Loan Refinancing Deemed a Taxable Distribution

The Tax Court found that the amount by which a taxpayer’s refinancing of a loan from his qualified retirement plan exceeded statutory limits was a deemed distribution subject to the 10% additional tax.

Under section 72(p)(2), a loan from a qualified retirement plan to a participant is not treated as a taxable distribution under three conditions: (1) The principal amount of the loan, when added to the outstanding balance of any other loans from the same plan, does not exceed the lesser of (a) $50,000 or (b) the greater of one-half of the present value of the nonforfeitable accrued benefit of the employee under the plan or $10,000. (2) The loan must be repaid within five years of its inception (unless used to acquire a home that is the participant’s principal residence), and (3) the loan has substantially level amortization, with quarterly or more frequent payments over its term.

Vincent Marquez worked for New York City as an emergency medical technician. He participated in the New York City Employees’ Retirement System, taking several loans from his account. In 2005, he refinanced his loans and signed an authorization document acknowledging that the refinancing would likely result in taxable income. Marquez was offered other options that would not result in income: an additional loan on the original terms or a new loan for a smaller amount.

The amount of the refinancing loan was $12,347. Marquez chose to repay the loan in the maximum number of payments allowed, 130 bimonthly payments. If he had borrowed on the original terms, he would have had to repay the balance in 77 bimonthly payments, the number of payments remaining on the earlier loan. Marquez used $7,717 to repay the earlier loan and received $4,630.

Marquez received a Form 1099-R for 2005 for $10,032, the amount by which the loan exceeded the section 72(p)(2) limit. He did not report the amount as income on his return and was issued a deficiency notice of $2,346 on the unreported loan proceeds and the 10% penalty. He argued that his limit should have been based upon the section 72(p)(2)(A)(i) amount of $50,000. However, the court pointed out, because his nonforfeitable accrued benefit under the plan was less than $50,000, the section 72(p)(2)(A)(ii) amount of one-half that accrued benefit amount applied. Marquez’s use of an example in Treas. Reg. § 1.72(p)-1 in support of his argument was unavailing, since the example presumed an account balance over $100,000, the court said. Therefore, the court found that the $10,032 was a deemed distribution includable in income and that the distribution did not meet any of the exceptions of section 72(t) and thus was subject to the 10% penalty.

  Vincent Marquez v. Commissioner, TC Summary Opinion 2009-80

By Alice A. Upshaw, CPA, MPA, instructor of accounting, and Darlene Pulliam, CPA, Ph.D., McCray Professor of Accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.