The Tax Cuts and Jobs Act of 2017 (the “Act”), which was enacted on December 22, 2017, extends the time for rolling over the plan offset amount (defined below) from an outstanding plan loan, thereby helping the borrowing participant to avoid adverse tax consequences.
Background. A qualified defined contribution retirement plan (such as a 401(k) plan) often allows a participant to take a loan from his or her individual account under the plan. The loans are repaid through installment payments made at least quarterly. The participant may terminate employment (or the plan may terminate) while there is an outstanding balance on the loan. In such case, the plan may provide the following: The outstanding balance will become immediately due and payable to the plan. Should the participant fail to make the payment, the plan will terminate the loan, and reduce the balance of the participant’s individual account by the amount of the outstanding loan balance. This reduction is called a “plan offset”, and the amount of the reduction is called a “plan offset amount”.
The plan offset amount is taxed to the participant as ordinary income. Further, if the participant is under age 59 and ½, the plan offset amount will be subject to the 10 percent excise tax on the early plan distributions. However, the tax as ordinary income and 10% excise tax can be avoided, if the plan offset amount is rolled over by the participant, within 60 days after the date of the offset by the plan, to an eligible retirement plan (generally a qualified retirement plan or an IRA).
The New Rule. Section 13613 of the Act amended Code section 402(c) to extend the time for rolling over a plan offset amount, and avoiding the above adverse tax consequences. Under this amendment, the plan offset amount may be rolled over at any time prior to the due date (including extensions) for filing the tax return of the participant for the year in which the plan offset amount arises. However, the extension applies only if:
–either the plan has terminated, or the plan offset results from the participant’s failure to meet repayment terms of the loan because of the participant’s termination of employment; and
–the plan offset amount was otherwise taxable.
This amendment to the Code applies to plan offsets arising in tax years starting after Dec. 31, 2017. In any event, even if the rollover is made, the plan offset amount must still be reported on a Form 1099-R.
The Plan Offset Amount Differs From A Deemed Distribution. A “deemed distribution” with respect to a plan loan differs from a plan offset. A deemed distribution arises when the participant misses a scheduled installment payment on the loan (and the miss is not cured), or the loan otherwise fails to meet a requirement or limit under Code section 72 or the underlying Treasury regulations. A deemed distribution will also result in tax at ordinary rates and (if the participant is under age 59 and ½), the 10% excise tax. However, these adverse tax consequences cannot be avoided by rolling over the deemed distribution. Note that if both a deemed distribution and plan offset (with no rollover) occur, the participant could be taxed twice with respect to the plan loan.