[Federal Register Volume 67, Number 232 (Tuesday, December 3, 2002)]
[Rules and Regulations]
[Pages 71821-71826]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-29204]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9021]
RIN 1545-AX68


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 affect administrators of, 
participants in, and beneficiaries of qualified employer plans that 
permit

[[Page 71822]]

participants or beneficiaries to receive loans from plans, including 
loans from section 403(b) contracts and other contracts issued under 
qualified employer plans.

DATES: Effective Date: These regulations are effective December 3, 
2002.
    Applicability Date: These regulations apply to assignments, 
pledges, and loans made on or after January 1, 2004.

FOR FURTHER INFORMATION CONTACT: Vernon S. Carter, (202) 622-6060 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) under section 72 of the Internal Revenue Code of 1986 
(Code). 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 July 31, 2000, final regulations were published in the Federal 
Register in TD 8894 (65 FR 46588) with respect to issues arising under 
section 72(p)(2). On the same date, a notice of proposed rulemaking 
(REG-116495-99) was published in the Federal Register (65 FR 46677) 
with respect to issues arising under section 72(p)(2) that were not 
addressed in the 2000 final regulations. The proposed regulations 
addressed the suspension of loan repayments during a leave of absence 
for military service in accordance with section 414(u)(4), the effect 
of a new loan following a deemed distribution of a prior loan, and the 
effect of refinancings and multiple loans. The preamble to the proposed 
regulations also requested comments on the application of the 
Electronic Signature in Global and National Commerce Act (114 Stat. 
464) (ESIGN), which had been enacted shortly before publication of the 
proposed regulations. Following publication of the proposed 
regulations, comments were received and a public hearing was held on 
January 17, 2001. After consideration of the comments received 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, the repayment schedule, and 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. Such a 
loan is not a deemed distribution to the extent it does not exceed the 
lesser of (i) an amount equal to $50,000, reduced to the extent that 
the participant's or beneficiary's highest balance for plan loans 
outstanding during the preceding 12 months exceeds the current balance 
for plan loans, or (ii) 50 percent of the participant's or 
beneficiary's nonforfeitable benefit. Under section 72(p)(2)(D), these 
limitations apply by treating the loans from all plans of the 
employer's controlled group as one loan.
    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 employer plan or a government plan.

Summary of Comments Received, Changes Made, and Summary of the Final 
Regulations

    These final regulations retain the general structure and much of 
the substance of the proposed regulations, including a variety of 
examples illustrating the provisions. Some changes have been made in 
connection with specific recommendations for modifications and 
clarifications. The comments received in response to the proposed 
regulations are generally summarized below.

A. Loan Repayment Suspension During Leave of Absence for Military 
Service in Accordance with Section 414(u)(4)

    The proposed regulations stated that, under section 414(u)(4), a 
plan that permits suspension of loan repayment during a leave of 
absence for military service (as defined in 38 U.S.C. chapter 43) will 
not cause the loan to be deemed distributed, even if the leave exceeds 
a year. The rule was conditioned on loan repayments resuming upon the 
completion of the military service, the amount remaining due on the 
loan being repaid in substantially level installments, and the loan 
being fully repaid by the end of the original term of the loan plus the 
period of the military service. One commentator was concerned that 
because the requirement that interest accruing during military service 
be paid within the extended term would result in larger loan payments 
following military service than payments preceding military service, 
the rule could work a hardship on some participants. The commentator 
suggested that the regulations be modified to allow extension of the 
loan term in these cases to the period necessary to repay the loan with 
payments in the same amount as before the military service leave. 
Another commentator requested that the same extension of loan 
repayments be permitted for other bona fide leaves of absence.
    Section 414(u)(4) accommodates military service personnel by 
permitting postponement of loan repayments while performing military 
service, but does not alter the accrual of interest or any conditions 
in section 72(p)(2). Under the proposed regulations, upon resuming 
repayment, a lender may permit a participant to choose to increase the 
amount of the payments or to make payments at the previous rate with a 
balloon payment due at the end of the required time. The IRS and 
Treasury believe that the amendments suggested by these comments would 
not satisfy the conditions in section 72(p)(2) that are unaffected by 
section 414(u)(4). Therefore, the final regulations adopt the 
regulation as proposed. However, an example in the final regulations 
has been modified to reflect the application of a maximum 6 percent 
interest rate during the military leave in accordance with the 
Soldiers' and Sailors' Civil Relief Act Amendments of 1942. A 
modification has also been made to clarify that loan repayments can be 
revised at the end of a military leave to extend the repayment schedule 
in the event the loan originally had a term of

[[Page 71823]]

fewer than five years, as discussed below at the end of section C.

B. May Another Loan Be Extended After a Deemed Distribution

    The proposed regulations provided that if a loan is deemed 
distributed to a participant or beneficiary and has not been repaid, 
then, unless certain conditions are satisfied, any payment made to the 
participant or beneficiary thereafter will not be treated as a loan for 
purposes of section 72(p)(2). Specifically, the proposed regulations 
provided that to avoid this result, the plan must enter into an 
agreement under which either repayments are made by payroll withholding 
or adequate security for the additional loan (in addition to the 
participant's accrued benefit) is obtained. Some commentators stated 
that because individuals often hold section 403(b) annuity contracts 
with more than one issuer, it may be difficult for an issuer to 
determine whether an individual has defaulted on a plan loan with 
another issuer. A concern was expressed that if upon a deemed 
distribution a form 1099-R, Distributions From Pensions, Annuities, 
Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc., is 
not issued reflecting taxable income, a subsequent loan to a defaulting 
participant could subject the loan issuer to penalties.
    However, in order to satisfy the limitations on the maximum amount 
that may be loaned from plans of the employer imposed by section 
72(p)(2)(A), the issuer of any loan under section 72(p)(2) must inquire 
about other loans made from the plan or any other plan of the employer 
before extending a loan. As part of this process, the issuer can 
condition a new loan on a participant's disclosure of such prior loans 
and, for this purpose, can rely on an employee's certification 
concerning the status of prior loans, assuming the issuer has no reason 
to doubt the employee's certification. Accordingly, the final 
regulations adopt the provision as proposed.

C. May a Loan Be Refinanced

    The proposed regulations provided that, while a loan may be 
refinanced, the refinancing arrangement must satisfy the requirements 
of section 72(p)(2)(B) and (C) that loans be repaid in substantially 
level installments, not less often than quarterly and over a period not 
in excess of five years (longer for certain home loans). Under the 
proposed regulations, a refinancing is treated as a continuation of the 
prior loan, plus a new loan to the extent of any increase in the loan 
balance. Thus, while a refinancing loan can be repaid over a five-year 
period from the date of the refinancing to the extent the refinancing 
loan exceeds the prior loan amount, the prior outstanding loan must 
continue to be repaid in substantially level installments over a period 
not longer than the original term remaining on the prior loan in order 
for the refinancing not to result in a deemed distribution. A 
refinancing can also satisfy the repayment requirements of section 
72(p)(2)(B) and (C) if the refinanced loan is repaid within the 
original term remaining on the prior loan. If any portion of the 
refinancing loan has a later repayment date than the original term 
remaining on the prior loan, then both the prior loan and the 
refinancing loan are treated as outstanding at the time of the 
refinancing for purposes of the limitations on the maximum amount that 
may be loaned from plans of the employer under section 72(p)(2) (which 
is generally the lesser of a $50,000 amount described above or 50 
percent of the employee's nonforfeitable benefit). These standards were 
illustrated in examples.
    Commentators requested that the regulations be modified so that the 
rules for refinancings accommodate a prior loan with a term of less 
than five years that is refinanced to a date that is five years from 
the date of the prior loan.
    The final regulations generally adopt the provision on loan 
refinancings as proposed. However, the refinancing rules have been 
modified to conform with the recommendation made by commentators on the 
extension of a prior loan with an original term of less than five years 
to a term of five years from the date of the prior loan. A similar 
modification has also been made for repayments made following a 
military leave.

D. Are Multiple Loans Permitted

    Section 72(p)(2) does not prohibit a participant from borrowing 
from a plan more than once a year. However, in order to address the 
risk that additional loans could be taken out in order to avoid 
repayment of prior loans, the proposed regulations provided that a 
deemed distribution occurs if a participant obtains more than two loans 
a year.
    Several commentators stated that obtaining loans simply to repay 
previous loans is an abuse that should not be permitted, and 
commentators and others also provided information indicating that the 
vast majority of defined contribution plans already include limitations 
under which a participant is not permitted to have more than two loans 
outstanding at any time. However, commentators generally requested the 
flexibility of being allowed to make more than two loans per year to a 
participant and provided various examples of situations (such as a 
parent with several children in college) in which a participant might 
have a legitimate need for multiple borrowings during a year. They also 
noted that there is no direct statutory foundation for limiting the 
number of loans under section 72(p) and that the special 12-month rule 
with respect to the calculation of the $50,000 limitation under section 
72(p)(2)(A)(i) inherently limits the number of loans that can be made 
for larger borrowings. In recognition of these comments, the final 
regulations do not include any limitation on the number of loans that 
can be made under section 72(p)(2). Treasury and the IRS recognize that 
the absence of any limitation on the number of loans that may be made 
to a participant will allow certain practices that could not otherwise 
occur without generating taxable income through a deemed distribution 
under section 72(p). For example, as pointed out by certain 
commentators, the use of a participant's account balance under a 
qualified employer plan to secure a credit card is a practice that 
would not be permissible if the regulations were to limit the number of 
loans that could be made to a participant from a plan. Thus, Treasury 
and the IRS recognize that, because the final regulations do not 
include any limitation on the number of loans that can be made, there 
will be no section 72(p) barrier to credit card loans that otherwise 
meet the requirements of that section.

E. Application of ESIGN

    The 2000 final regulations require that the terms of a plan loan be 
set forth in an enforceable agreement and provide that the agreement 
may be set forth in an electronic medium that satisfies standards that 
are based on the standards for an electronic consent to a distribution 
contained in Sec.  1.411(a)-11(f)(2). As noted in the preamble to the 
proposed regulations under Sec.  1.417(a)(3)-1 published in the Federal 
Register on October 7, 2002 (67 FR 62417) (relating to disclosure of 
relative values of optional forms of benefit), the IRS and the Treasury 
Department are considering the extent to which notices under the 
various Code requirements relating to qualified retirement plans can be 
provided electronically, taking into account the effect of ESIGN. As 
further noted in that preamble, the IRS and the Treasury Department 
anticipate issuing proposed regulations regarding

[[Page 71824]]

these issues, and invite comments on these issues. The requirements 
applicable to electronic plan loan agreements may be considered in 
connection with those upcoming proposed regulations as well.\1\
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    \1\ The staff of the Board of Governors of the Federal Reserve 
System (Board) has advised the IRS that a plan loan that satisfies 
section 72(p)(2) and these regulations would constitute an extension 
of credit under 12 CFR 226.2(a)(14) of regulation Z, implementing 
the Truth in Lending Act (TILA). Thus, unless the plan or the loan 
is otherwise excepted from the application of regulation Z (for 
example, the plan could be exempt because the plan has not made 
enough loans to be considered a creditor under regulation Z, or a 
particular loan could be exempt because it exceeds TILA's limit of 
$25,000 for loans not secured by real property or a dwelling), a 
plan loan that satisfies the requirements of Q&A-3(b) of Sec.  
1.72(p)-1 would be subject to the disclosure and other requirements 
of regulation Z. The staff of the Board has further advised the IRS 
and Treasury that, pending the Board's adoption of final rules 
regarding electronic disclosures, creditors may provide electronic 
disclosures required by regulation Z if the consumer's consent is 
obtained as required under ESIGN. See 66 FR 17322 (March 30, 2001, 
relating to reg. M, Consumer Leasing Act); 66 FR 17329 (March 30, 
2001, relating to reg. Z, TILA); 66 FR 17779 (April 4, 2001, 
relating to reg. B, Equal Credit Opportunity Act); 66 FR 17786 
(April 4, 2001, relating to reg. E, Electronic Fund Transfer Act); 
and 66 FR 17795 (April 4, 2001, relating to reg. DD, Truth in 
Savings Act).
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F. May Section 457(b) Governmental Plans Have Plan Loans

    Commentators requested that the regulations be modified to clarify 
that eligible governmental plans under section 457(b) are permitted to 
offer loans to employees in a manner consistent with section 72(p). 
Proposed regulations under section 457 (REG-105885-99) that were 
published in the Federal Register on May 8, 2002 (67 FR 30826), clarify 
the conditions under which loans can be made to participants in such 
plans (at proposed Sec.  1.457-6(f)) and that section 72(p) applies to 
any such loan (at proposed Sec.  1.457-7(b)(3)).

G. Regulation Effective Date

    The proposed regulations would have been effective on the first 
January 1 that is at least 6 months after they are published as final 
regulations. These final regulations apply to assignments, pledges, and 
loans made on or after January 1, 2004, but do not apply to loans made 
under an insurance contract that is in effect on December 31, 2003, if 
the insurance carrier is required to offer loans to contractholders 
that are not secured (other than by the participant's or beneficiary's 
benefit under the contract).

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 do 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 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.

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(p)-1 is amended as follows:
    1. A-9, Q&A-19, and Q-20 are revised, and A-20 is added.

    2. A-22 is amended by adding paragraph (d).
    The revisions and additions read as follows:


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

* * * * *
    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 (or such longer period as may apply under section 414(u) and 
paragraph (b) of this Q&A-9), that a participant is on a bona fide 
leave of absence, either without pay from the employer or at a rate of 
pay (after applicable employment tax withholdings) 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 permissible term of the 
loan and the amount of the installments due after the leave ends must 
not be less than the amount required under the terms of the original 
loan.
    (b) Military service. In accordance with section 414(u)(4), if a 
plan suspends the obligation to repay a loan made to an employee from 
the plan for any part of a period during which the employee is 
performing service in the uniformed services (as defined in 38 U.S.C. 
chapter 43), whether or not qualified military service, such suspension 
shall not be taken into account for purposes of section 72(p) or this 
section. Thus, if a plan suspends loan repayments for any part of a 
period during which the employee is performing military service 
described in the preceding sentence, such suspension shall not cause 
the loan to be deemed distributed even if the suspension exceeds one 
year and even if the term of the loan is extended. However, the loan 
will not satisfy the repayment term requirement of section 72(p)(2)(B) 
and the level amortization requirement of section 72(p)(2)(C) unless 
loan repayments resume upon the completion of such period of military 
service and the loan is repaid thereafter by amortization in 
substantially level installments over a period that ends not later than 
the latest permissible term of the loan.
    (c) Latest permissible term of a loan. For purposes of this Q&A-9, 
the latest permissible term of a loan is the latest date permitted 
under section 72(p)(2)(B) (i.e., five years from the date of the loan, 
assuming that the replacement loan does not qualify for the exception 
at section 72(p)(2)(B)(ii) for principal residence plan loans) plus any 
additional period of suspension permitted under paragraph (b) of this 
Q&A-9.
    (d) Examples. The following examples illustrate the rules of this 
Q&A-9 and are based upon the assumptions described in the introductory 
text of this section:

    Example 1. (i) On July 1, 2003, 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. The participant was not performing military service 
during this period. 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, 2008.
    (ii) Because the loan satisfies the requirements of section 
72(p)(2), the

[[Page 71825]]

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, 2008 repaid the full balance remaining due.
    Example 2. (i) The facts are the same as in Example 1, except 
the participant was on leave of absence performing service in the 
uniformed services (as defined in chapter 43 of title 38, United 
States Code) for two years and the rate of interest charged during 
this period of military service is reduced to 6 percent compounded 
annually under 50 App. section 526 (relating to the Soldiers' and 
Sailors' Civil Relief Act Amendments of 1942). After the military 
service ends on April 2, 2006, the participant resumes active 
employment on April 19, 2006, continues the monthly installments of 
$825 thereafter, and on June 30, 2010, repays the full balance 
remaining due ($6,487).
    (ii) Because the loan satisfies the requirements of section 
72(p)(2) and paragraph (b) of this Q&A-9, the participant does not 
have a deemed distribution. Alternatively, section 72(p)(2) would 
also be satisfied if the amount of each monthly installment after 
April 19, 2006, is increased to $930 in order to repay the loan by 
June 30, 2010 (without any balance remaining due then).
* * * * *
    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 and what effect 
does the deemed distribution have on subsequent loans?
    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 for purposes 
of applying section 72 to the participant or the 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-16 of this section.
    (b) Effect on subsequent loans--(1) Application of section 
72(p)(2)(A). A loan that is deemed distributed under section 72(p) 
(including interest accruing thereafter) and that has not been repaid 
(such as by a plan loan offset) is considered outstanding for purposes 
of applying section 72(p)(2)(A) to determine the maximum amount of any 
subsequent loan to the participant or beneficiary.
    (2) Additional security for subsequent loans. If a loan is deemed 
distributed to a participant or beneficiary under section 72(p) and has 
not been repaid (such as by a plan loan offset), then no payment made 
thereafter to the participant or beneficiary is treated as a loan for 
purposes of section 72(p)(2) unless the loan otherwise satisfies 
section 72(p)(2) and this section and either of the following 
conditions is satisfied:
    (i) There is an arrangement among the plan, the participant or 
beneficiary, and the employer, enforceable under applicable law, under 
which repayments will be made by payroll withholding. For this purpose, 
an arrangement will not fail to be enforceable merely because a party 
has the right to revoke the arrangement prospectively.
    (ii) The plan receives adequate security from the participant or 
beneficiary that is in addition to the participant's or beneficiary's 
accrued benefit under the plan.
    (3) Condition no longer satisfied. If, following a deemed 
distribution that has not been repaid, a payment is made to a 
participant or beneficiary that satisfies the conditions in paragraph 
(b)(2) of this Q&A-19 for treatment as a plan loan and, subsequently, 
before repayment of the second loan, the conditions in paragraph (b)(2) 
of this Q&A-19 are no longer satisfied with respect to the second loan 
(for example, if the loan recipient revokes consent to payroll 
withholding), the amount then outstanding on the second loan is treated 
as a deemed distribution under section 72(p).
    Q-20: May a participant refinance an outstanding loan or have more 
than one loan outstanding from a plan?
    A-20: (a) Refinancings and multiple loans--(1) General rule. A 
participant who has an outstanding loan that satisfies section 72(p)(2) 
and this section may refinance that loan or borrow additional amounts 
if, under the facts and circumstances, the loans collectively satisfy 
the amount limitations of section 72(p)(2)(A) and the prior loan and 
the additional loan each satisfy the requirements of section 
72(p)(2)(B) and (C) and this section. For this purpose, a refinancing 
includes any situation in which one loan replaces another loan.
    (2) Loans that repay a prior loan and have a later repayment date. 
For purposes of section 72(p)(2) and this section (including paragraph 
(a)(3) of this Q&A-20 and the amount limitations of section 
72(p)(2)(A)), if a loan that satisfies section 72(p)(2) is replaced by 
a loan (a replacement loan) and the term of the replacement loan ends 
after the latest permissible term of the loan it replaces (the replaced 
loan), then the replacement loan and the replaced loan are both treated 
as outstanding on the date of the transaction. For purposes of the 
preceding sentence, the latest permissible term of the replaced loan is 
the latest date permitted under section 72(p)(2)(C) (i.e., five years 
from the original date of the replaced loan, assuming that the replaced 
loan does not qualify for the exception at section 72(p)(2)(B)(ii) for 
principal residence plan loans and that no additional period of 
suspension applied to the replaced loan under Q&A-9 (b) of this 
section). Thus, for example, if the term of the replacement loan ends 
after the latest permissible term of the replaced loan and the sum of 
the amount of the replacement loan plus the outstanding balance of all 
other loans on the date of the transaction, including the replaced 
loan, fails to satisfy the amount limitations of section 72(p)(2)(A), 
then the replacement loan results in a deemed distribution. This 
paragraph (a)(2) does not apply to a replacement loan if the terms of 
the replacement loan would satisfy section 72(p)(2) and this section 
determined as if the replacement loan consisted of two separate loans, 
the replaced loan (amortized in substantially level payments over a 
period ending not later than the last day of the latest permissible 
term of the replaced loan) and, to the extent the amount of the 
replacement loan exceeds the amount of the replaced loan, a new loan 
that is also amortized in substantially level payments over a period 
ending not later than the last day of the latest permissible term of 
the replaced loan.
    (b) Examples. The following examples illustrate the rules of this 
Q&A-20 and are based on the assumptions described in the introductory 
text of this section:

    Example 1. (i) A participant with a vested account balance that 
exceeds $100,000 borrows $40,000 from a plan on January 1, 2005, to 
be repaid in 20 quarterly installments of $2,491 each. Thus, the 
term of the loan ends on December 31, 2009. On January 1, 2006, when 
the outstanding balance on the loan is $33,322, the loan is 
refinanced and is replaced by a new $40,000 loan from the plan to be 
repaid in 20 quarterly installments. Under the terms of the 
refinanced loan, the loan is to be repaid in

[[Page 71826]]

level quarterly installments (of $2,491 each) over the next 20 
quarters. Thus, the term of the new loan ends on December 31, 2010.
    (ii) Under section 72(p)(2)(A), the amount of the new loan, when 
added to the outstanding balance of all other loans from the plan, 
must not exceed $50,000 reduced by the excess of the highest 
outstanding balance of loans from the plan during the 1-year period 
ending on December 31, 2005, over the outstanding balance of loans 
from the plan on January 1, 2006, with such outstanding balance to 
be determined immediately prior to the new $40,000 loan. Because the 
term of the new loan ends later than the term of the loan it 
replaces, under paragraph (a)(2) of this Q&A-20, both the new loan 
and the loan it replaces must be taken into account for purposes of 
applying section 72(p)(2), including the amount limitations in 
section 72(p)(2)(A). The amount of the new loan is $40,000, the 
outstanding balance on January 1, 2006, of the loan it replaces is 
$33,322, and the highest outstanding balance of loans from the plan 
during 2005 was $40,000. Accordingly, under section 72(p)(2)(A), the 
sum of the new loan and the outstanding balance on January 1, 2006, 
of the loan it replaces must not exceed $50,000 reduced by $6,678 
(the excess of the $40,000 maximum outstanding loan balance during 
2005 over the $33,322 outstanding balance on January 1, 2006, 
determined immediately prior to the new loan) and, thus, must not 
exceed $43,322. The sum of the new loan ($40,000) and the 
outstanding balance on January 1, 2006, of the loan it replaces 
($33,322) is $73,322. Since $73,322 exceeds the $43,322 limit under 
section 72(p)(2)(A) by $30,000, there is a deemed distribution of 
$30,000 on January 1, 2006.
    (iii) However, no deemed distribution would occur if, under the 
terms of the refinanced loan, the amount of the first 16 
installments on the refinanced loan were equal to $2,907, which is 
the sum of the $2,491 originally scheduled quarterly installment 
payment amount under the first loan, plus $416 (which is the amount 
required to repay, in level quarterly installments over 5 years 
beginning on January 1, 2006, the excess of the refinanced loan over 
the January 1, 2006, balance of the first loan ($40,000 minus 
$33,322 equals $6,678)), and the amount of the 4 remaining 
installments was equal to $416. The refinancing would not be subject 
to paragraph (a)(2) of this Q&A-20 because the terms of the new loan 
would satisfy section 72(p)(2) and this section (including the 
substantially level amortization requirements of section 72(p)(2)(B) 
and (C)) determined as if the new loan consisted of 2 loans, one of 
which is in the amount of the first loan ($33,322) and is amortized 
in substantially level payments over a period ending December 31, 
2009 (the last day of the term of the first loan) and the other of 
which is in the additional amount ($6,678) borrowed under the new 
loan. Similarly, the transaction also would not result in a deemed 
distribution (and would not be subject to paragraph (a)(2) of this 
Q&A-20) if the terms of the refinanced loan provided for repayments 
to be made in level quarterly installments (of $2,990 each) over the 
next 16 quarters.
    Example 2. (i) The facts are the same as in Example 1(i), except 
that the applicable interest rate used by the plan when the loan is 
refinanced is significantly lower due to a reduction in market rates 
of interest and, under the terms of the refinanced loan, the amount 
of the first 16 installments on the refinanced loan is equal to 
$2,848 and the amount of the next 4 installments on the refinanced 
loan is equal to $406. The $2,848 amount is the sum of $2,442 to 
repay the first loan by December 31, 2009 (the term of the first 
loan), plus $406 (which is the amount to repay, in level quarterly 
installments over 5 years beginning on January 1, 2006, the $6,678 
excess of the refinanced loan over the January 1, 2006, balance of 
the first loan).
    (ii) The transaction does not result in a deemed distribution 
(and is not subject to paragraph (a)(2) of this Q&A-20) because the 
terms of the new loan would satisfy section 72(p)(2) and this 
section (including the substantially level amortization requirements 
of section 72(p)(2)(B) and (C)) determined as if the new loan 
consisted of 2 loans, one of which is in the amount of the first 
loan ($33,322) and is amortized in substantially level payments over 
a period ending December 31, 2009 (the last day of the term of the 
first loan), and the other of which is in the additional amount 
($6,678) borrowed under the new loan. The transaction would also not 
result in a deemed distribution (and not be subject to paragraph 
(a)(2) of this Q&A-20) if the terms of the new loan provided for 
repayments to be made in level quarterly installments (of $2,931 
each) over the next 16 quarters.
* * * * *
    A-22: * * *
    (d) Effective date for Q&A-19(b)(2) and Q&A-20. Q&A-19(b)(2) and 
Q&A-20 of this section apply to assignments, pledges, and loans made on 
or after January 1, 2004.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.

    Approved: November 7, 2002.
Pamela F. Olson,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 02-29204 Filed 12-2-02; 8:45 am]
BILLING CODE 4830-01-P