April 25, 2014
Authored by: benefitsbclp
The situation involved in Private Letter Ruling 201407027 illustrates that a participant can be caught between a rock and hard place when a qualified plan loan must be repaid upon termination of employment.
Administering qualified plan loan repayments following a participant’s termination of employment can be burdensome for employers. Most plans provide that a qualified plan loan must be repaid upon termination of employment to avoid a situation in which the employer must arrange for loan repayments other than through payroll deduction. Some plan recordkeepers provide post-termination loan administration services, but since loan administration errors can be costly and time-consuming to fix, employers tend to prefer requiring repayment upon termination of employment.
A plan loan which satisfies all the requirements under Section 72(p) of the Internal Revenue Code does not cause a taxable event at the time the loan proceeds are distributed from the plan. In addition, if loan repayments are remitted in accordance with the loan terms and the requirements of Code Section 72(p), no taxable event occurs during the term of the loan. However, if a loan is defaulted during the term for non-payment or any other reason, the tax rules treat the outstanding loan balance as a deemed distribution, meaning that the entire amount is treated for tax purposes as a distribution. A deemed distribution of a plan loan is not eligible for rollover. Therefore, when a participant defaults on a loan during employment, she has a deemed distribution which is taxable, but the