Correcting Plan Loan Failures: Self-Correction

Editor's Note: This is the fifteenth installment in a series concerning correcting plan loan failures. 

Q. I am getting hung up on the old rules when only VCP could be used to correct loan failures and in order to do so there had to be employer action that caused the failure to repay the loan. Is the IRS more lenient under the new rule? Is this when the employer needs to review the facts carefully to make sure the employee is not playing the system? 

A. Under the IRS’ 401(k) Plan Fix-it Guide, it states, “Generally, for a plan loan to be eligible for relief from income tax reporting under VCP: Employer action caused the participant’s failure to repay the loan, and correction should be done within the maximum time for the loan, usually five years from the date the original loan was made.”

The 401(k) Plan Fix-it Guide is very helpful and informative but does not have any legal standing. Furthermore, there is often a delay in the IRS updating the website. The current EPCRS procedure (and the previous version) states the following: 

(3) Correction methods for certain § 72(p) plan loan failures. (a) In general. The correction methods set forth in section 6.07(3)(b), (c), and (d) apply to plan loans that do not comply with one or more requirements of § 72(p)(2); however, these correction methods are not available if the maximum period for repayment of the loan pursuant to § 72(p)(2)(B) has expired. Further, the IRS reserves the right to limit the use of these correction methods to situations that it considers appropriate, for example, if the loan failure is caused by employer action.

The key phrase in the provision is that the "IRS reserves the right to limit the use of these correction methods." In other words, if the IRS felt the plan or the employees were abusing the self-correction option, they could limit its use to loan failures caused by employer action. Otherwise, the correction option is available regardless of the cause of the failure. Therefore, if an employer felt that the employee was "playing the system," the employer is well within its rights to deny the correction and issue the Form 1099-R.

Editor’s Note: This content is taken from “Loans: Correcting Taxation, Qualification and Fiduciary Failures,” an April 15, 2020 ASPPA Webinar presented by Stephen W. Forbes J.D., LL.M. of Forbes Retirement Plan Consulting. 

Opinions expressed are those of the author, and do not necessarily reflect the views of ASPPA or its members.