A spouse beneficiary wants to repay the deceased participant’s loan after a deemed distribution has occurred. Is the repayment considered an after-tax contribution?
Rev. 09/25/03, E-mail Alert 2003-18

The 2000 final loan regulations permit a participant or a beneficiary to repay a loan after a deemed distribution of the loan in accordance with IRC §72(p). Such a repayment is considered a contribution of after-tax dollars. However, the loan repayment is not considered an after-tax contribution for ACP (§401(m)) testing or annual limitation (§415(c)(2)(B)) testing purposes. In addition, it is not necessary that the plan permit after-tax contributions in order for this rule to apply. Below is Q&A 21 of the final plan loan regulations.

IRS Final Loan Regulations of 2000
Q&A 21

Q-21: Is a participant's tax basis under the plan increased if the participant repays the loan after a deemed distribution?

A-21: (a) Repayments after deemed distribution. Yes, if the participant or beneficiary repays the loan after a deemed distribution of the loan under section 72(p), then, for purposes of section 72(e), the participant's or beneficiary's investment in the contract (tax basis) under the plan increases by the amount of the cash repayments that the participant or beneficiary makes on the loan after the deemed distribution. However, loan repayments are not treated as after-tax contributions for other purposes, including sections 401(m) and 415(c)(2)(B).

(b) Example. The following example illustrates the rules in paragraph (a) of this Q&A-21 and is based on the assumptions described in the introductory text of this section:

Example. (i) A participant receives a $20,000 loan on January 1, 2003, to be repaid in 20 quarterly installments of $1,245 each.

On December 31, 2003, the outstanding loan balance ($19,179) is deemed distributed as a result of a failure to make quarterly installment payments that were due on September 30, 2003 and December 31, 2004. On June 30, 2004, the participant repays $5,147 (which is the sum of the three installment payments that were due on September 30, 2003, December 31, 2003, and March 31, 2004, with interest thereon to June 30, 2004, plus the installment payment due on June 30, 2004). Thereafter, the participant resumes making the installment payments of $1,245 from September 30, 2004 through December 31, 2007. The loan repayments made after December 31, 2003 through December 31, 2007 total $22,577.

(ii) Because the participant repaid $22,577 after the deemed distribution that occurred on December 31, 2003, the participant has investment in the contract (tax basis) equal to $22,577 (14 payments of $1,245 each plus a single payment of $5,147) as of December 31, 2007.

Final Loan Regulations of 2000