Retirement Plan Loans and Exiting Employees

As discussed in our seminars, the Tax Cuts and Jobs Act changed the rules for deemed distributions of loans from employer-sponsored retirement plans when an employee leaves employment.  (See page 57 of the M+O=CPE Individual Tax Year-End Workshop Reference Book Tax Year 2018 for a discussion of these provisions.)

The outstanding loan amount is treated as a deemed distribution, unless the former employee contributes the outstanding loan amount to a different qualified plan, including a traditional IRA.  Such a contribution is treated as a rollover of the deemed distribution to the different qualified plan.  If the employee does not make this rollover contribution of the loan amount to a different qualified plan or IRA, the deemed distribution is taxable, and it is often subject to the 10% early-distribution penalty.

Prior to the 2018 tax year, employees had 60 days from the date of the end of their employment to make the rollover contribution.  However, effective in 2018, the rollover contribution must occur by the due date, including extensions, for the tax return that covers the year in which the deemed distribution occurs.

As a result, if a client has such a deemed distribution, they now have more time to undo the tax effects of it by making a rollover contribution of the loan amount to a different qualified plan.  Such clients may benefit from an extension, which effectively gives them more time to make the rollover contribution.