The Softer Side of the IRS: Memorandum on Calculating the Maximum Participant Loan Amount

Posted by Maria T. Hurd, CPA

Some people believe you can never get enough of a good thing. Some people believe all good things must come to an end.  After two months of writing about the participant loan rules: The Paradox of Participant Loans in Default: A Taxable Distribution of a Loan Balance Still Considered to Remain Outstanding; EPCRS: Participant Loan Corrections; Participant Loan Refinancing; The DOL’s Assessment on the Quality of Financial Statement Audits: The Aftermath,we thought our loan series had come to an end, but an “encore” became appropriate when an IRS Memorandum to its retirement plan auditors released on April 20, 2017 provided good news  regarding the maximum participant loan calculation.

As we previously discussed, the IRS does not want participants to carry a $50,000 loan balance permanently by taking multiple plan loans. To prevent it, Internal Revenue Code Section 72(p) requires the adjustment of the maximum $50,000 loan balance by the HIGHEST balance outstanding in the last twelve months.

As usual, the devil is in the details and those who create the rules have to expect the unexpected by considering multiple iterations that are possible, regardless of whether they are plausible.

In this case, the general rule assumes that a participant will amortize the loan over the maximum repayment period of five years.  But what happens when a participant takes and almost immediately repays multiple loans within the same year?  Some practitioners argued that you had to consider the total of all previously outstanding loans for the year while others argued that only the highest outstanding loan balance in the last twelve months should be considered, without aggregating the balances. The IRS Memorandum agrees with the latter, as the following example they provided shows:

“For example, a participant borrowed $30,000 in February which was fully repaid in April, and $20,000 in May which was fully repaid in July, before applying for a third loan in December.  The plan may determine that no further loan would be available, since $30,000 + $20,000 = $50,000.  Alternatively, the plan may identify “the highest outstanding balance” as $30,000, and permit the third loan in the amount of $20,000.  At this time, the law does not clearly preclude either computation of the highest outstanding loan balance in the above example. “

Practitioners have welcomed the flexibility provided in these administrative guidelines given to IRS agents.  Like Sears, the IRS sometimes shows its softer side.

Photo by tim (License)

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