal residence plan
loan) and the amount of the installments due after the leave ends (or,
if earlier, after the first year of the leave or such longer period as
may apply under section 414(u)) must not be less than the amount
required under the terms of the original loan.
(b) Military service. See section 414(u)(4) for special rules
relating to military service.
(c) Example. The following example illustrates the rules of
paragraph (a) of this Q&A-9 and is based upon the assumptions described
in the introductory text of this section:
Example. (i) On July 1, 2002, a participant with a
nonforfeitable account balance of $80,000 borrows $40,000 to be
repaid in level monthly installments of $825 each over 5 years. The
loan is not a principal residence plan loan. The participant makes 9
monthly payments and commences an unpaid leave of absence that lasts
for 12 months. Thereafter, the participant resumes active employment
and resumes making repayments on the loan until the loan is repaid
in full (including interest that accrued during the leave of
absence). The amount of each monthly installment is increased to
$1,130 in order to repay the loan by June 30, 2007.
(ii) Because the loan satisfies the requirements of section
72(p)(2), the participant does not have a deemed distribution.
Alternatively, section 72(p)(2) would be satisfied if the
participant continued the monthly installments of $825 after
resuming active employment and on June 30, 2007 repaid the full
balance remaining due.
Q-10: If a participant fails to make the installment payments
required under the terms of a loan that satisfied the requirements of
Q&A-3 of this section when made, when does a deemed distribution occur
and what is the amount of the deemed distribution?
A-10: (a) Timing of deemed distribution. Failure to make any
installment payment when due in accordance with the terms of the loan
violates section 72(p)(2)(C) and, accordingly, results in a deemed
distribution at the time of such failure. However, the plan
administrator may allow a cure period and section 72(p)(2)(C) will not
be considered to have been violated if the installment payment is made
not later than the end of the cure period, which period cannot continue
beyond the last day of the calendar quarter following the calendar
quarter in which the required installment payment was due.
(b) Amount of deemed distribution. If a loan satisfies Q&A-3 of
this section when made, but there is a failure to pay the installment
payments required under the terms of the loan (taking into account any
cure period allowed under paragraph (a) of this Q&A-10), then the
amount of the deemed distribution equals the entire outstanding balance
of the loan (including accrued interest) at the time of such failure.
(c) Example. The following example illustrates the rules in
paragraphs (a) and (b) of this Q&A-10 and is based upon the assumptions
described in the introductory text of this section:
Example. (i) On August 1, 2002, a participant has a
nonforfeitable account balance of $45,000 and borrows $20,000 from a
plan to be repaid over 5 years in level monthly installments due at
the end of each month. After making all monthly payments due through
July 31, 2003, the participant fails to make the payment due on
August 31, 2003 or any other monthly payments due thereafter. The
plan administrator allows a three-month cure period.
(ii) As a result of the failure to satisfy the requirement that
the loan be repaid in level installments pursuant to section
72(p)(2)(C), the participant has a deemed distribution on November
30, 2003, which is the last day of the three-month cure period for
the August 31, 2003 installment. The amount of the deemed
distribution is $17,157, which is the outstanding balance on the
loan at November 30, 2003. Alternatively, if the plan administrator
had allowed a cure period through the end of the next calendar
quarter, there would be a deemed distribution on December 31, 2003
equal to $17,282, which is the outstanding balance of the loan at
December 31, 2003.
Q-11: Does section 72 apply to a deemed distribution as if it were
an actual distribution?
A-11: (a) Tax basis. If the employee's account includes after-tax
contributions or other investment in the contract under section 72(e),
section 72 applies to a deemed distribution as if it were an actual
distribution, with the result that all or a portion of the deemed
distribution may not be taxable.
(b) Section 72(t) and (m). Section 72(t) (which imposes a 10
percent tax on certain early distributions) and section 72(m)(5) (which
imposes a separate 10 percent tax on certain amounts received by a 5-
percent owner) apply to a deemed distribution under section 72(p) in
the same manner as if the deemed distribution were an actual
distribution.
Q-12: Is a deemed distribution under section 72(p) treated as an
actual distribution for purposes of the qualification requirements of
section 401, the distribution provisions of section 402, the
distribution restrictions of section 401(k)(2)(B) or 403(b)(11), or the
vesting requirements of Sec. 1.411(a)-7(d)(5) (which affects the
application of a graded vesting schedule in cases involving a prior
distribution)?
A-12: No; thus, for example, if a participant in a money purchase
plan who is an active employee has a deemed distribution under section
72(p), the plan will not be considered to have made an in-service
distribution to the participant in violation of the qualification
requirements applicable to money purchase plans. Similarly, the deemed
distribution is not eligible to be rolled over to an eligible
retirement plan and is not considered an impermissible distribution of
an amount attributable to elective contributions in a section 401(k)
plan. See also Sec. 1.402(c)-2, Q&A-4(d) and Sec. 1.401(k)-1(d)(6)(ii).
Q-13: How does a reduction (offset) of an account balance in order
to repay a plan loan differ from a deemed distribution?
A-13: (a) Difference between deemed distribution and plan loan
offset amount. (1) Loans to a participant from a qualified employer
plan can give rise to two types of taxable distributions--
(i) A deemed distribution pursuant to section 72(p); and
(ii) A distribution of an offset amount.
(2) As described in Q&A-4 of this section, a deemed distribution
occurs when the requirements of Q&A-3 of this section are not
satisfied, either when the loan is made or at a later time. A deemed
distribution is treated as a distribution to the participant or
beneficiary only for certain tax purposes and is not a distribution of
the accrued benefit. A distribution of a plan loan offset amount (as
defined in Sec. 1.402(c)-2, Q&A-9(b)) occurs when, under the terms
governing a plan loan, the accrued benefit of the participant or
beneficiary is reduced (offset) in order to repay the loan (including
the enforcement of the plan's security interest in the accrued
benefit). A distribution of a plan loan offset amount could occur in a
variety of circumstances, such as where the terms governing the plan
loan require that, in the event of the participant's request for a
distribution, a loan be repaid immediately or treated as in default.
(b) Plan loan offset. In the event of a plan loan offset, the
amount of the
[[Page 46594]]
account balance that is offset against the loan is an actual
distribution for purposes of the Internal Revenue Code, not a deemed
distribution under section 72(p). Accordingly, a plan may be prohibited
from making such an offset under the provisions of section 401(a),
401(k)(2)(B) or 403(b)(11) prohibiting or limiting distributions to an
active employee. See Sec. 1.402(c)-2, Q&A-9(c), Example 6. See also
Q&A-19 of this section for rules regarding the treatment of a loan
after a deemed distribution.
Q-14: How is the amount includible in income as a result of a
deemed distribution under section 72(p) required to be reported?
A-14: The amount includible in income as a result of a deemed
distribution under section 72(p) is required to be reported on Form
1099-R (or any other form prescribed by the Commissioner).
Q-15: What withholding rules apply to plan loans?
A-15: To the extent that a loan, when made, is a deemed
distribution or an account balance is reduced (offset) to repay a loan,
the amount includible in income is subject to withholding. If a deemed
distribution of a loan or a loan repayment by benefit offset results in
income at a date after the date the loan is made, withholding is
required only if a transfer of cash or property (excluding employer
securities) is made to the participant or beneficiary from the plan at
the same time. See Secs. 35.3405-1, f-4, and 31.3405(c)-1, Q&A-9 and
Q&A-11, of this chapter for further guidance on withholding rules.
Q-16: If a loan fails to satisfy the requirements of Q&A-3 of this
section and is a prohibited transaction under section 4975, is the
deemed distribution of the loan under section 72(p) a correction of the
prohibited transaction?
A-16: No, a deemed distribution is not a correction of a prohibited
transaction under section 4975. See Secs. 141.4975-13 and 53.4941(e)-
1(c)(1) of this chapter for guidance concerning correction of a
prohibited transaction.
Q-17: What are the income tax consequences if an amount is
transferred from a qualified employer plan to a participant or
beneficiary as a loan, but there is an express or tacit understanding
that the loan will not be repaid?
A-17: If there is an express or tacit understanding that the loan
will not be repaid or, for any reason, the transaction does not create
a debtor-creditor relationship or is otherwise not a bona fide loan,
then the amount transferred is treated as an actual distribution from
the plan for purposes of the Internal Revenue Code, and is not treated
as a loan or as a deemed distribution under section 72(p).
Q-18: If a qualified employer plan maintains a program to invest in
residential mortgages, are loans made pursuant to the investment
program subject to section 72(p)?
A-18: (a) Residential mortgage loans made by a plan in the ordinary
course of an investment program are not subject to section 72(p) if the
property acquired with the loans is the primary security for such loans
and the amount loaned does not exceed the fair market value of the
property. An investment program exists only if the plan has
established, in advance of a specific investment under the program,
that a certain percentage or amount of plan assets will be invested in
residential mortgages available to persons purchasing the property who
satisfy commercially customary financial criteria. A loan will not be
considered as made under an investment program if--
(1) Any of the loans made under the program matures upon a
participant's termination from employment;
(2) Any of the loans made under the program is an earmarked asset
of a participant's or beneficiary's individual account in the plan; or
(3) The loans made under the program are made available only to
participants or beneficiaries in the plan.
(b) Paragraph (a)(3) of this Q&A-18 shall not apply to a plan
which, on December 20, 1995, and at all times thereafter, has had in
effect a loan program under which, but for paragraph (a)(3) of this
Q&A-18, the loans comply with the conditions of paragraph (a) of this
Q&A-18 to constitute residential mortgage loans in the ordinary course
of an investment program.
(c) No loan that benefits an officer, director, or owner of the
employer maintaining the plan, or their beneficiaries, will be treated
as made under an investment program.
(d) This section does not provide guidance on whether a residential
mortgage loan made under a plan's investment program would result in a
prohibited transaction under section 4975, or on whether such a loan
made by a plan covered by Title I of ERISA would be consistent with the
fiduciary standards of ERISA or would result in a prohibited
transaction under section 406 of ERISA. See 29 CFR 2550.408b-1.
Q-19: If there is a deemed distribution under section 72(p), is the
interest that accrues thereafter on the amount of the deemed
distribution an indirect loan for income tax purposes?
A-19: (a) General rule. Except as provided in paragraph (b) of this
Q&A-19, a deemed distribution of a loan is treated as a distribution
for purposes of section 72. Therefore, a loan that is deemed to be
distributed under section 72(p) ceases to be an outstanding loan for
purposes of section 72, and the interest that accrues thereafter under
the plan on the amount deemed distributed is disregarded in applying
section 72 to the participant or beneficiary. Even though interest
continues to accrue on the outstanding loan (and is taken into account
for purposes of determining the tax treatment of any subsequent loan in
accordance with paragraph (b) of this Q&A-19), this additional interest
is not treated as an additional loan (and, thus, does not result in an
additional deemed distribution) for purposes of section 72(p). However,
a loan that is deemed distributed under section 72(p) is not considered
distributed for all purposes of the Internal Revenue Code. See Q&A-11
through Q&A-16 of this section.
(b) Exception for purposes of applying section 72(p)(2)(A) to a
subsequent loan. In the case of a loan that is deemed distributed under
section 72(p) and that has not been repaid (such as by a plan loan
offset), the unpaid amount of such loan, including accrued interest, is
considered outstanding for purposes of applying section 72(p)(2)(A) to
determine the maximum amount of any subsequent loan to the participant
or beneficiary.
Q-20: May a participant refinance an outstanding loan or have more
than one loan outstanding from a plan?
A-20: [Reserved]
Q-21: Is a participant's tax basis under the plan increased if the
participant repays the loan after a deemed distribution?
A-21: (a) Repayments after deemed distribution. Yes, if the
participant or beneficiary repays the loan after a deemed distribution
of the loan under section 72(p), then, for purposes of section 72(e),
the participant's or beneficiary's investment in the contract (tax
basis) under the plan increases by the amount of the cash repayments
that the participant or beneficiary makes on the loan after the deemed
distribution. However, loan repayments are not treated as after-tax
contributions for other purposes, including sections 401(m) and
415(c)(2)(B).
(b) Example. The following example illustrates the rules in
paragraph (a) of this Q&A-21 and is based on the assumptions described
in the introductory text of this section:
Example. (i) A participant receives a $20,000 loan on January 1,
2003, to be repaid in 20 quarterly installments of $1,245 each.
[[Page 46595]]
On December 31, 2003, the outstanding loan balance ($19,179) is
deemed distributed as a result of a failure to make quarterly
installment payments that were due on September 30, 2003 and
December 31, 2003. On June 30, 2004, the participant repays $5,147
(which is the sum of the three installment payments that were due on
September 30, 2003, December 31, 2003, and March 31, 2004, with
interest thereon to June 30, 2004, plus the installment payment due
on June 30, 2004). Thereafter, the participant resumes making the
installment payments of $1,245 from September 30, 2004 through
December 31, 2007. The loan repayments made after December 31, 2003
through December 31, 2007 total $22,577.
(ii) Because the participant repaid $22,577 after the deemed
distribution that occurred on December 31, 2003, the participant has
investment in the contract (tax basis) equal to $22,577 (14 payments
of $1,245 each plus a single payment of $5,147) as of December 31,
2007.
Q-22: When is the effective date of section 72(p) and the
regulations in this section?
A-22: (a) Statutory effective date. Section 72(p) generally applies
to assignments, pledges, and loans made after August 13, 1982.
(b) Regulatory effective date. This section applies to assignments,
pledges, and loans made on or after January 1, 2002.
(c) Loans made before the regulatory effective date--(1) General
rule. A plan is permitted to apply Q&A-19 and Q&A-21 of this section to
a loan made before the regulatory effective date in paragraph (b) of
this Q&A-22 (and after the statutory effective date in paragraph (a) of
this Q&A-22) if there has not been any deemed distribution of the loan
before the transition date or if the conditions of paragraph (c)(2) of
this Q&A-22 are satisfied with respect to the loan.
(2) Consistency transition rule for certain loans deemed
distributed before the regulatory effective date. (i) The rules in this
paragraph (c)(2) of this Q&A-22 apply to a loan made before the
regulatory effective date in paragraph (b) of this Q&A-22 (and after
the statutory effective date in paragraph (a) of this Q&A-22) if there
has been any deemed distribution of the loan before the transition
date.
(ii) The plan is permitted to apply Q&A-19 and Q&A-21 of this
section to the loan beginning on any January 1, but only if the plan
reported, in Box 1 of Form 1099-R, for a taxable year no later than the
latest taxable year that would be permitted under this section (if this
section had been in effect for all loans made after the statutory
effective date in paragraph (a) of this Q&A-22), a gross distribution
of an amount at least equal to the initial default amount. For purposes
of this section, the initial default amount is the amount that would be
reported as a gross distribution under Q&A-4 and Q&A-10 of this section
and the transition date is the January 1 on which a plan begins
applying Q&A-19 and Q&A-21 of this section to a loan.
(iii) If a plan applies Q&A-19 and Q&A-21 of this section to such a
loan, then the plan, in its reporting and withholding on or after the
transition date, must not attribute investment in the contract (tax
basis) to the participant or beneficiary based upon the initial default
amount.
(iv) This paragraph (c)(2)(iv) of this Q&A-22 applies if--
(A) The plan attributed investment in the contract (tax basis) to
the participant or beneficiary based on the deemed distribution of the
loan;
(B) The plan subsequently made an actual distribution to the
participant or beneficiary before the transition date; and
(C) Immediately before the transition date, the initial default
amount (or, if less, the amount of the investment in the contract so
attributed) exceeds the participant's or beneficiary's investment in
the contract (tax basis). If this paragraph (c)(2)(iv) of this Q&A-22
applies, the plan must treat the excess (the loan transition amount) as
a loan amount that remains outstanding and must include the excess in
the participant's or beneficiary's income at the time of the first
actual distribution made on or after the transition date.
(3) Examples. The rules in paragraph (c)(2) of this Q&A-22 are
illustrated by the following examples, which are based on the
assumptions described in the introductory text of this section (and,
except as specifically provided in the examples, also assume that no
distributions are made to the participant and that the participant has
no investment in the contract with respect to the plan). Example 1,
Example 2, and Example 4 of this paragraph (c)(3) of this Q&A-22
illustrate the application of the rules in paragraph (c)(2) of this
Q&A-22 to a plan that, before the transition date, did not treat
interest accruing after the initial deemed distribution as resulting in
additional deemed distributions under section 72(p). Example 3 of this
paragraph (c)(3) of this Q&A-22 illustrates the application of the
rules in paragraph (c)(2) of this Q&A-22 to a plan that, before the
transition date, treated interest accruing after the initial deemed
distribution as resulting in additional deemed distributions under
section 72(p). The examples are as follows:
Example 1. (i) In 1998, when a participant's account balance
under a plan is $50,000, the participant receives a loan from the
plan. The participant makes the required repayments until 1999 when
there is a deemed distribution of $20,000 as a result of a failure
to repay the loan. For 1999, as a result of the deemed distribution,
the plan reports, in Box 1 of Form 1099-R, a gross distribution of
$20,000 (which is the initial default amount in accordance with
paragraph (c)(2)(ii) of this Q&A-22) and, in Box 2 of Form 1099-R, a
taxable amount of $20,000. The plan then records an increase in the
participant's tax basis for the same amount ($20,000). Thereafter,
the plan disregards, for purposes of section 72, the interest that
accrues on the loan after the 1999 deemed distribution. Thus, as of
December 31, 2001, the total taxable amount reported by the plan as
a result of the deemed distribution is $20,000 and the plan's
records show that the participant's tax basis is the same amount
($20,000). As of January 1, 2002, the plan decides to apply Q&A-19
of this section to the loan. Accordingly, it reduces the
participant's tax basis by the initial default amount of $20,000, so
that the participant's remaining tax basis in the plan is zero.
Thereafter, the amount of the outstanding loan is not treated as
part of the account balance for purposes of section 72. The
participant attains age 59\1/2\ in the year 2003 and receives a
distribution of the full account balance under the plan consisting
of $60,000 in cash and the loan receivable. At that time, the plan's
records reflect an offset of the loan amount against the loan
receivable in the participant's account and a distribution of
$60,000 in cash.
(ii) For the year 2003, the plan must report a gross
distribution of $60,000 in Box 1 of Form 1099-R and a taxable amount
of $60,000 in Box 2 of Form 1099-R.
Example 2. (i) The facts are the same as in Example 1, except
that in 1999, immediately prior to the deemed distribution, the
participant's account balance under the plan totals $50,000 and the
participant's tax basis is $10,000. For 1999, the plan reports, in
Box 1 of Form 1099-R, a gross distribution of $20,000 (which is the
initial default amount in accordance with paragraph (c)(2)(ii) of
this Q&A-22) and reports, in Box 2 of Form 1099-R, a taxable amount
of $16,000 (the $20,000 deemed distribution minus $4,000 of tax
basis ($10,000 times ($20,000/$50,000)) allocated to the deemed
distribution). The plan then records an increase in tax basis equal
to the $20,000 deemed distribution, so that the participant's
remaining tax basis as of December 31, 1999, totals $26,000 ($10,000
minus $4,000 plus $20,000). Thereafter, the plan disregards, for
purposes of section 72, the interest that accrues on the loan after
the 1999 deemed distribution. Thus, as of December 31, 2001, the
total taxable amount reported by the plan as a result of the deemed
distribution is $16,000 and the plan's records show that the
participant's tax basis is $26,000. As of January 1, 2002, the plan
decides to apply Q&A-19 of this section to the loan. Accordingly, it
reduces the participant's tax basis by the initial default amount of
$20,000, so that the participant's
[[Page 46596]]
remaining tax basis in the plan is $6,000. Thereafter, the amount of
the outstanding loan is not treated as part of the account balance
for purposes of section 72. The participant attains age 59\1/2\ in
the year 2003 and receives a distribution of the full account
balance under the plan consisting of $60,000 in cash and the loan
receivable. At that time, the plan's records reflect an offset of
the loan amount against the loan receivable in the participant's
account and a distribution of $60,000 in cash.
(ii) For the year 2003, the plan must report a gross
distribution of $60,000 in Box 1 of Form 1099-R and a taxable amount
of $54,000 in Box 2 of Form 1099-R.
Example 3. (i) In 1993, when a participant's account balance in
a plan is $100,000, the participant receives a loan of $50,000 from
the plan. The participant makes the required loan repayments until
1995 when there is a deemed distribution of $28,919 as a result of a
failure to repay the loan. For 1995, as a result of the deemed
distribution, the plan reports, in Box 1 of Form 1099-R, a gross
distribution of $28,919 (which is the initial default amount in
accordance with paragraph (c)(2)(ii) of this Q&A-22) and, in Box 2
of Form 1099-R, a taxable amount of $28,919. For 1995, the plan also
records an increase in the participant's tax basis for the same
amount ($28,919). Each year thereafter through 2001, the plan
reports a gross distribution equal to the interest accruing that
year on the loan balance, reports a taxable amount equal to the
interest accruing that year on the loan balance reduced by the
participant's tax basis allocated to the gross distribution, and
records a net increase in the participant's tax basis equal to that
taxable amount. As of December 31, 2001, the taxable amount reported
by the plan as a result of the loan totals $44,329 and the plan's
records for purposes of section 72 show that the participant's tax
basis totals the same amount ($44,329). As of January 1, 2002, the
plan decides to apply Q&A-19 of this section. Accordingly, it
reduces the participant's tax basis by the initial default amount of
$28,919, so that the participant's remaining tax basis in the plan
is $15,410 ($44,329 minus $28,919). Thereafter, the amount of the
outstanding loan is not treated as part of the account balance for
purposes of section 72. The participant attains age 59\1/2\ in the
year 2003 and receives a distribution of the full account balance
under the plan consisting of $180,000 in cash and the loan
receivable equal to the $28,919 outstanding loan amount in 1995 plus
interest accrued thereafter to the payment date in 2003. At that
time, the plan's records reflect an offset of the loan amount
against the loan receivable in the participant's account and a
distribution of $180,000 in cash.
(ii) For the year 2003, the plan must report a gross
distribution of $180,000 in Box 1 of Form 1099-R and a taxable
amount of $164,590 in Box 2 of Form 1099-R ($180,000 minus the
remaining tax basis of $15,410).
Example 4. (i) The facts are the same as in Example 1, except
that in 2000, after the deemed distribution, the participant
receives a $10,000 hardship distribution. At the time of the
hardship distribution, the participant's account balance under the
plan totals $50,000. For 2000, the plan reports, in Box 1 of Form
1099-R, a gross distribution of $10,000 and, in Box 2 of Form 1099-
R, a taxable amount of $6,000 (the $10,000 actual distribution minus
$4,000 of tax basis ($10,000 times ($20,000/$50,000)) allocated to
this actual distribution). The plan then records a decrease in tax
basis equal to $4,000, so that the participant's remaining tax basis
as of December 31, 2000, totals $16,000 ($20,000 minus $4,000).
After 1999, the plan disregards, for purposes of section 72, the
interest that accrues on the loan after the 1999 deemed
distribution. Thus, as of December 31, 2001, the total taxable
amount reported by the plan as a result of the deemed distribution
plus the 2000 actual distribution is $26,000 and the plan's records
show that the participant's tax basis is $16,000. As of January 1,
2002, the plan decides to apply Q&A-19 of this section to the loan.
Accordingly, it reduces the participant's tax basis by the initial
default amount of $20,000, so that the participant's remaining tax
basis in the plan is reduced from $16,000 to zero. However, because
the $20,000 initial default amount exceeds $16,000, the plan records
a loan transition amount of $4,000 ($20,000 minus $16,000).
Thereafter, the amount of the outstanding loan, other than the
$4,000 loan transition amount, is not treated as part of the account
balance for purposes of section 72. The participant attains age
59\1/2\ in the year 2003 and receives a distribution of the full
account balance under the plan consisting of $60,000 in cash and the
loan receivable. At that time, the plan's records reflect an offset
of the loan amount against the loan receivable in the participant's
account and a distribution of $60,000 in cash.
(ii) In accordance with paragraph (c)(2)(iv) of this Q&A-22, the
plan must report in Box 1 of Form 1099-R a gross distribution of
$64,000 and in Box 2 of Form 1099-R a taxable amount for the
participant for the year 2003 equal to $64,000 (the sum of the
$60,000 paid in the year 2003 plus $4,000 as the loan transition
amount).
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: July 13, 2000.
Jonathan Talisman,
Deputy Assistant Secretary of the Treasury.
[FR Doc. 00-18815 Filed 7-28-00; 8:45 am]
BILLING CODE 4830-01-U