The IRS issued proposed regulations and new frequently asked questions regarding the extension of the normal 60-day rollover period to roll over a qualified plan loan offset (QPLO), which was provided for under the Tax Cuts and Jobs Act of 2017 (TCJA). While the proposed regulations will primarily affect the recordkeepers of qualified plans (which will need to administer the extension), plan sponsors should be aware of the proposed regulations and discuss compliance with their recordkeepers and other paying agents for their qualified retirement plans that allow loans.
As background, when a qualified retirement plan loan becomes immediately due and payable—which most often occurs upon default, but could also happen if the plan’s terms require immediate repayment upon a termination of employment—and the loan is not repaid, the loan is either treated as a “deemed distribution” or a “loan offset,” depending on whether the participant has had a distributable event. If the participant has had a distributable event—for example, a termination of employment or reaching age 59½ where the plan allows for an in-service distribution at that age—then failure to repay the loan is treated as a loan offset. Otherwise, it is treated as a deemed distribution.
This distinction is important because a loan offset is treated as an actual distribution, while a deemed distribution is not, and a plan loan offset may be an eligible rollover distribution unless it is ineligible for some other reason (e.g., is a required minimum distribution). For that reason, unless the loan offset is a QPLO, it must be recontributed to an eligible retirement plan within 60 days of the date of the offset to the extent it is eligible for rollover. By contrast, a QPLO can be rolled over at any time up to the deadline for the participant to file his or her tax return (including extensions, regardless of whether the taxpayer requests the extension) for the year in which the loan offset is treated as distributed. For some participants, this extended rollover period could provide an important opportunity to restore retirement plan savings that otherwise would be lost.
In order to qualify as a QPLO, (1) the distribution of the loan offset must occur solely by reason of failure to make repayments due to the participant’s termination of employment or the termination of the plan, and (2) the loan that is offset must have met all the requirements of Internal Revenue Code Section 72(p) prior to the applicable circumstance under (1). The TCJA did not provide detail about what it means for the distribution of the loan offset to occur “solely” because of the termination of employment of the participant.
The proposed regulations fill this gap by providing that distribution of the loan offset will be treated as being made “solely” by reason of failure to repay the loan due to severance from employment if the plan loan offset relates to the failure to satisfy the repayment terms of the loan and it occurs during the first year following termination of employment. This provides a bright-line rule to make the determination of whether a plan loan offset is a QPLO. It also allows a plan loan offset to be treated as a QPLO (and eligible for the extended rollover period) even if the participant makes loan repayments for some period of time following his or her termination of employment, provided that the plan loan offset occurs within the first year of the termination of employment.
The preamble to the proposed regulations indicates that, as provided in the instructions to the 2020 Form 1099-R, recordkeepers and paying agents should report a QPLO entering Code M (a code specifically for QPLOs) in Box 7 of the Form 1099-R.
The final regulations will be effective when published, but in the meantime, plan sponsors and participants can rely on the proposed regulations from August 20, 2020 until the final regulations are published.