[Federal Register Volume 65, Number 147 (Monday, July 31, 2000)]
[Rules and Regulations]
[Pages 46588-46596]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-18815]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8894]
RIN 1545-AE41


Loans From a Qualified Employer Plan to Plan Participants or 
Beneficiaries

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to loans 
made from a qualified employer plan to plan participants or 
beneficiaries. These final regulations provide guidance on the 
application of section 72(p) of the Internal Revenue Code. These 
regulations 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: Effective Date: These regulations are effective July 31, 2000.
    Applicability Date: For dates of applicability, see Sec. 1.72(p)-1, 
Q&A-22 (a) through (c)(2).

FOR FURTHER INFORMATION CONTACT: Vernon S. Carter, (202) 622-6070 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains final regulations (26 CFR Part 1) under 
section 72 of the Internal Revenue Code of 1986 (Code). These 
regulations provide guidance concerning the tax treatment of loans that 
are deemed to be distributed under section 72(p). Section 72(p) was 
added by section 236 of the Tax Equity and Fiscal Responsibility Act of 
1982 (96 Stat. 324), and amended by the Technical Corrections Act of 
1982 (96 Stat. 2365), the Deficit Reduction Act of 1984 (98 Stat. 494), 
the Tax Reform Act of 1986 (100 Stat. 2085), and the Technical and 
Miscellaneous Revenue Act of 1988 (102 Stat. 3342).
    On December 21, 1995, a notice of proposed rulemaking (EE-106-82) 
was published in the Federal Register (60 FR 66233) with respect to 
many of the issues arising under section 72(p)(2). The preamble to the 
1995 proposed regulations requested comments 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, 
additional proposed regulations addressing this issue were published 
January 2, 1998 (REG-209476-82), in the Federal Register (63 FR 42). 
Written comments were received on the 1998 proposed regulations, but no 
public hearing was requested. After consideration of all comments 
received on both the 1995 and the 1998 proposed regulations, the 
proposed regulations are adopted as revised by this Treasury decision.

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. For example, except in the 
case of certain home loans, the exception in section 72(p)(2) only 
applies to a loan that by its terms is to be repaid over not more than 
five years in substantially level installments.
    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 \1\), 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.
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    \1\ With respect to coverage under Title I of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 829) (ERISA), the 
Department of Labor (DOL) has advised the IRS 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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Summary of Comments Received and Changes Made and Summary of the 
Final Regulations

    In general, comments received on the proposed regulations were 
favorable and, accordingly, the final regulations retain the general 
structure and substance of the proposed regulations, including a wide 
variety of examples illustrating the rules in the final regulations. 
However, commentators made a number of specific recommendations for 
modifications and clarifications of the regulations. The comments are 
summarized below, along with the IRS' and Treasury's consideration of 
those comments.

A. Cure Period for Missed Payments

    The 1995 proposed regulations stated that the section 72(p)(2)(C) 
requirement that repayments be made in level installments at least 
quarterly would not

[[Page 46589]]

be violated if payments are not made until the end of a grace period 
that the plan administrator may allow, but only to the extent the grace 
period does not continue beyond the last day of the calendar quarter 
following the calendar quarter in which the required installment 
payment was due. Commentators suggested that the proposed regulations 
should specify how the grace period is to be established, such as 
whether the grace period must be contained in the plan document, a 
separate loan program that is deemed to be a part of the plan document 
pursuant to DOL 29 CFR 2550.408b-1(d)(2), or the summary plan 
description, and whether it is permissible for a plan to have grace 
periods on a participant by participant basis (so long as this did not 
discriminate in favor of the highly compensated employees).
    Some commentators requested that a plan participant have a 
reasonable period of time (such as up to 30 days) to cure a default 
after the plan administrator has sent a notice of default, and that the 
section 72(p) regulations mandate that the plan administrator send a 
notice of default within a reasonable period of time (such as 30 days) 
after it has discovered the default. These commentators suggested that 
grace and cure periods might be conditioned upon the plan administrator 
having an appropriate procedure in place for timely identification of 
defaults and curing defects. Some commentators requested that final 
regulations permit a plan administrator to use his or her discretion, 
under special circumstances, to provide a grace period of up to one 
year from the date of a missed payment.
    Many of these suggested changes relate to legal requirements other 
than section 72(p), such as the application of the fiduciary 
requirements of ERISA \2\ and Federal and state laws that apply to 
debtors and creditors. The 1995 proposed regulations allowed a grace 
period up to the end of the next following quarter. Thus, a plan could 
select a grace period of, for example, 30 days or 90 days and could 
provide a special notice to the participant concerning the grace 
period. Thus, many of the suggested changes would involve the 
imposition of new and complicated rules for which there is no apparent 
basis in section 72(p) and which would in any case be difficult to 
enforce and to administer. Accordingly, the final regulations retain 
the same rules as the proposed regulations. However, the final 
regulations use the term cure period instead of grace period.
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    \2\ The Department of Labor has advised the IRS that, with 
respect to plans covered by Title I of ERISA, the administration of 
a participant loan program involves the management of plan assets. 
Therefore, fiduciary conduct undertaken in the administration of 
such a loan program must conform to the rules that govern 
transactions involving plan assets. See, generally, ERISA sections 
403, 404, and 406. Fiduciary conduct in the administration of a loan 
program would include decisions concerning the rules governing the 
program, including establishing standards to govern the 
appropriateness of making any particular loan and the appropriate 
treatment of any defaulted loan. Further, absent an exemption, any 
loan between a plan covered by Title I of ERISA and a party in 
interest to the plan (including plan participants and beneficiaries) 
would constitute a prohibited transaction under section 406(a)(1)(B) 
of ERISA. DOL has promulgated a regulation at 29 CFR 2550.408b-1 
providing guidance regarding the statutory exemption contained in 
section 408(b)(1) of ERISA for plan loans to parties in interest who 
are participants or beneficiaries. Further, some loans by plans 
(whether or not covered under Title I of ERISA) may constitute 
prohibited transactions under section 4975(c)(1)(B) of the Internal 
Revenue Code. Under section 102 of Reorganization Plan No. 4 of 
1978, (43 FR 47,713) (1978), the Secretary of Labor has jurisdiction 
to promulgate regulations under section 4975(d)(1) of the Internal 
Revenue Code, which provides a limited exemption to the prohibition 
of section 4975(c)(1)(B) of the Internal Revenue Code.
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    The final regulations also include a new cross-reference to section 
414(u)(4), (relating to military service) which was added to the Code 
by the Small Business Job Protection Act of 1996 (110 Stat. 1755).

B. Treatment of Loans After Deemed Distribution

    The 1998 proposed regulations provide that once a loan is deemed 
distributed under section 72(p) of the Code, interest that accrues 
thereafter on that loan is not included in income and, 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 majority of the comments on 
this issue urged that the positions taken in the 1998 proposed 
regulations addressing post-default interest be adopted in the final 
regulations. Some commentators asked that the regulations provide 
further guidance on or revise the treatment of interest that accrues on 
a loan that is a deemed distribution under section 72(p), as described 
in Q&A-19 of the 1998 proposed regulations. Commentators noted that, in 
the case of a plan that has chosen to permit additional loans after a 
default that has not been cured, the rule in the proposed regulations 
requiring interest to be taken into account in determining the maximum 
amount of any subsequent loan would involve costs to make system and 
procedural changes to calculate the accrued interest on the defaulted 
loan for this limited application. Other commentators urged that 
participants be taxed on the additional interest after a default, 
either annually or as an accumulated amount at the time of a loan 
offset, as an incentive for the participant to repay the loan.
    One commentator raised the issue of how a deemed distribution would 
be taken into account in a plan with a graded vesting schedule.
    The final regulations generally adopt the rules in the proposed 
regulations, but the regulations have been revised to indicate that a 
deemed distribution is not taken into account as a distribution for 
purposes of the requirements of Sec. 1.411(a)-7(d)(5) (relating to the 
determination of a participant's account balance if a distribution is 
made at a time when the participant's vesting percentage may increase).

C. Enforceable Agreement and New Technologies

    The 1995 proposed regulations required that a loan be evidenced by 
a legally enforceable agreement and that the legally enforceable 
agreement be set forth in writing or in another form approved by the 
Commissioner. Commentators asked whether a participant needs to sign a 
loan agreement document and whether loans made electronically, such as 
over phone or voice response units, would be permitted.
    Some comments requested elimination of the requirement that a loan 
be evidenced by a legally enforceable agreement. However, the final 
regulations retain this requirement. There is, arguably, no difference 
between a loan that is not legally enforceable and a cash distribution 
that the employee is permitted to return to the plan. The final 
regulations clarify that, as long as a signature is not required in 
order for the loan to be enforceable under applicable law, the 
agreement need not be signed.
    The final regulations also require the agreement to be set forth in 
a written paper document or in another form approved by the 
Commissioner. However, the final regulations also treat this 
requirement as satisfied if the loan agreement is set forth in any 
electronic medium that satisfies certain standards. The standards in 
these final regulations for use of an electronic medium for a loan are 
the same as the standards for use of an electronic medium for a consent 
to a distribution under Sec. 1.411(a)-11(f)(2). 65 FR 6001 (February 8, 
2000). Specifically, a loan agreement will not fail to satisfy section

[[Page 46590]]

72(p)(2) of the Code merely because the loan agreement is in an 
electronic medium reasonably accessible to the participant or the 
beneficiary under a system that is reasonably designed to preclude 
anyone other than the participant or the beneficiary from requesting a 
loan, that provides the participant or the beneficiary with a 
reasonable opportunity to review the terms of the loan and to confirm, 
modify, or rescind the terms of the loan before the loan is made, and 
that provides the participant or the beneficiary, within a reasonable 
period after the loan is made, with a confirmation of the loan terms 
through a written paper document or an electronic medium.\3\ If an 
electronic medium is used to provide confirmation of the loan terms, 
the electronic medium must be reasonably accessible to the participant 
or the beneficiary and the electronic confirmation must be provided 
under a system reasonably designed to give the confirmation in a manner 
no less understandable to the participant or the beneficiary than a 
written paper document. Also, the participant or the beneficiary must 
be advised of the right to request and to receive a copy of the 
confirmation on a written paper document without charge.
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    \3\ Neither the regulations regarding use of electronic medium 
under section 411 nor these regulations apply for purposes of 
satisfying the requirements of section 417, including the 
requirement of section 417(a)(2)(A) that spousal consent be 
witnessed by a notary public or plan representative.
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    The Electronic Signatures in Global and National Commerce Act (114 
Stat. 464) (the Electronic Signatures Act) was signed on June 30, 2000. 
Title I of the Electronic Signatures Act, which is generally effective 
October 1, 2000, applies to certain electronic records and signatures 
in commerce. In the Notice of Proposed Rulemaking that appears in this 
issue of the Federal Register, comments are requested on the impact of 
the Electronic Signatures Act on these regulations and on any future 
guidance that may be needed on the application of the Electronic 
Signatures Act to plan loan transactions.

D. Mortgage Investment Program

    Some commentators requested that the special rule in the 1995 
proposed regulations under which section 72(p) would not apply to loans 
made under a residential mortgage investment program be revised to 
eliminate the requirement that the loans also be available to 
nonparticipants. This special rule is not based on an explicit 
statutory provision, but is based on legislative history \4\ indicating 
the understanding that section 72(p) was not intended to apply to loans 
made in the ordinary course of a bona fide residential mortgage 
investment program. The IRS and Treasury have concluded that there is a 
risk that the intent of the section 72(p)(2) limitations might be 
thwarted if a category of loans extended solely to participants were 
not subject to section 72(p). However, the extension of this 
requirement to otherwise bona fide mortgage investment programs that 
were in effect at the time the 1995 proposed regulations were issued 
would be inappropriate and, accordingly, the final regulations permit 
plans with these preexisting programs to continue to make such loans. 
The special rule in the final regulations is not intended to provide 
guidance on whether, or to what extent, a plan that is covered by Title 
I of ERISA may make such residential mortgage loans available to 
participants or beneficiaries of the plan without violating the 
provisions of Title I of ERISA.\5\
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    \4\ H.R. Conf. Rep. No. 97-760, 97th Cong., 2d Sess. 620 (1982), 
1982-2 C.B. 672 and S. Rep. No. 97-494, 97th Cong., 2d Sess. 319, 
321 (1982).
    \5\ See, for example, PTCE 88-59.
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E. Other Changes

    The requirement that a 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. 
For this purpose, the 1995 proposed regulations provided that a 
principal residence has the same meaning as a principal residence under 
section 1034. To reflect the repeal of section 1034 \6\ and the use of 
the same term in section 121, the final regulations provide that a 
principal residence has the same meaning as a principal residence under 
section 121.\7\
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    \6\ Section 1034 was repealed by section 312(b) of the Taxpayer 
Relief Act of 1997 (Public Law 105-34) (111 Stat. 788).
    \7\ Like the 1995 proposed regulations, the final regulations 
(at Q&A-7) apply the tracing rules of section 163(h)(3) of the Code 
to trace whether a loan is a principal residence plan loan. Notice 
88-74 (1988-2 C.B. 385), sets forth certain standards applicable 
under section 163(h)(3).
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F. Effective Date of Final Regulations

    Both the 1995 and the 1998 proposed regulations were proposed to 
apply for assignments, pledges, and loans made on or after the first 
January 1 that is at least six months after the issuance of final 
regulations. Under certain limited conditions, the 1998 proposed 
regulations permitted loans made before this proposed general effective 
date to apply Q&A-19, relating to interest accruing after a deemed 
distribution, and Q&A-20, relating to basis resulting from repayments 
after a deemed distribution. Comments on these transition conditions 
were generally favorable, but one commentator requested that plan 
sponsors be permitted to rely on these rules for loans made before the 
general effective date if any reasonable and consistent method had been 
used to report deemed distributions before the general effective date. 
The rules in the 1998 proposed regulations for pre-effective date loans 
included carefully considered, specific conditions in order for such 
loans to be able to rely on Q&A-19 and Q&A-20 (including several 
detailed examples illustrating the application of these transition 
conditions) and these rules have been retained in the final 
regulations.
    Commentators also requested that the general effective date be the 
first January 1 that is at least 6 or 12 months after the date of the 
final regulations to allow for proper redesign and testing of plan loan 
administration systems. Consistent with the proposed effective date and 
these comments, the final regulations are applicable to assignments, 
pledges, and loans made on or after January 1, 2002.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 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 
regulations 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, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Vernon S. Carter, 
Office of Division Counsel/Associate Chief Counsel (Tax Exempt and 
Government Entities). 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.

[[Page 46591]]

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is 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.
    The addition reads 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 (96 
Stat. 324) 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 paragraph (b) of Q&A-3 of this section), with adequate security 
and with an interest rate and repayment terms that are commercially 
reasonable. (The particular interest rate used, which is solely for 
illustration, 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. The regulations and examples in this section do not 
provide guidance on whether a loan from a plan would result in a 
prohibited transaction under section 4975 of the Internal Revenue Code 
or on whether a loan from a plan covered by Title I of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 829) (ERISA) would be 
consistent with the fiduciary standards of ERISA or would result in a 
prohibited transaction under section 406 of ERISA. The questions and 
answers are as follows:
    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) and this section, 
a loan made from a contract that has been purchased under a qualified 
employer plan (including a contract that has been distributed to the 
participant or beneficiary) is 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) and this 
section, any assignment or pledge of (or agreement to assign or to 
pledge) any portion of a participant's or beneficiary's interest in a 
contract that has been purchased under a qualified employer plan 
(including a contract that has been distributed to the participant or 
beneficiary) is 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) and this section, 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) 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 and date of the loan and the 
repayment schedule. The agreement does not have to be signed if the 
agreement is enforceable under applicable law without being signed. The 
agreement must be set forth either--

[[Page 46592]]

    (1) In a written paper document;
    (2) In an electronic medium that is reasonably accessible to the 
participant or the beneficiary and that is provided under a system that 
satisfies the following requirements:
    (i) The system must be reasonably designed to preclude any 
individual other than the participant or the beneficiary from 
requesting a loan.
    (ii) The system must provide the participant or the beneficiary 
with a reasonable opportunity to review and to confirm, modify, or 
rescind the terms of the loan before the loan is made.
    (iii) The system must provide the participant or the beneficiary, 
within a reasonable time after the loan is made, a confirmation of the 
loan terms either through a written paper document or through an 
electronic medium that is reasonably accessible to the participant or 
the beneficiary and that is provided under a system that is reasonably 
designed to provide the confirmation in a manner no less understandable 
to the participant or beneficiary than a written document and, under 
which, at the time the confirmation is provided, the participant or the 
beneficiary is advised that he or she may request and receive a written 
paper document at no charge, and, upon request, that document is 
provided to the participant or beneficiary at no charge; or
    (3) In such other form as may be approved by the Commissioner.
    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. 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 paragraph (b) of 
Q&A-3 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 section 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 paragraph (b) of 
Q&A-3 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 the introductory text of this section:

    Example 1. (i) 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.
    (ii) 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. (i) A participant with a nonforfeitable account 
balance of $30,000 borrows $20,000 as a loan repayable in level 
monthly installments over five years.
    (ii) 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 2550.408b-1(f)(2).)
    Example 3. (i) 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.
    (ii) 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. (i) On August 1, 2002, 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 
2003, the participant fails to make any of the payments due 
thereafter.
    (ii) 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 paragraph (c) of Q&A-10 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?
    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 121.
    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, a refinancing cannot qualify 
as a principal residence plan loan. 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 the introductory text of this section:

    Example. (i) On July 1, 2003, a participant requests a $50,000 
plan loan to be repaid in level monthly installments over 15 years. 
On August 1, 2003, the participant acquires a principal residence 
and pays a portion of the purchase price with a $50,000 bank loan. 
On September 1, 2003, the plan loans $50,000 to the participant, 
which the participant uses to pay the bank loan.
    (ii) 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)), the 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

[[Page 46593]]

72(p)(2)(C) does not apply for a period, not longer than one year (or 
such longer period as may apply under section 414(u)), that a 
participant is on a bona fide 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 (including 
interest that accrues during the leave of absence) must be repaid by 
the latest date permitted under section 72(p)(2)(B) (e.g., the 
suspension of payments cannot extend the term of the loan beyond 5 
years, in the case of a loan that is not a principal residence plan 
loan) and the amount of the installments due after the leave ends (or, 
if earlier, after the first year of the leave or such longer period as 
may apply under section 414(u)) must not be less than the amount 
required under the terms of the original loan.
    (b) Military service. See section 414(u)(4) for special rules 
relating to military service.
    (c) Example. The following example illustrates the rules of 
paragraph (a) of this Q&A-9 and is based upon the assumptions described 
in the introductory text of this section:

    Example. (i) On July 1, 2002, a participant with a 
nonforfeitable account balance of $80,000 borrows $40,000 to be 
repaid in level monthly installments of $825 each over 5 years. The 
loan is not a principal residence plan loan. The participant makes 9 
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 
in full (including interest that accrued during the leave of 
absence). The amount of each monthly installment is increased to 
$1,130 in order to repay the loan by June 30, 2007.
    (ii) 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, 2007 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 cure period and section 72(p)(2)(C) will not 
be considered to have been violated if the installment payment is made 
not later than the end of the cure period, which period cannot 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 
cure period allowed under paragraph (a) of this Q&A-10), then the 
amount of the deemed distribution equals the entire outstanding balance 
of the loan (including accrued interest) at the time of such failure.
    (c) Example. The following example illustrates the rules in 
paragraphs (a) and (b) of this Q&A-10 and is based upon the assumptions 
described in the introductory text of this section:

    Example. (i) On August 1, 2002, a participant has a 
nonforfeitable account balance of $45,000 and borrows $20,000 from a 
plan to be repaid over 5 years in level monthly installments due at 
the end of each month. After making all monthly payments due through 
July 31, 2003, the participant fails to make the payment due on 
August 31, 2003 or any other monthly payments due thereafter. The 
plan administrator allows a three-month cure period.
    (ii) 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, 2003, which is the last day of the three-month cure period for 
the August 31, 2003 installment. The amount of the deemed 
distribution is $17,157, which is the outstanding balance on the 
loan at November 30, 2003. Alternatively, if the plan administrator 
had allowed a cure period through the end of the next calendar 
quarter, there would be a deemed distribution on December 31, 2003 
equal to $17,282, which is the outstanding balance of the loan at 
December 31, 2003.

    Q-11: Does section 72 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) Section 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) in 
the same manner as if the deemed distribution were an actual 
distribution.
    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, the 
distribution restrictions of section 401(k)(2)(B) or 403(b)(11), or the 
vesting requirements of Sec. 1.411(a)-7(d)(5) (which affects the 
application of a graded vesting schedule in cases involving a prior 
distribution)?
    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 is not considered an impermissible distribution of 
an amount attributable to elective contributions in a section 401(k) 
plan. See also Sec. 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

[[Page 46594]]

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. See also 
Q&A-19 of this section for rules regarding the treatment of a loan 
after a deemed distribution.
    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: No, 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 or is otherwise not a bona fide loan, 
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: (a) 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. A loan will not be 
considered as made under an investment program if--
    (1) Any of the loans made under the program matures upon a 
participant's termination from employment;
    (2) Any of the loans made under the program is an earmarked asset 
of a participant's or beneficiary's individual account in the plan; or
    (3) The loans made under the program are made available only to 
participants or beneficiaries in the plan.
    (b) Paragraph (a)(3) of this Q&A-18 shall not apply to a plan 
which, on December 20, 1995, and at all times thereafter, has had in 
effect a loan program under which, but for paragraph (a)(3) of this 
Q&A-18, the loans comply with the conditions of paragraph (a) of this 
Q&A-18 to constitute residential mortgage loans in the ordinary course 
of an investment program.
    (c) No loan that benefits an officer, director, or owner of the 
employer maintaining the plan, or their beneficiaries, will be treated 
as made under an investment program.
    (d) This section does not provide guidance on whether a residential 
mortgage loan made under a plan's investment program would result in a 
prohibited transaction under section 4975, or on whether such a loan 
made by a plan covered by Title I of ERISA would be consistent with the 
fiduciary standards of ERISA or would result in a prohibited 
transaction under section 406 of ERISA. See 29 CFR 2550.408b-1.
    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. In the case of a loan that is deemed distributed under 
section 72(p) and that has not been repaid (such as by a plan loan 
offset), the unpaid amount of such loan, including accrued interest, 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: May a participant refinance an outstanding loan or have more 
than one loan outstanding from a plan?
    A-20: [Reserved]
    Q-21: Is a participant's tax basis under the plan increased if the 
participant repays the loan after a deemed distribution?
    A-21: (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-21 and is based on the assumptions described 
in the introductory text of this section:
    Example. (i) A participant receives a $20,000 loan on January 1, 
2003, to be repaid in 20 quarterly installments of $1,245 each.

[[Page 46595]]

On December 31, 2003, 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, 2003 and 
December 31, 2003. On June 30, 2004, the participant repays $5,147 
(which is the sum of the three installment payments that were due on 
September 30, 2003, December 31, 2003, and March 31, 2004, with 
interest thereon to June 30, 2004, plus the installment payment due 
on June 30, 2004). Thereafter, the participant resumes making the 
installment payments of $1,245 from September 30, 2004 through 
December 31, 2007. The loan repayments made after December 31, 2003 
through December 31, 2007 total $22,577.
    (ii) Because the participant repaid $22,577 after the deemed 
distribution that occurred on December 31, 2003, the participant has 
investment in the contract (tax basis) equal to $22,577 (14 payments 
of $1,245 each plus a single payment of $5,147) as of December 31, 
2007.

    Q-22: When is the effective date of section 72(p) and the 
regulations in this section?
    A-22: (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 January 1, 2002.
    (c) Loans made before the regulatory effective date--(1) General 
rule. A plan is permitted to apply Q&A-19 and Q&A-21 of this section to 
a loan made before the regulatory effective date in paragraph (b) of 
this Q&A-22 (and after the statutory effective date in paragraph (a) of 
this Q&A-22) if there has not been any deemed distribution of the loan 
before the transition date or if the conditions of paragraph (c)(2) of 
this Q&A-22 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) of this Q&A-22 apply to a loan made before the 
regulatory effective date in paragraph (b) of this Q&A-22 (and after 
the statutory effective date in paragraph (a) of this Q&A-22) 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-21 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 (if this 
section had been in effect for all loans made after the statutory 
effective date in paragraph (a) of this Q&A-22), 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-21 of this section to a loan.
    (iii) If a plan applies Q&A-19 and Q&A-21 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) of this Q&A-22 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 transition date, the initial default 
amount (or, if less, the amount of the investment in the contract so 
attributed) exceeds the participant's or beneficiary's investment in 
the contract (tax basis). If this paragraph (c)(2)(iv) of this Q&A-22 
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 first 
actual distribution made on or after the transition date.
    (3) Examples. The rules in paragraph (c)(2) of this Q&A-22 are 
illustrated by the following examples, which are based on the 
assumptions described in the introductory text of this section (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 of this paragraph (c)(3) of this Q&A-22 
illustrate the application of the rules in paragraph (c)(2) of this 
Q&A-22 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 of this 
paragraph (c)(3) of this Q&A-22 illustrates the application of the 
rules in paragraph (c)(2) of this Q&A-22 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). The examples are as follows:

    Example 1.  (i) In 1998, 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 1999 when 
there is a deemed distribution of $20,000 as a result of a failure 
to repay the loan. For 1999, 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 this Q&A-22) 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 1999 deemed distribution. Thus, as of 
December 31, 2001, 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, 2002, 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 2003 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.
    (ii) For the year 2003, the plan must report a gross 
distribution of $60,000 in Box 1 of Form 1099-R and a taxable amount 
of $60,000 in Box 2 of Form 1099-R.
    Example 2.  (i) The facts are the same as in Example 1, except 
that in 1999, 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 1999, 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 
this Q&A-22) 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, 1999, 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 1999 deemed distribution. Thus, as of December 31, 2001, 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, 2002, 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

[[Page 46596]]

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 2003 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.
    (ii) For the year 2003, the plan must report a gross 
distribution of $60,000 in Box 1 of Form 1099-R and a taxable amount 
of $54,000 in Box 2 of Form 1099-R.
    Example 3. (i) In 1993, 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 
1995 when there is a deemed distribution of $28,919 as a result of a 
failure to repay the loan. For 1995, 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 this Q&A-22) and, in Box 2 
of Form 1099-R, a taxable amount of $28,919. For 1995, the plan also 
records an increase in the participant's tax basis for the same 
amount ($28,919). Each year thereafter through 2001, 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, 2001, 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, 2002, 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). 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 2003 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 1995 plus 
interest accrued thereafter to the payment date in 2003. 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.
    (ii) For the year 2003, 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. (i) The facts are the same as in Example 1, except 
that in 2000, 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 2000, 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, 2000, totals $16,000 ($20,000 minus $4,000). 
After 1999, the plan disregards, for purposes of section 72, the 
interest that accrues on the loan after the 1999 deemed 
distribution. Thus, as of December 31, 2001, the total taxable 
amount reported by the plan as a result of the deemed distribution 
plus the 2000 actual distribution is $26,000 and the plan's records 
show that the participant's tax basis is $16,000. As of January 1, 
2002, 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 2003 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.
    (ii) In accordance with paragraph (c)(2)(iv) of this Q&A-22, 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 2003 equal to $64,000 (the sum of the 
$60,000 paid in the year 2003 plus $4,000 as the loan transition 
amount).

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.

    Approved: July 13, 2000.
Jonathan Talisman,
Deputy Assistant Secretary of the Treasury.
[FR Doc. 00-18815 Filed 7-28-00; 8:45 am]
BILLING CODE 4830-01-U