The IRS Does Not Believe You Made A Loan

The issue came up here at command center this past week. It is worth discussing, as the issue is repetitive and – if the IRS aims it your way – the results can be brutal.

We are talking about loans.

More specifically, loans to/from yourself and among companies you own.

What’s the big deal, right? It is all your money.

Yep, it’s your money. What it might not be, however, is a loan.

Let’s walk through the story of James Polvony.

In 1996 he joined his wife’s company, Archetone Limited (Limited) as a 49% owner. Limited was a general contractor.

In 2002 he started his own company, Povolny Group (PG). PG was a real estate brokerage.

The real estate market died in 2008. Povolny was looking for other sources of income.

He won a bid to build a hospital for the Algerian Ministry of Health.

He formed another company, Archetone International LLC (LLC), for this purpose.

The Algerian job required a bank guaranty. This created an issue, as the best he could obtain was a line of credit from Wells Fargo. He took that line of credit to a UK bank and got a guarantee, but he still had to collateralize the US bank. He did this by borrowing and moving monies around his three companies.

The Algerian government stopped paying him. Why? While the job was for the Algerian government, it was being funded by a non-Algerian third party. This third party wanted a cut of the action. Povolny did not go along, and – shockingly – progress payments, and then actual job progress, ceased.

The deal was put together using borrowed money, so things started unravelling quickly.

International was drowning. Povolny had Limited pay approximately $241,000 of International’s debts.

PG also loaned International and Limited approximately $70 grand. PG initially showed this amount as a loan, but PG amended its return to show the amount as “Cost of Goods Sold.”

COMMENT: PG was making money. Cost of goods sold is a deduction, whereas a loan is not, at least not until it becomes uncollectible. I can see the allure of another deduction on a profitable tax return. Still, to amend a return for this reason strikes me as aggressive.

Limited also deducted its $241 grand, not as cost-of-goods-sold but as a bad-debt deduction.

Let’s regroup here for a moment.

• Povolny moved approximately $311 grand among his companies, and
• He deducted the whole thing using one description or another.

This caught the IRS’ attention.

Why?

Because it matters how Polvony moved monies around.

A loan can result in a bad debt deduction.

A capital contribution cannot. Granted, you may have a capital loss somewhere down the road, but that loss happens when you finally shut down the company or otherwise dispose of your stock or ownership interest.

Timing is a BIG deal in this area.

If you want the IRS to respect your assertion of a loan, then be prepared to show the incidents of a loan, such as:

• A written note
• An interest rate
• A maturity date
• Repayment schedule
• Recourse if the debtor does not perform (think collateral)

Think of yourself as SunTrust or Fifth Third Bank making a loan and you will get the idea.

The Court made short work of Povolny:

·       The $241 thousand loan did not have a written note, no maturity date and no required interest payments.

·       Ditto for the $70 grand.

The Court did not find the commercially routine attributes of debt, so it decided that there was no debt.

Povolny was moving his own capital around.

He as much said so when he said that he “didn’t see the merit” in creating written notes, interest rates and repayment terms.

The Polvony case is not remarkable. It happens all the time. What it does, however, is to tentpole how important it is to follow commercially customary banking procedures when moving monies among related companies.

But is it all your money, isn’t it?

Yep, it is. Be lax and the IRS will take you at your word and figure you are just moving your own capital around.

And there is no bad debt deduction on capital.

Our case this time was Povolny Group, Incorporated et al v Commissioner, TC Memo 2018-37.

The Abbott Laboratories 401(k)

Something caught my eye recently about student loans. A 401(k) is involved, so there is a tax angle.

Abbott Laboratories is using their “Freedom 2 Save” program to:

… enable full-time and part-time employees who qualify for the company's 401(k) – and who are also contributing 2 percent of their eligible pay toward student loans – to receive an amount equivalent to the company's traditional 5 percent "match" deposited into their 401(k) plans. Program recipients will receive the match without requiring any 401(k) contribution of their own.”

Abbott will put money into an employee’s 401(k), even if the employee is not himself/herself contributing.

As I understand it, the easiest way to substantiate that one’s student loan is 2% or more of one’s eligible pay is to allow Abbott to withhold and remit the monthly loan amount. For that modest disclosure of personal information, one receives a 5% employer “match” contribution.

I get it. It can be difficult to simultaneously service one’s student loan and save for retirement.

Let’s take this moment to discuss the three main ways to fund a 401(k) account.

(1)  What you contribute. Let’s say that you set aside 6% of your pay.

(2)  What your employer is committed to contributing. In this example, say that the company matches the first 4% and then ½ of the next 2%. This is called the “match,” and in this example it would be 5%.

(3)  A discretionary company contribution. Perhaps your employer had an excellent year and wants to throw a few extra dollars into the kitty. Do not be skeptical: I have seen it happen. Not with my own 401(k), mind you (I am a career CPA, and CPA firms are notorious), but by a client. 

Abbott is not the first, by the way. Prudential Retirement did something similar in 2016.

The reason we are talking about this is that the IRS recently blessed one of these plans in a Private Letter Ruling. A PLR is an IRS opinion requested by, and issued to, a specific taxpayer. One generally has to write a check (the amount varies depending upon the issue), but in return one receives some assurance from the IRS on how a transaction is going to work-out taxwise. Depending upon, a PLR is virtually required tax procedure. Consider certain corporate mergers or reorganizations. There may be billions of dollars and millions of shareholders involved. One gets a PLR – period – as the downside might be career-ending.

Tax and retirement pros were (and are) concerned how plans like Abbott’s will pass the “contingent benefits” prohibition. Under this rule, a company cannot make other employee benefits – say health insurance – contingent on an employee making elective deferrals into the company’s 401(k) plan.

The IRS decided that the prohibition did not apply as the employees were not contributing to the 401(k) plan. The employer was. The employees were just paying their student loans.

By the way, Abbott Laboratories has subsequently confirmed that it was they who requested and received the PLR.

Technically, a PLR is issued to a specific taxpayer and this one is good only for Abbott Laboratories. Not surprisingly there are already calls to codify this tax result. Once in the Code or Regulations, the result would be standardized and a conservative employer would not feel compelled to obtain its own PLR.

I doubt you and I will see this in our 401(k)s.  This strikes me as a “big company” thing, and a big company with a lot of younger employees to boot.

Great recruitment feature, though.

A Bank Of America Horror Story

A major corporation hounds you almost to the point of death. You sue. You receive a settlement. Is it taxable?

Like so much of tax law, it depends. For example, did the attorney include the magic words that complete the incantation?  

Mr. and Mrs. French received a deficiency notice for their 2012 tax year. The IRS wanted $7,231 in taxes and $1,446 in penalties.

At issue was whether a settlement payment was taxable.

Let’s lay out the story:

·      In 2008 the French’s bought a house.

·      Shortly thereafter Bank of America bought their mortgage.

·      In August, 2009 Bank of America transferred their loan to a subsidiary, BAC Home Loan Servicing.

·      In December, 2009 Mr. and Mrs. French signed a loan modification agreement. The modification was to become effective February 1, 2010.

A loan modification means that that payments were temporarily suspended, an interest rate was changed, the loan term was lengthened and so on. There was a lot of modifications going on around that time.

·      Mrs. French suffered from a very bad back. She was admitted to the hospital in October, 2009 for surgery.

·      From late 2009 into early 2010 Bank of America began calling the French’s on a routine basis, sometimes up to 5 times a day. They were hounding the French’s that their mortgage was about to go into foreclosure.

·      Mr. French was concerned about the effect of these endless calls on his wife. He requested that Bank of America call him on another line, that way he could shield his wife from the stress. Bank of America couldn’t care less. If anything, they were continued receiving multiple calls from multiple people across multiple BAC offices.

·      Mrs. French went into the hospital in December, 2009 and again in January, 2010.

·      In January, 2010 Mr. French spoke with a BAC representative. He explained the loan modification. The representative had no idea what Mr. French was talking about. He explained that – whoever Mr. French sent the modification to – it was not BAC. He instructed Mr. French to redo the paperwork, stop payment on the old check and enclose a new check.

·      After much hassle, Mr. French was told that the modification was accepted and that he should start making payments per the new agreement. He made 10 payments of $1,067.10.

·      When she was finally discharged from the hospital on January 21, 2010, a Bank of America representative called to tell Mrs. French that “officers were on their way to evict” them.

·      On January 23, she started experiencing chest pain and shortness of breath. She went back to the hospital. He suffered two pulmonary emboli, passed away twice but was resuscitated. She was discharged February 4, 2010.

·      BAC did not process the first modification as they promised Mr. French. BAC kept their higher monthly payments and interest rate. To make matters worse, they posted their monthly payments to a non-interest- bearing escrow account and treated the payments as if they were processing fees.

·      In October 2010 BAC told Mr. French that they were not honoring the first modification and that the loan was severely delinquent. They sent a second modification, with conditions and terms injurious to the French’s. For example, the second modification did not even address the 10 payments the French’s had previously sent. Mr. French, his back to a wall, signed the second modification in November, 2010.

·      BAC continued, increasing their monthly payment from $1,067.10 to $1,081.49. In September, 2011, BAC sent the French’s a notice that their checks would not be applied and would instead be returned if not for the higher amount.

Finally, the French’s hired an attorney.

The phone calls stopped.

The French’s sued on six claims, alleging fraud, integration of the first and second loan modifications, punitive damages, additional damages, attorney fees and so forth.

What they did not sue for was personal damages to Mrs. French’s health. 

They settled in 2012. The French’s received $41,333, and the attorneys received $20,666.

The French’s did not report the settlement as income on their 2012 tax return.

The IRS wanted to know why.

The French’s presented several arguments:

(1)  $7,500 of the settlement was not taxable under the “disputed debt” doctrine.

If one party does not agree to the terms of a debt, later settlement does not necessarily mean income. It may mean repayment of amounts improperly charged the borrower, for example. An interesting argument, but the Court noted that the settlement agreement never mentioned disputed or contested debt.

(2)  They were being repaid their own money.

(3)  IRC Section 104(a)(2)

 § 104 Compensation for injuries or sickness.

 (a)  In general.

Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include-

(1)  amounts received under workmen's compensation acts as compensation for personal injuries or sickness;

(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

To me, this was – by far – their best argument.

But it is one that BAC would never, ever put in writing.

The Court was however willing to look back to the six claims the attorneys filed for Mr. and Mrs. French. Unfortunately, the only language it found was the following:

… suffered lost time, inconvenience, distress [and] fear, and have been denied the benefit of the loan modification they were promised, and are being charged too much on their loan.”

These, folks, are not the magic words to open the Section 104(a)(2) door. For one thing, the words referred to both Mr. and Mrs. French.

The French’s owed the tax, but the IRS relented on the penalties.

Too bad the attorneys did not run the paperwork past a competent tax practitioner before it was too late.

Our case this time was French v Commissioner, T.C. Summary Opinion 2018-36.

Amending Your Way Into A Penalty

I have a set of tax returns in my office for someone who dropped off the tax grid for years. I suspect we will be fighting penalties and requesting a payment plan in the too-near future.

It reminded me of why not filing returns is a bad idea.

Here’s one: she has refunds she cannot use because the statute period has expired.

She could have used the refunds, as she has other years with tax due.

There is another reason.

Let’s say that you file a return, but you file it late. For example, you extend the return to October, but you don’t get around to filing until the following January or February. You have a refund so you do not care.

Many tax professionals would agree with you. Penalties apply on tax due. If there is no tax due, then – voila – no penalty (generally speaking).

But you later amend the return. Or the IRS adjusts the return for you. However it happened, you now owe tax.

Consider this:

          § 6651 Failure to file tax return or to pay tax

(a)  Addition to the tax.

In case of failure-

(1)    to file any return required under authority […]on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;

This is called the “late filing” penalty.

I am looking at a tax case from 1998. Greg Vinikoor (GK) married Melissa Vinikoor (MV). Best I can figure, her dad must have been loaded, as he was repeatedly transferring shares of stock to the newlyweds. GK graduated from college and took a job making $12 grand a year. They got everything out of that $12 grand, including:

·      trips to Hawaii, San Diego, Scottsdale and San Francisco

·      shopping trips to Saks Fifth Avenue, Neiman Marcus and Nordstrum

·      membership at the Tucson Country Club

We both know that they were not paying for this on that $12,000 salary. They were either borrowing against or selling stock that dad had transferred.

The IRS wanted to know why they were not reporting stock gains on their tax returns. There had been quite the run-up in value since dad had acquired the stock. In the case of a gift, dad’s low basis in the stock would carryover to the couple. Since gain = price – basis, that low basis meant a juicy gain, and the IRS wanted its cut.

Good question.

Uhhh…. Because we bought the stock from dad, they answered. Yeah, that’s it. We have a new – and higher! - basis because we bought the stock. We bought it on loan, and we have to pay dad back.

Fine, said the IRS. Show us the loan agreement.

Don’t have one, they replied.

Show us where you paid interest to dad.

We haven’t – not yet, they responded.

Is there a fixed repayment date?

Just an understanding, they susurrated.

How about security? Did you give any collateral for the loan?

No, not really, they murmured.

The Court was zero impressed.

After the stock rose, XXX [dad], the supposed creditor in these transactions never made any demand on petitioners for repayment, even though the value of the stock had increased substantially and petitioners were diminishing the stock with spendthrift habits.”

The Court decided this was a gift. There was gain, there was tax.

Guess who failed to file their tax return on time?

Yep, the Vinikoors.

Now they had penalties.

More specifically, that 25% penalty we talked about. It totaled over $38 grand.

And there is the trap. That late filing can haunt and hurt you if you later amend or the IRS adjusts the return to increase income. That penalty goes to back when, not the date you amended or the IRS adjusted.

File those returns on time, folks. Amend later if you do not have all the information, but at least you got the horse over the wire on time.

Our case this time – as you may have guessed – was Vinikoor v Commissioner.

Blowing Up An IRA

I am not a fan of using retirement funds to address day-to-day financial stresses.

That is not to downplay financial stresses; it is instead to point out that using retirement funds too easily can open yet another set of problems.

Those who have followed me for a while know that I disapprove of using retirement funds to start a business: the so-called Rollovers as Business Startups, whose humorous acronym is ROBS. I know that – in a seminar setting – it is possible to mitigate the tax risks that ROBS pose. I do not however practice in a seminar setting. Heck, I am lucky if a client calls in advance to discuss whatever he/she is getting ready to do.

Let me give you a couple of ROBS pitfalls:

(1) You have your IRA buy a fourplex. You spend time cleaning, doing maintenance and repairs and routinely running to Home Depot.

Question: Is there a tax risk here?

(2) You have your IRA buy a business. You have your son and daughter run the business. You work there part-time and draw a paycheck.

Question: Is there a tax risk here?

The answer to both is yes. Consider:

(1) You are buying stuff at Home Depot, stuff that the IRA should have been buying - as the IRA owns the fourplex, not you. If you are over age 50, you can contribute $6,500 to the IRA annually. Say that you have already written that check for the year. You are now overfunding the IRA every time you go to Home Depot. Granted, one trip is not a big deal, but make routine trips – or incur a major repair – and the facts change. That triggers a 6% penalty – every year - until you take the money back out.

(2) There are restrictions on direct and indirect benefits from an IRA. You are receiving a paycheck from an asset the IRA owns. While arguable, I am confident that your paycheck is a prohibited benefit.

I am looking a Tax Court case where the taxpayer had her IRA lend $40,000 to her dad in 2005. A few years went by and she had the IRA lend $60,000 to a friend.

In 2013 she changed IRA custodians. The new custodian saw those two loans, and she had problems. Perhaps the custodian could not transfer the promissory notes. Perhaps there were no notes. Perhaps the custodian realized that a loan to one’s dad is not allowed. This part of the case is not clear.

COMMENT: It is possible to have an IRA lend money. I have a client who does so on a regular basis. Think however of acting like a bank, with due diligence, promissory notes, periodic interest and lending to nonrelated independent third-parties.

The IRS saw easy money:

(1)  There was a taxable distribution in 2013;

(2)  … and a 10% penalty for early distribution;

(3)  … and the “substantial understatement” penalty because the tax numbers changed enough to rise to the level of “substantial.”

How do you think it turned out for our tax protagonist?

Go back to the dates.

She loaned money to her dad in 2005.

Let’s glance over IRC Section 408(e)(2)

 (2)  Loss of exemption of account where employee engages in prohibited transaction.

(A)  In general. If, during any taxable year of the individual for whose benefit any individual retirement account is established, that individual or his beneficiary engages in any transaction prohibited by section 4975 with respect to such account, such account ceases to be an individual retirement account as of the first day of such taxable year.

The loan was a prohibited transaction. She blew up her IRA as of January 1, 2005. This means that she should have reported ALL of her IRA as taxable income in 2005, of which we can be quite sure she did not.

Can the IRS assess taxes for 2005?

Nope. Too many years have gone by. The standard statute of limitations for assessments is three years.

So, the IRS will tag her in 2013, right?

Nope, they cannot. For one thing, the prohibited transaction did not occur in 2013, and the IRS is not allowed to time-travel just because it serves their purpose.

But there is a bigger reason. Read the last part of Sec 408(e)(2) again.

There was no IRA in 2013. There could be no distribution, no 10% penalty, none of that, as “that” would require the existence of an IRA.

And there was no IRA.

The name of the case for the home gamers is Marks v Commissioner.

When The IRS Says Loan Repayments Are Taxable Wages

Here is a common-enough fact pattern:

(1) You have a company.

(2) You loan the company money.

(3) The company has an unprofitable stretch.

(4) Your accountant tells you to reduce or stop your paycheck.

(5) You still have bills to pay. The company pays them for you, reporting them as repayments of your loan.

What could go wrong?

Let’s look at the Singer Installations, Inc v Commissioner case.

Mr. Singer started Singer Installations in 1981. It was primarily involved with servicing, repairing and modifying recreational vehicles, although it also sold cabinets used in the home construction.

After a rough start, the business started to grow. The company was short of working capital, so Mr. Singer borrowed personally and relent the money to the company. All in all, he put in around two-thirds of a million dollars.

PROBLEM: Forget about the formalities of debt: there was no written note, no interest, no repayment schedule, nothing. All that existed was a bookkeeping entry.

The business was growing. Singer had problems, but they were good problems.

Let’s fast-forward to 2008 and the Great Recession. No one was modifying recreational vehicles, and construction was drying up. Business went south. Singer had tapped-out his banks, and he was now borrowing from family.

He lost over $330 grand in 2010 and 2011 alone. The company stopped paying him a salary. The company paid approximately $180,000 in personal expenses, which were reported as loan repayments.

The IRS disagreed. They said the $180 grand was wages. He was drawing money before and after. And – anyway – that note did not walk or quack like a real note, so it could not be a loan repayment. It had to be wages. What else could it be?

Would his failure to observe the niceties of a loan cost him?

Here is the Court:

We recognize that Mr. Singer’s advances have some of the characteristics of equity – the lack of a promissory note, the lack of a definitive maturity date, and the lack of a repayment schedule …”

This is going to end poorly.

 … but we do not believe those factors outweigh the evidence of intent.”

Wait, is he going to pull this out …?

 … because intent of parties to create [a] loan was overwhelming and outweighed other factors.”

He won …!

However, we cannot find that all of the advances were loans.”

Then what would they be?

While we believe that Mr. Singer had a reasonable expectation of repayment for advances made between 2006 and 2008, we do not find that a similarly reasonable expectation of repayment existed for later advances.”

Why not, Sheldon?

 After 2008 the only source of capital was from Mr. Singer’s family and Mr. Singer’s personal credit cards.”

And …?

No reasonable creditor would lend to petitioner.”

Ouch.

The Court decided that advances in 2008 and earlier were bona fide loans. Business fortunes changed drastically, and advances made after 2008 were not loans but instead were capital contributions.

This “no reasonable creditor would lend” can be a difficult standard to work with. I have known multimillionaires who became such because they did not know when to give up. I remember one who became worth over $30 million – on his third try.

Still, the Court is not saying to fold the company. It is just saying that – past a certain point – you have injected capital rather than made a loan. That point is when an independent third party would refuse to lend money, no matter how sweet the deal.

Why would the IRS care?

The real-world difference is that it is more difficult tax-wise to withdraw capital from a business than it is to repay a loan. Repay a loan and you – with the exception of interest – have no tax consequence.

Withdraw capital – assuming state law even allows it – and the weight of the tax Code will grind you to dust trying to make it taxable – as a dividend, as a capital gain, as glitter from the tax fairy.

It was a mixed win for Singer, but at least he did not have to pay taxes on those phantom wages.

Can The IRS Reduce Your Refund for Other Debt?

You file a tax return showing tax due (before withholdings) of $503.

You have withholdings of $1,214.

You therefore have a refund of $711 ($1,214 - $711).

The IRS takes your refund because you owe taxes for another year.

The IRS later audits your return. It turns out that you owe another $1,403.

Question:  Can you get back the $711 that went who-knows-where?

The tax lingo is the “right of offset.”

Here is Code section 6402(a):

(a)       General rule

In the case of any overpayment, the Secretary, within the applicable period of limitations, may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall, subject to … refund any balance to such person.

The pace car in this area was Pacific Gas & Electric Co v U.S.

Pacific Gas & Electric had an overpayment for 1982 of almost $37 million. It filed for a refund, and the IRS included interest for sitting on PG&E’s money well into 1988. However, the IRS miscalculated and overpaid interest by approximately $3.3 million.

The IRS wanted its money back, but what to do?

In 1992 PG&E filed another refund on the same tax year!

So the IRS lopped-off $3.3 million as an “offset” for the earlier interest overpayment.

On to Court they went. There were tax-nerd issues, such as the tax years under dispute having closed under the statute of limitations. That issue did not concern the Court. What did concern the Court was whether the IRS was correct in shorting a tax refund by its previous overpayment of interest.

The IRS can clearly offset for a tax.

But was the interest paid PG&E the equivalent of a tax?

And the Court decided it was not:

·      Interest you (as a taxpayer) owe the IRS is considered a “deemed” tax thanks to Section 6601(e).

Any reference to this title (except subchapter B of chapter 63, relating to deficiency procedures) to any tax imposed by this title shall be deemed also to refer to interest imposed by this section on such tax.”

·      But there is no Code section going the other way - that is, when the IRS pays you interest.

PG&E won its case and kept the interest.

Back to our taxpayer.

He did not have a chance of having the IRS return the $711 it had previously applied to another tax year. What made his case interesting is that his offset year was audited, resulting in an addition to his tax.  It made sense that he would want his withholding to be applied to its proper tax year before the IRS went offsetting everything in sight.

It made sense but it was not the correct answer. The IRS’ authority to offset is quite broad.

BTW, the offset is not just for taxes. It can be for student loans or monies owed to state agencies (think child support).  The offset is not limited to your tax refund either: your federal retirement and social security can also be offset.

When Your Employer Bungles Your Retirement Plan Loan

I admit that I am not a fan of borrowing from an employer retirement plan, except perhaps as a next-to-last step before being evicted.

Things go wrong.

Lose your job, for example, and not only are you looking for work but you also have a tax bill on a loan you cannot pay back.

You do not even have to lose your job.

Ms. Frias participated in her company’s retirement plan. She was getting ready to go on maternity leave when she borrowed $40,000 from her 401(k). Her employer was to withhold from her paycheck (to be paid biweekly), and there was a make-up provision allowing her to correct any shortfall by the end of the following month.

COMMENT: Retirement plan proceeds are normally tax-free if repaid over a period of five years or less.

She went on leave on or around August 1^st.  She was drawing on her accumulated vacation and sick time.  Sounds pretty routine.

She returned to work October 12th.

In November, she learned that her employer had failed to withhold any monies for her 401(k) loan.

She immediately wrote a $1,000 check and increased her withholding to get caught-up.

Nonetheless, at the end of the year the plan administrator (Mutual of America Life) sent her a $40,000 Form 1099R on the loan.

They however sent it to her electronically. Having no reason to expect one, she did not realize that she had even received a 1099. Goes without saying it was not on her tax return.

You know the IRS matched this up and sent her a notice.

What do you think: does she have a tax issue?

No question her employer messed up.

And that she tried to correct it.

However, the law is strict:

Although a loan may satisfy the section 72(p) requirements, “a deemed distribution occurs at the first time that the requirements … of this section are not satisfied, in form or operation.”

Her first payment was due in August, the month following the loan. If she had a deemed distribution, it would have occurred then. A distribution – even a “deemed” one – would be taxable.

There remained hope, though:

The plan administrator may provide the plan participant with an opportunity to cure the failure, and a deemed distribution does not occur unless the participant fails to pay the delinquent payment within the cure period.”

This is a nice safety valve. If the employer gives you a “cure” period, you can still avoid having the fail and its associated tax.

What was her cure period?

The end of the following month: September.

When did she write a check?

November, when she realized that there was a problem.

Too late.

She had one last long shot: a “leave of absence” exception.

Which is Code section 72(p)(2)(C), and it provides for interruption in a loan repayment schedule if one is not drawing a paycheck or not drawing enough to meet the minimum loan payment.

Her argument? She was not receiving her “regular” paycheck. She instead was drawing on her vacation and sick time bank.

Problem: she nonetheless received a check, and the Court was unwilling to part-and-parcel its source. She was collecting enough to make the loan payments.

She was hosed.

She did nothing wrong, but her employer’s negligence cost her somewhere near $15 grand in unnecessary taxes.