As background, IRS regulations under Internal Revenue Code Section 72(p), which govern participant loans from certain retirement plans such as 401(k) plans, provide that loan repayments must involve a substantially level amortization of the loan. A participant’s failure to make any installment repayment when due violates that level amortization requirement and generally results in a “deemed distribution” (i.e. a taxable event for the participant) at the time of such failure. However, under an exception to that rule, the regulations provide that a plan administrator can allow a cure period that applies to certain missed loan repayments. The maximum permissible cure period ends on the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.
In IRS Office of Chief Counsel Advice Memorandum 201736022 (the “Memorandum”), released on September 8, 2017, the IRS addressed the cure period by analyzing two factual situations. For both factual situations, the IRS assumed the following: (1) the taxpayer receives a proper loan from his or her 401(k) plan account on January 1, 2018, repayable in five years (with the last installment payment due December 31, 2022); (2) level installment payments are due at the end of each month (with the first installment payment due January 31, 2018); and (3) the plan provides for the maximum permissible cure period.
Note that the failure to make all participant loan repayments in a timely manner is extremely common. However, even if a repayment is not made within a plan’s cure period (assuming the plan provides for a cure period), the plan sponsor might be able to file an application under the IRS’s Voluntary Correction Program to avoid having the affected participant incur a taxable event. That step can be extremely important in calming a participant’s emotions, particularly in cases where the failure resulted from an error in the plan sponsor’s payroll system. I recently prepared IRS applications for two clients to address this issue, so please let me know if you or your clients have any questions about this.