The Internal Revenue Service issued July 28, 2000, final regulations relating to the tax treatment of loans made from a qualified employer plan, to plan participants or beneficiaries along with loan issues that were not addressed in proposed regulations issued in 1995.

The final rules adopt the 1995 proposed rules for establishing a period for a plan participant to make up missed loan payments.

The 1995 proposed regulations stated that the required repayments be made in level installments no less than quarterly, would not be violated if payments were not made until the end of a grace period that the plan administrator may allow, but only to the extent that the grace period does not continue beyond the last day of the calendar quarter, following the calendar quarter in which the required installment payment was due.

For example, a plan could select a grace period of, thirty or ninety days and provide a special notice to the participant concerning the grace period. The final regulations retain the same rules as the proposed regulations. Please note, however, the final regulations use the term "cure" period instead of "grace" period.

The final rules also have generally adopted the proposed regulations on the treatment of loans after a deemed distribution, except for a revision to indicate that a deemed distribution is not taken into account as a distribution for purposes of the requirements of Section 1.411(a)-7(d)(5) relating to the determination of a participant's account balance if a distribution is made at a time when the participant's vesting percentage may increase.

The proposed regulations issued in 1998 provided that once a loan is deemed distributed under Section 72(p), interest that accrues thereafter on that loan is not included in income and, for the purposes of calculating the maximum permitted amount of any subsequent loan, a loan that has been deemed distributed is considered outstanding until the loan obligation has been satisfied.

The proposed regulations provide that if a loan is deemed distributed to a participant or beneficiary and has not been repaid, no payment made thereafter to the participant or beneficiary will be treated as a loan for the purposes of Section 72(p)(2), unless certain conditions are satisfied.

Specifically, there must be 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, or the plan must receive adequate security for the additional loan, in addition to the participant's accrued benefit under the plan.

The proposed regulations also provide that while a loan can be refinanced and additional amounts may be borrowed, the refinancing and multiple loan arrangements must satisfy the requirements in Section 72(p)(2)(B) and (C) that each loan be repaid in level installments, not less than quarterly, over five years, or longer for certain home loans.

Under the proposed regulations, a refinancing is, treated as a new loan that is then applied to repay a prior loan if the new loan both replaces a prior loan and has a later repayment date. The transaction will result in a deemed distribution if the amount of the new loan, plus the prior outstanding loan exceeds the amount limitations of Section 72(p)(2)(A). This rule does not apply to a refinancing loan under which the amount of the prior loan is to be repaid by the original repayment date of the prior loan.