Qualified retirement plan loans.

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

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

Deemed Distributions

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

If the loan initially satisfies all applicable requirements, but payments are not made in accordance with the loan terms, a deemed distribution occurs. The amount of the deemed distribution for failure to make a payment in accordance with the loan terms is the entire unpaid balance at the time of such failure. The plan administrator may allow for a grace period, in which case a deemed distribution will not occur until the last day of the grace period. Generally, the grace period may not continue beyond the last day of the calendar quarter following the calendar quarter in which the required payment is due.

Distributions of an Offset

Amount

A distribution of a plan loan offset amount occurs when, under the terms of the plan, a participants account balance is actually reduced in order to repay die loan. The offset is treated as an actual distribution by the plan to the participant of the offset amount. The terms of the plan document and/ or loan policy will specify under what conditions a loan will be considered in default and an offset is to occur.

Tax Issues

The most significant tax implications relating to deemed distributions and distributions of plan loan offset amounts are the effects on a plans qualified status. Certain types of qualified plans (e.g., money purchase pension plans) cannot offer in-service withdrawals to participants, Sec. 401(k) funds can only be distributed in certain circumstances. Violating these distribution rules can potentially result in disqualification, which means die plan loses its favorable tax status. Deemed distributions are not treated as actual distributions affecting a plan's status. However, distributions of plan loan offset amounts are considered actual distributions, and therefore could jeopardize the tax-qualified status of a plan.

In addition to income tax, both deemed distributions and distributions of an offset amount are subject to the 10% penalty tax on premature distributions under Sec. 72(t) and the 15% penalty tax on excess distributions under Sec. 498OA, if these penalty taxes otherwise apply. Both types of distributions are reported on a Form 1099-R.