Loans to plan participants

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[EE-106-82]

RIN 1545-AE45

Loans to plan participants

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed Income Tax Regulations under

section 72(p) of the Internal Revenue Code relating to loans made from

a qualified employer plan to plan participants or beneficiaries.

Section 72(p) was added by section 236 of the Tax Equity and Fiscal

Responsibility Act of 1982, and amended by the Technical Corrections

Act of 1982, the Deficit Reduction Act of 1984, the Tax Reform Act of

1986 and the Technical and Miscellaneous Revenue Act of 1988. These

regulations provide guidance to the public with respect to this

provision, and affect any plan participant or beneficiary who receives

a loan from a qualified employer plan.

DATES: Written comments and requests for a public hearing must be

received by March 20, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (EE-106-82), Attention:

Plan Loans Guidance, room 5228, Internal Revenue Service, POB 7604, Ben

Franklin Station, Washington, DC 20044. In the alternative, submissions

may be hand delivered between the hours of 8 a.m. and 5 p.m. to:

CC:DOM:CORP:R (EE-106-82), Courier's Desk, Internal Revenue Service,

1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Vernon S. Carter, of the Office of the

Associate Chief Counsel (Employee Benefits and Exempt Organizations),

IRS, at (202) 622-6070 (not a toll free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to the Income Tax

Regulations (26 CFR Part 1) under section 72 of the Internal Revenue

Code of 1986 (Code). These amendments are proposed to conform the

regulations to section 236 of the Tax Equity and Fiscal Responsibility

Act of 1982 (TEFRA), which added section 72(p) to the Code, and to the

amendments to section 72(p) made by the Technical Corrections Act of

1982, the Deficit Reduction Act of 1984, the Tax Reform Act of 1986 and

the Technical and Miscellaneous Revenue Act of 1988.

Explanation of Provisions

Section 72(p) of the Code generally provides that an amount

received as a loan from a qualified employer plan by a participant or

beneficiary is treated as received as a distribution from the plan for

purposes of section 72 (a deemed distribution), except to the extent

certain conditions are satisfied. 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), 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. A loan from a contract purchased under a qualified employer plan

is also treated as a loan from the plan. Section 72(p) also 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 to be treated as a loan from the plan.

Under section 72(p), 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 certain requirements relating to the terms

of the loan and the repayment schedule, and to the extent the loan

satisfies certain limitations on the amount loaned. The proposed

regulations require that the loan be evidenced by an enforceable

agreement, set forth in writing or in another form that is approved by

the Commissioner of Internal Revenue, that includes terms that satisfy

the statutory requirements. Thus, the agreement must specify the amount

of the loan, the term of the loan, and the repayment schedule. The

agreement may be set forth in more than one document.

If a loan fails to satisfy the repayment requirements or the

enforceable agreement requirement, the proposed regulations provide for

the balance then due under the loan to be treated as a distribution

from the plan. This may occur at the time the loan is made or at a

later date if the loan is not repaid in accordance with the repayment

schedule. If the loan satisfies the repayment requirements and the

enforceable agreement requirement, but at the time the loan is made the

amount of the loan exceeds the statutory limitation on the amount that

is permitted to be loaned, the proposed regulations provide that only

the excess amount is a deemed distribution.

One of the repayment requirements is that the loan be repaid within

five years, unless the loan is used to acquire a dwelling unit which

within a reasonable time is used as the principal residence of the

participant. The proposed regulations provide that a principal

residence has the same meaning as under section 1034 (relating to the

taxation of a sale of a residence) and that tracing rules established

under section 163(h)(3)(B) (relating to interest deductions for

indebtedness incurred with respect to the acquisition of a principal

residence) will be used to determine whether the section

72(p)(2)(B)(ii) exception to the five-year repayment requirement

applies. (Notice 88-74 (1988-2 C.B. 385), sets forth certain standards

applicable under section 163(h)(3).)

The Tax Reform Act of 1986 amended section 72(p) to require that,

in order for a loan to not be treated as a distribution, the loan must

be repaid in substantially level installments (not less frequently than

quarterly) over the term of the loan. Section 72(p) authorizes

regulations to allow exceptions from this requirement. Pursuant to this

authorization, the proposed regulations permit loan repayments to be

suspended during a leave of absence of up to one year, if the

participant's pay from the employer is insufficient to service the

debt, but only if the loan is repaid by the latest date permitted under

section 72(p)(2)(B).

If the repayment terms of a loan are not satisfied after the loan

has been made due to a failure to make a scheduled loan repayment, the

proposed regulations provide for the balance then due under the loan to

be deemed to be distributed. The proposed regulations permit a grace

period, to the extent the grace period does not extend beyond the end

of the calendar quarter next following the calendar quarter in which

the repayment was scheduled to be made.

If a loan is treated as a distribution under section 72(p), the

proposed regulations state that the amount so distributed is to be

treated as a taxable distribution, subject to the normal rules of

section 72 if the participant's interest in the plan includes after-tax

contributions (or other tax basis). A deemed distribution would also be

a distribution for purposes of the 10

[[Page 66234]]

percent tax in section 72(t) and the excise tax on excess distributions

under section 4980A. However, a deemed distribution under section 72(p)

is not treated as an actual distribution for purposes of the

qualification requirements of section 401, the rollover and income

averaging provisions of section 402 and the distribution restrictions

of section 403(b).

By contrast, if a participant's accrued benefit is reduced (offset)

in order to repay a loan, an actual distribution occurs for purposes of

the provisions in sections 401, 402 and 403(b) referred to above. Thus,

for example, a plan is prohibited from enforcing its security interest

in a participant's account balance attributable to amounts contributed

pursuant to an election under section 401(k) until a date on which

distribution is permitted under section 401(k).

The proposed regulations do not address all issues arising under

section 72(p). Comments are requested on whether further guidance

should be provided on issues that are not addressed and how the issues

should be resolved, including the effect of a deemed distribution on

the tax treatment of subsequent distributions from the plan and the

application of the $50,000 limitation and the five year repayment

requirement to a refinancing and to multiple loan arrangements.

Taxpayers may rely on these proposed regulations for guidance

pending the issuance of final regulations. If, and to the extent,

future guidance is more restrictive than the guidance in these proposed

regulations, the future guidance will be applied without retroactive

effect.

Special Analysis

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and, therefore, a Regulatory

Flexibility Analysis is not required. Pursuant to section 7805(f), this

notice of proposed rulemaking will be submitted to the Chief Counsel

for Advocacy of the Small Business Administration for comment on its

impact on small business.

Comments and Request for Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (a signed original

and eight (8) copies) that are submitted timely to the following

address: CC:DOM:CORP:R (EE-106-82), Attention: Plan Loans Guidance,

room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. All comments will be available for public

inspection and copying. A public hearing may be scheduled if requested

in writing by any person that timely submits written comments. If a

public hearing is scheduled, notice of the date, time, and place for

the hearing will be published in the Federal Register.

Drafting Information

The principal author of these proposed regulations is Vernon S.

Carter, Office of the Associate Chief Counsel (Employee Benefits and

Exempt Organizations). 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.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be 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 to read 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

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 Q&A-3(b) of this section), with adequate security and with an

interest rate and repayment terms that are commercially reasonable.

(The particular interest rate used for illustration in this section 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. No inference

should be drawn from these regulations or the examples therein that a

loan would not result in a prohibited transaction under section 4975 or

would be consistent with the fiduciary standards of Title I of the

Employee Retirement Income Security Act of 1974, as amended. See, for

example, 29 CFR Sec. 2550.408b-1 (interpreting the statutory prohibited

transaction exemption for loans to participants and beneficiaries).

Questions and Answers

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), a loan made from

a contract that has been purchased under a qualified employer plan

(including a contract that

[[Page 66235]]

has been distributed to the participant or beneficiary) shall be

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), any

assignment or pledge of (or agreement to assign or to pledge) by a

participant or beneficiary of any portion of his or her interest in a

contract that has been purchased under a qualified employer plan

(including a contract that has been distributed) shall be 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), 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) set forth in writing or in such other form as may be approved

by the Commissioner, 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 of the loan, the term of

the loan, and the repayment schedule.

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, with respect

to that amount. 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 Q&A-3(b) 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 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 Q&A-3(b) 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 ASSUMPTIONS FOR EXAMPLES:

Example 1. (a) 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.

(b) 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. (a) A participant with a nonforfeitable account balance

of $30,000 borrows $20,000 as a loan repayable in level monthly

installments over five years.

(b) 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 Sec. 2550.408b-1(f)(2)).

Example 3. (a) 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.

(b) 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. (a) On August 1, 1998, 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 1999,

the participant fails to make any of the payments due thereafter.

(b) 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 Q&A-10(c) Example 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?

[[Page 66236]]

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 1034.

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. 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 ASSUMPTIONS FOR EXAMPLES:

Example. (a) On July 1, 1999, a participant requests a $50,000 plan

loan to be repaid in level monthly installments over 15 years. On

August 1, 1999, the participant acquires a principal residence and pays

a portion of the purchase price with a $50,000 bank loan. On September

1, 1999, the plan loans $50,000 to the participant, which the

participant uses to pay the bank loan.

(b) 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)), such 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 72(p)(2)(C) does not apply for a period, not longer than one

year, that a participant is on a 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 must be repaid

by the latest date permitted under section 72(p)(2)(B) and the

installments due after the leave ends (or, if earlier, after the first

year of the leave) must not be less than those required under the terms

of the original loan.

(b) Example. The following example illustrates the rules of

paragraph (a) of this Q&A-9 and is based upon the assumptions described

in ASSUMPTIONS FOR EXAMPLES:

Example. (a) On July 1, 1997, a participant with a nonforfeitable

account balance of $80,000, borrows $40,000 to be repaid in level

monthly installments of $825 each over five years. The loan is not a

principal residence plan loan. The participant makes nine 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. The

amount of each monthly installment is increased to $1,130 in order to

repay the loan by June 30, 2002.

(b) 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, 2002 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 grace period, and section 72(p)(2)(C) will

not be considered to have been violated until the last day of the grace

period. Any such grace period shall be given effect for purposes of

section 72(p)(2)(C) only to the extent it does not 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

grace period allowed under the preceding paragraph (a) of this Q&A-10),

then the amount of the deemed distribution equals the entire

outstanding balance of the loan at the time of such failure.

(c) Example. The following example illustrates the rules in Q&A-

10(a) and (b) of this section and is based upon the assumptions

described in ASSUMPTIONS FOR EXAMPLES:

Example. (1) On August 1, 1998, 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 all monthly payments due through July 31, 1999, the

participant fails to make the payment due on August 31, 1999 or any

other monthly payments due thereafter. The plan administrator allows a

three-month grace period.

(2) 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, 1999, which

is the last day of the three-month grace period for the August 31, 1999

installment. The amount of the deemed distribution is $17,157, which is

the outstanding balance on the loan at November 30, 1999.

Alternatively, if the plan administrator had allowed a grace period

through the end of the next calendar quarter, there would be a deemed

distribution on December 31, 1999 equal to $17,282, which is the

outstanding balance of the loan at December 31, 1999.

Q-11: Do sections 72 and 4980A 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) Sections 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)

[[Page 66237]]

in the same manner as if the deemed distribution were an actual

distribution.

(c) Section 4980A. For purposes of section 4980A, a deemed

distribution under section 72(p) is taken into account in determining

an individual's excess distributions, as provided in Sec. 54.4981A-1T,

Q&A a-8.

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, or the

distribution restrictions of section 401(k)(2)(B) or 403(b)(11)?

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 the participant is not eligible to elect income

averaging with respect to the deemed distribution. See also

Secs. 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 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.

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: 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, 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: 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. Loans will not be

considered as made under an investment program if the loans are only

made available to, or any loan is earmarked for, any person or persons

who are participants or beneficiaries in the plan, or if such loans

mature upon a participant's termination from employment. In addition,

no loan that benefits an officer, director, or owner of the employer

maintaining the plan, or his or her beneficiaries, will be treated as

made under an investment program. No inference should be drawn that a

transaction under such an investment program is not a prohibited

transaction under section 503 or 4975 or is not a violation of the

applicable fiduciary standards for an employee benefit plan, so that

such a loan could be a prohibited transaction if it does not satisfy

the requirements of 29 CFR 2550.408b-1.

Q-19: When is the effective date of these regulations?

A-19: This section applies to assignments, pledges, and loans made

on or after the date that is three months after the date of publication

of the final regulations in the Federal Register.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 95-30874 Filed 12-20-95; 8:45 am]

BILLING CODE 4830-01-U