[Federal Register Volume 60, Number 245 (Thursday, December 21, 1995)]
[Proposed Rules]
[Pages 66233-66237]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30874]



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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