[Federal Register Volume 63, Number 1 (Friday, January 2, 1998)]
[Proposed Rules]
[Pages 42-45]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-33983]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-209476-82]
RIN 1545-AE41


Loans to Plan Participants

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document amends 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 section 
72(p), and 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: Written comments and requests for a public hearing must be 
received by April 2, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209476-82), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered between the 
hours 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209476-82), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue NW, 
Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the Internet by selecting the ``Tax Regs'' option on 
the IRS Home Page, or by submitting comments directly to the IRS 
Internet site at <a href="http://www.irs.ustreas.gov/prod/tax__regs/
comments.html">http://www.irs.ustreas.gov/prod/tax__regs/
comments.html</a>.

FOR FURTHER INFORMATION CONTACT:
Concerning the regulations Vernon S. Carter, (202) 622-6070; concerning 
submissions or requests to speak at the hearing, La Nita VanDyke, (202) 
622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Proposed Income 
Tax Regulations (26 CFR Part 1) under section 72 of the Internal 
Revenue Code of 1986 (Code). These amendments provide additional 
guidance concerning the tax treatment of loans that are deemed to be 
distributed under section 72(p).

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.
    Regulations were proposed in 1995 \1\ with respect to many of the 
issues arising under section 72(p)(2). The preamble to the 1995 
proposed regulations requested comments on whether further guidance 
should be provided 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, these new proposed regulations address this 
issue.
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    \1\ Proposed Sec. 1.72(p)-1 (EE-106-82) was published in the 
Federal Register (60 FR 66233) on December 21, 1995.
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    These new proposed regulations provide that once a loan is deemed 
distributed under section 72(p), the interest that accrues thereafter 
on that loan is not included in income.\2\ Further, because the loan 
amount is treated as distributed for purposes of section 72, neither 
the income that resulted from the deemed distribution nor the interest 
that accrues thereafter increases the participant's investment in the 
contract (tax basis) for purposes of section 72.
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    \2\ This treatment applies for purposes of determining the 
amount taxable under section 72 (including application of return of 
tax basis). However, as discussed below, the loan is still 
considered outstanding for purposes of determining the maximum 
amount of any subsequent loan to the participant under section 
72(p)(2)(A). Even though interest continues to accrue on the 
outstanding loan and is taken into account for purposes of 
determining the maximum amount of any subsequent loan, this 
additional interest is not treated as an additional loan that 
results in a further deemed distribution for purposes of section 
72(p).
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    For example, assume that, after a loan has been made from a defined 
contribution plan to a participant, a deemed distribution occurs as a 
result of failure to make timely loan repayments (e.g., the repayments 
were not to be made by payroll withholding \3\). The participant's 
total account then consists of non-loan assets and a receivable for the 
loan balance. At separation from employment, the participant's vested

[[Page 43]]

account balance is reduced (offset) by the loan amount and the 
remaining account balance is distributed in a lump sum to the 
participant. In this case, in addition to the income that previously 
arose as a result of the deemed distribution due to the failure to make 
timely payments on the loan, the participant would have a taxable 
distribution at separation from employment for the remaining account 
balance reflecting the non-loan assets that are distributed in a lump 
sum (with no tax basis as a result of the prior deemed distribution of 
the loan amount). The offset of the loan balance (i.e., the offset of 
the loan receivable by the loan amount) would be disregarded for 
purposes of section 72 because the loan had previously been deemed 
distributed as a result of the failure to make timely payments on the 
loan.
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    \3\ With respect to coverage under Title I of the Employee 
Retirement Income Security Act of 1974, the Department of Labor has 
advised the Service 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.
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    A loan that is deemed distributed under section 72 is nevertheless 
outstanding for other purposes until the loan obligation is satisfied 
(e.g., by cash repayment or by offset against the participant's accrued 
benefit). Q&A-13 of the 1995 proposed regulations lists other 
differences between a deemed distribution and a loan offset. In 
addition, 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 proposed regulations also provide that if a participant makes 
any cash repayments on a loan after the loan is deemed distributed, the 
repayments increase the participant's tax basis in the plan in the same 
manner as if the repayments were after-tax contributions. However, such 
repayments are not treated as after-tax contributions for purposes of 
section 401(m) or 415(c)(2)(B).
    These regulations are proposed to become effective for loans made 
on or after the first January 1 that is at least 6 months after the 
date the regulations are published as final regulations in the Federal 
Register (the regulatory effective date). These regulations also revise 
the proposed effective date for the 1995 proposed regulations, so that 
the same proposed effective date would apply to the 1995 proposed 
regulations and these proposed regulations.
    Generally, a plan is permitted to apply the new proposed 
regulations to loans made before the regulatory effective date. 
However, the regulations include a special consistency rule applicable 
if there has been any deemed distribution of the loan before the date 
the plan switches to the new proposed regulations for the loan. In this 
event, a plan is not permitted to apply the new proposed regulations to 
the loan unless the plan reported, in Box 1 of Form 1099-R, a gross 
distribution with respect to the loan that is at least equal to the 
amount required by the 1995 proposed regulations (referred to as the 
initial default amount in the new proposed regulations) for a taxable 
year that is not later than the latest year that would be permitted 
under the 1995 proposed regulations. In such a case, the plan may apply 
the new proposed regulations to the loan even though, in the past, the 
plan reported deemed distributions with respect to the loan in a manner 
that is not consistent with the new proposed regulations.
    If a plan does apply the new proposed regulations to a pre-
regulatory effective date loan that has been deemed distributed, then 
the plan, in its subsequent reporting and withholding, must not 
attribute investment in the contract (tax basis) to the participant 
based upon the initial default amount. For example, a plan that 
reported income for the initial default amount plus all interest 
accruing thereafter as a result of the default and made corresponding 
increases in the participant's tax basis would comply with this 
consistency rule by reducing the participant's tax basis by an amount 
equal to the initial default amount. However, a special rule applies if 
a plan had increased a participant's tax basis by the initial default 
amount and, just before the first actual distribution made after the 
plan switches to applying the new proposed regulations to the loan, the 
sum of the participant's tax basis immediately before the switch plus 
any increase in basis thereafter is less than the initial default 
amount (as a result of intervening distributions). In this case, a loan 
transition amount equal to the amount by which the initial default 
amount exceeds the participant's tax basis is treated as remaining 
outstanding and that amount is includible in the participant's income 
at the time of the next actual distribution from the plan to the 
participant. The proposed regulations include examples illustrating the 
application of the consistency rule.
    Comments are requested on whether the final regulations should 
include further guidance relating to plan loans made to participants 
before the regulatory effective date.
    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 Analyses

    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 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 
regulation 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, 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 Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments that are submitted 
timely (preferable a signed original and eight copies) to the IRS. All 
comments will be available for public inspection and copying. A public 
hearing will be scheduled if requested in writing by a 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 regulations is Vernon S. Carter, 
Office of 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.

Amendments to the Previously Proposed 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: 126 U.S.C. 7805. * * *

    Par. 2. Section 1.72(p)-1 of the proposed regulations published 
December 21, 1995, (60 FR 66233) is amended as follows:

[[Page 44]]

    1. Q&A-19 is redesignated as Q&A-21.
    2. New Q&A-19 and Q&A-20 are added.
    3. Q&A-21, as redesignated, is revised.
    The additions and revision read as follows:


Sec. 1.72(p)-1  Loans treated as distributions.

* * * * *
    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. A loan that is deemed distributed under section 72(p) 
(including interest accruing thereafter) and that has not been repaid 
(such as by a plan loan offset) 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: Is a participant's tax basis in the plan increased if the 
participant repays the loan after a deemed distribution?
    A-20: (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-20 and is based on the assumptions described 
in ASSUMPTIONS FOR EXAMPLES:

    Example. (a) A participant receives a $20,000 loan on January 1, 
1999, to be repaid in 20 quarterly installments of $1,245 each. On 
December 31, 1999, 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, 1999 and December 31, 1999. 
On June 30, 2000, the participant repays $5,147 (which is the sum of 
the three installment payments that were due on September 30, 1999, 
December 31, 1999, and March 31, 2000, with interest thereon to June 
30, 2000, plus the installment payment that was due on June 30, 
2000). Thereafter, the participant resumes making the installment 
payments of $1,245 from September 30, 2000 through December 31, 
2003. The loan repayments made after December 31, 1999 through 
December 31, 2003 total $22,577.
    (b) Because the participant repaid $22,577 after the deemed 
distribution that occurred on December 31, 1999, the participant has 
investment in the contract (tax basis) equal to $22,577 as of 
December 31, 2003.

    Q-21: When is the effective date of section 72(p) and these 
regulations?
    A-21: (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 the first January 1 that is at 
least 6 months after the date of publication of the final regulations 
in the Federal Register (the regulatory effective date).
    (c) Loans made before the regulatory effective date--(1) General 
rule. A plan is permitted to apply Q&A-19 and Q&A-20 of this section to 
a loan made before the regulatory effective date (and after the 
statutory effective date in paragraph (a) of this Q&A-21) if there has 
not been any deemed distribution of the loan before the transaction 
date or if the conditions of paragraph (c)(2) of this Q&A-21 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) apply to a loan made before the regulatory effective 
date (and after the statutory effective date in paragraph (a) of this 
Q&A-21) 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-20 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, 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-20 of this section to a loan.
    (iii) If a plan applies Q&A-19 and Q&A-20 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) 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 first actual distribution made on or 
after the transition date, the initial default amount (or, if less, the 
amount of the investment in the contract so attributed) exceeds the sum 
of the participant's or beneficiary's investment in the contract (tax 
basis) immediately before the transition date plus any increase in the 
participant's or beneficiary's investment in the contract (tax basis) 
on or after the transition date. If this paragraph (c)(2)(iv) 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 actual 
distribution.
    (3) Examples. The rules in paragraph (c)(2) of this Q&A-21 are 
illustrated by the following examples, which are based on the 
assumptions described in ASSUMPTIONS FOR EXAMPLES (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 illustrate the application of these rules 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 illustrates the

[[Page 45]]

application of these rules 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).

    Example 1. (a) In 1995, 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 1996 when 
there is a deemed distribution of $20,000 as a result of a failure 
to repay the loan. For 1996, 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 Q&A-21 of this section) 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 1996 deemed 
distribution. Thus, as of December 31, 1998, 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, 1999, 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 2000 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.
    (b) For the year 2000, the plan must report a gross distribution 
of $60,000 on Box 1 of Form 1099-R and a taxable amount of $60,000 
in Box 2 of Form 1099-R.
    Example 2. The facts are the same as in Example 1, except that 
in 1996, 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 1996, 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 
Q&A-21 of this section) 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, 1996 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 1996 deemed distribution. Thus, as of December 
31, 1998, 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, 1999, 
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 $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 2000 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.
    (b) For the year 2000, the plan must report a gross distribution 
of $60,000 on Box 1 of Form 1099-R and a taxable amount of $54,000 
in Box 2 of Form 1099-R.
    Example 3. (a) In 1990, 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 
1992 when there is a deemed distribution of $28,919 as a result of a 
failure to repay the loan. For 1992, 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 Q&A-21 of this section) and, 
in Box 2 of Form 1099-R, a taxable amount of $28,919. For 1992, the 
plan also records an increase in the participant's tax basis for the 
same amount ($28,919). Each year thereafter through 1998, 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, 1998, 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, 1999, 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) as of December 31, 1999. 
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 2000 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 1992 plus interest accrued thereafter to 
the payment date in 2000. 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.
    (b) For the year 2000, 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. (a) The facts are the same as in Example 1, except 
that in 1997, 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 1997, 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, 1997 totals $16,000 ($20,000 minus $4,000). After 
1996, the plan disregards, for purposes of section 72, the interest 
that accrues on the loan after the 1996 deemed distribution. Thus, 
as of December 31, 1998, the total taxable amount reported by the 
plan as a result of the deemed distribution plus the 1997 actual 
distribution is $26,000 and the plan's records show that the 
participant's tax basis is $16,000. As of January 1, 1999, 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 2000 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.
    (b) In accordance with paragraph (c)(2)(iv) of Q&A-21 of this 
section, 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 2000 equal to $64,000 (the sum of 
the $60,000 paid in the year 2000 plus $4,000 as the loan transition 
amount).
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
[FR Doc. 97-33983 Filed 12-31-97; 8:45 am]
BILLING CODE 4830-01-M